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What is staking.png

What is staking?

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PDAX

June 30, 2022

6 min read

BeginnerCrypto Basics

TL;DR

Proof-of-stake (PoS) is an alternative consensus protocol that is more energy-efficient and faster than the more conventional Proof-of-Work (PoW) mechanism used by Bitcoin. PoS involves network nodes putting up a stake as collateral in order to participate in validating transactions and earning the network rewards, instead of solving cryptographic hashes as it is with PoW. 

What is staking?

Blockchains like Bitcoin and Ethereum run on a Proof-of-Work (PoW) consensus protocol which makes use of “mining” to solve complex mathematical equations to secure and authenticate cryptocurrency transactions. However, PoW blockchains have often been criticized as costly in terms of energy consumption and are relatively slower in terms of transaction speeds due to the amount of network traffic generated by miners.

To address these issues, more recent blockchains now use a Proof-of-Stake (PoS) protocol which is more energy-efficient and faster than mining. Instead of investing in high-performance hardware to outcompete other nodes in mining blocks, node operators only have to lock up a certain amount of coins to the network as a “stake” to signal their interest in contributing computational power to the blockchain and to be rewarded with more coin in return. 

How does staking work?

To understand PoS, we have to be familiar first with how mining in PoW blockchains operates. In simple terms, mining is essentially a competition between all the miners in the network to solve a cryptographically generated mathematical puzzle called a “hash”. Solving a hash grants a miner the privilege of validating the transactions for the next block in the chain which will earn them the corresponding network rewards. 

A mining blockchain is set up in this way to keep miners acting independently from one another and to incentivize them to dedicate more powerful hardware to the network, thereby creating a healthy competition that contributes to network sustainability and growth. 

But the mathematical puzzles that miners race to solve do not really play a part in processing the network transactions themselves but are merely there to keep the network decentralized. This results in a lot of additional energy costs just to maintain the competitive dynamic between miners–and a lot of criticism from environmentalists.

To resolve this, a PoS blockchain replaces the mining mechanism with a staking mechanism wherein those who wish to participate in the network only have to stake or lock away their cryptocurrency onto the network, with the amount of their stake corresponding to the probability of being selected to validate the next block in the chain. Essentially, the system is like a lottery wherein the more stake you put out, the more frequently you’ll be selected to validate blocks and earn more rewards. Thus instead of investing in expensive graphics processing units (GPUs) to outdo other miners, a node in a PoS blockchain only has to “out-stake” other nodes to earn more staking rewards. 

This setup thus maintains the decentralized dynamics of a network but without the additional energy and hardware costs and with significantly less network traffic as it is with mining. 

Meanwhile, the stake also effectively functions as collateral which forces node operators to act honestly and uphold the protocol since acting maliciously will result in their stake being “slashed” equating to a financial loss on their end. 

What are the pros and cons of staking?

It’s worth noting that the rewards in staking are rarely ever as high as mining, and those wishing to make significant profits from staking must first be able to stake a rather hefty amount of cryptocurrency as well. The amount required to stake is naturally kept very high to prevent individuals with lots of financial resources (or “whales”) from claiming too much influence over the network, thereby keeping it decentralized. 

On the upside, staking does not require node operators to invest in high-performance hardware which can take up a lot of room and require a lot of electricity not just to run the machines all day, but to also keep them from overheating. As such, staking is a clearly better alternative to mining because it doesn’t carry the same kind of negative impact on the environment.

One probable disadvantage when it comes to staking is determining the potential value of the rewards you receive since there’s no telling for sure what the value of the coin will be in the future. Cryptocurrency can be a volatile investment vehicle and if the price of the coin that you’re being rewarded with happens to fall significantly, then instead of a yield you may end up with losses despite receiving the rewards.

Furthermore, locking your coins for staking means you won’t be able to readily trade them whenever you want to, which could be an issue during times of market volatility.

Blockchains that make use of staking

There are various cryptocurrencies that run on PoS mechanisms, which market themselves as having faster transaction speeds and lower fees than more well-known PoW blockchains like Bitcoin or Ethereum. On PDAX, some of the notable PoS cryptocurrencies include Cardano (ADA), Solana (SOL), BNB (BNB), Polkadot (DOT), Chainlink (LINK), The Graph (GRT), Polygon (MATIC), and Axie Infinity Shards (AXS). 

Aside from trading crypto, staking can be an alternative way for people to park their spare assets in investments that may potentially yield higher returns in the long term. 

Setting up your own staking node can be quite a technical and elaborate process however, and may also require some minimum hardware specifications (but which are far less demanding that PoW mining). As such, many users opt to just join staking pools instead, where individuals can conveniently delegate their stake to a node operator to earn a portion of the network rewards proportional to their contribution to the pool.

There are many online staking pools to choose from, which may even offer a wide range of conditions depending on the length of period you are willing to lock in your assets, or based on your desired rate of earnings. Generally, the longer the staking period, the higher the rates offered, and joining these pools can be as simple as connecting your wallet and verifying the amount you wish to stake. There are even some exchanges and decentralized finance (DeFi) apps already offer staking pools, so that you can switch conveniently from trading to staking whenever you like.  

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DISCLAIMER: The statements in this article do not constitute financial advice. PDAX does not guarantee the technical and financial integrity of the digital asset and its ecosystem. Any and all trading involving the digital asset is subject to the user’s risk and discretion and must be done after adequate and in-depth research and analysis.

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