What is staking?
It’s surprising how there are so many people in the crypto space that do not stake their cryptos. Some of them choose not to but most of them do not know about staking. So here I am, doing my best to explain what is staking. TLDR at the bottom.
What is staking?
In order to remain decentralized, operating without a central authority, cryptocurrency networks work by incorporating a consensus mechanism, which means all computers on that network can agree on what's going on at any given time without a central bank intermediary.
This means everyone's computer can agree on which transactions have taken place, for example, instead of a bank keeping track of it.
How does staking work?
- When the minimum balance is met, a node deposits that amount of cryptocurrency into the network as a stake (similar to a security deposit).
- The size of a stake is directly proportional to the chances of that node being chosen to forge the next block.
- If the node successfully creates a block, the validator receives a reward, similar to how a miner is rewarded in proof-of-work chains.
- Validators lose part of their stake if they double-sign or attempt to attack the network
Why do only some cryptocurrencies have staking?
This is where it starts to get more technical. Bitcoin, for instance, doesn’t allow staking. To understand why you need a little bit of background.
- Cryptocurrencies are typically decentralized, meaning there is no central authority running the show. So how do all the computers in a decentralized network arrive at the correct answer without having it fed to them by a central authority like a bank or a credit-card company? They use a “consensus mechanism.”
- Many cryptocurrencies — including Bitcoin and Ethereum 1.0 — use a consensus mechanism called Proof of Work. Via Proof of Work, the network throws a huge amount of processing power at solving problems like validating transactions between strangers on opposite sides of the planet and making sure nobody is trying to spend the same money twice. Part of the process involves “miners” all over the world competing to be the first to solve a cryptographic puzzle. The winner earns the right to add the latest “block” of verified transactions onto the blockchain — and receives some crypto in return.
For a relatively simple blockchain like Bitcoin’s (which functions a lot like a bank’s ledger, tracking incoming and outgoing transactions) Proof of Work is a scalable solution. But for something more complex like Ethereum — which has a huge variety of applications including the whole world of DeFi running on top of the blockchain — Proof of Work can cause bottlenecks when there’s too much activity. As a result transaction times can be longer and fees can be higher.
What are the advantages of staking?
Many long-term crypto holders look at staking as a way of making their assets work for them by generating rewards, rather than collecting dust in their crypto wallets.
Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions. (Some projects also award “governance tokens” to staking participants, which give holders a say in future changes and upgrades to that protocol.)
What are some staking risks?
Staking often requires a lockup or “vesting” period, where your crypto can’t be transferred for a certain period of time. This can be a drawback, as you won’t be able to trade staked tokens during this period even if prices shift. Before staking, it is important to research the specific staking requirements and rules for each project you are looking to get involved with.
How do I start staking?
Staking is generally open to anyone who wants to participate. That said, becoming a full validator can require a substantial minimum investment (ETH2, for example, requires a minimum of 32 ETH), technical knowledge, and a dedicated computer that can perform validations day or night without downtime. Participating on this level comes with security considerations and is a serious obligation, as downtime can cause a validator’s stake to become slashed.
But for the vast majority of participants, there’s a simpler way to participate. Via exchanges like Binance, Coinbase, Crypto.com and many more you can contribute an amount you can afford to a staking pool. This lowers the barrier to entry and allows investors to start earning rewards without having to operate their own validator hardware.
Validators lose part of their stake if they double-sign or attempt to attack the network – only if the slashing mechanism is used in your Proof of Stake design.
Staking involves the locking up of assets to participate in the validation of transactions on proof-of-stake blockchains – again, not true for all Proof of Stake protocols. So that line should be changed to "Staking oftentimes involves the locking up of assets … …"
TLDR: Staking involves the locking up of assets to participate in the validation of transactions on proof-of-stake blockchains, with a financial “reward” provided in exchange. This offers a digital asset alternative for yield generation in today's low or negative interest rate environment.
I hope this was helpful