What is Staking?

Introduction

Think about earning an interest on the amount you save; get the picture? In a nutshell, that's what Staking is the common crypto user. However, that description doesn't quite do justice to the topic. In this short article, we address what Staking is; how it works; some advantages & risks of staking crypto; and conclude with an outline on how to go about staking your coins.

Staking is the process whereby participants of a blockchain network that utilizes Proof-of-Stake (PoS) consensus mechanism can lock up their coins on the network in other to secure it and validate transactions; and in return, receive staking rewards. Staking and Proof-of-Stake (PoS) in particular was first implemented by Peercoin (PPC) in 2012 as an alternative to Proof-of-Work (PoW) consensus mechanism utilized by Bitcoin protocol. Since 2012 to date, the general landscape surrounding Staking has evolved with more blockchain networks sprung up to support the feature, some of which include Cosmos, Cardano, Tron and Ethereum (which transitioned from PoW to PoS in September, 2022 with it's "The Merge" Upgrade).

How does Staking work?

Staking is primarily associated with Proof-of-Stake blockchains. Participants must lock an amount of coins on the network as collateral to qualify as Validators on the network for block creation. The likelihood of being chosen as a Validator is determined by the quantity of coins staked; essentially meaning the more amount of coins held by a validator the higher their chances are to be selected for block creation. Once a validator is chosen by the network, they validate transactions to be included in a block, ensuring no malicious transactions are included; and in return they earn rewards in the form of newly minted coins and from transaction fees. Validators have an incentive to act with integrity and in favor of the network since any dishonest behavior could lead to them losing a sizable potion of their coins — a process termed Slashing.

Because the Proof-of-Stake mechanism has been argued to favour individual participants of the network who have a large amount of coins, participants with smaller coin balances may never get the opportunity to create a block and earn rewards. However, this has been addressed with a variant/adaptation of Proof-of-Stake (PoS) called Leased Proof-of-Stake (LPoS), whereby small coin balance participants can stake to a node which gains access to all the funds staked to it for the purposes of determining it's odds of creating a block. The individual then takes proportionate share of the fees generated if their lease node creates a block; and conversely help in securing the network overall. Other variants of Proof-of-Stake includes Delegated Proof-of-Stake (dPoS) and Proof-of-Importance etc.

How Staking works

Is Staking different from Mining?

YES. Staking and Mining are terms associated with Proof-of-Stake (PoS) and Proof-of-Work (PoW) blockchains respectively, and are used to describe how different blockchain networks operate with respect to network security & transaction validation. Both are essentially different. Mining involves the use of dedicated computers to solve complex mathematical puzzles in other to validate transactions and generate new blocks, necessitating substantial computational power and high energy utilization. On the other hand, Staking hinges on validators "staking/locking" their assets on the network to engage in the validation process and doesn't involve significant investment in hardware and infrastructure. Unlike Mining, Staking does not demand energy resources, rendering it a more eco-friendly and energy-efficient alternative.

Advantages of Staking Crypto

Staking crypto does come with it's advantages. Some of which include:

Earning Passive Income

Because of the prospect of earning rewards, one major advantage a network participant gains by staking their crypto is the income they can earn with relatively low risk. This presents an opportunity to make money without engaging in trading or investing in the cryptocurrency market.

Enhanced Network Security

Staking plays a role in upholding the security and reliability of PoS blockchains. By staking crypto, you have a hand in this process, which pitches you as a valuable member of the network irrespective of how many coins you have. Validators on the network are motivated to act and safeguard the network as any deceitful actions could lead to them losing their coins.

Reduced Energy Consumption

In contrast to Mining, which demands power and consumes a significant amount of energy, Staking proves to be more energy efficient. PoS systems consume far lower energy, and do not involve investing huge amount of money to purchase and maintain computer equipments, making them more environmentally sustainable.

Some Risks Associated with Staking Crypto

Despite its benefits, it is essential to acknowledge the risks that come with staking cryptocurrencies:

Risk of loss

Although highly unlikely for a network which has more participants staking, if perhaps the network gets compromised or a staking pool is poorly managed, an individual who staked their coins can possibly lose them all. This risk is mitigated by having more amounts of coins staked on the network overall, as an attacker would then have to conversely own more than half of the total coins staked on the network.

Slashing

Slashing is a penalty associated with PoS blockchains, and is applicable to Validators who breach network rules or engage in dishonesty activities like validating and adding malicious transactions into a new block. If a Validator node do not operate honestly, they risk having a sizable portion of their staked coins — both the Validator's own coins and those delegated to it by small network participants — "slashed" by the network.

Volatility, Lock-up & Unbonding periods

Cryptocurrency market prices can experience levels of unpredictability within minutes. When staking, different PoS blockchains have specific rules. Most common staking rules are the Lock-up and Unbonding periods, which are periods where you cannot withdraw your staked coins or a period where you have to wait after withdrawing for your coins to be available for spending respectively. If the market value of the coins you staked drops considerably during these periods, participants may encounter a loss in the worth of their assets — a risk worth considering.

Inflation

Although Staking does open a window to earn passive income, the rewards generated by the network concomitantly increases the total supply of coins circulating on the network, which can lead to loss of value of the coins over time.

How to Stake Crypto: A Simple Guide

Staking crypto is a straightforward process, as most crypto wallets have made the steps as easy as clicks of a button. Below is a typical sequence you would follow to accurately stake crypto:

• Set up a crypto wallet that allows staking for your chosen cryptocurrency
• Ensure your coins are in your wallet
• Navigate to an section within your wallet labelled "Stake", "Earn" or something similar
• Choose a staking platform or Validator
• Follow the prompts to lock your coins on the network and begin staking
• Keep an eye on your staking rewards and claim them periodically.

Some popular cryptocurrencies you can stake are Ethereum, Cosmos, Cardano, Tron, Tezos etc.

Key Takeaways

• Staking is the process whereby participants of a blockchain network that utilizes Proof-of-Stake (PoS) consensus mechanism can lock up their coins on the network in other to secure it and validate transactions; and in return, receive staking rewards
• Staking and Proof-of-Stake (PoS) in particular was first implemented by Peercoin (PPC) in 2012 as an alternative to Proof-of-Work (PoW) consensus mechanism utilized by Bitcoin protocol
• Although Staking crypto allows you to earn passive income, it is pertinent to factor in the associated risk like Slashing, Lock-up & Unbonding periods, Inflation etc when deciding to stake

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