Many people may consider staking an easier alternative to mining—one that is less resource-intensive. It can be defined as holding funds in your cryptocurrency wallet in order to support the operations and security of a blockchain network. In simple terms, staking is holding cryptocurrencies so you can earn rewards.
In many cases, you can stake your coins from your cryptocurrency wallet directly. Alternatively, you can take advantage of the staking services offered by exchanges. With Binance Staking, for instance, you can earn rewards by simply having your crypto-coins on the exchange.
You will need to first understand Proof of Stake (PoS) and how it works if you want to better understand staking. Proof of Stake is a consensus mechanism that lets blockchains operate in a more energy-efficient manner while maintaining some degree of decentralization.
Take a closer look.
What Is PoS (Proof of Stake)?
You might already know about PoW (Proof of Work) if you know about Bitcoin and how it works. It is the process through which transactions are gathered into blocks. These blocks are then connected to make the blockchain. Miners typically compete to find a solution for a difficult mathematical puzzle. The miner that solves it first gets to add the next blockchain block.
PoW is a robust mechanism but it involves too much arbitrary computation. The only purpose of the puzzle that miners solve is to ensure the network is secure. It has no other purpose. Some people could argue that this alone justifies the excess of computation.
But someone else may wonder: is the high computational cost really necessary in maintaining decentralized consensus?
That is where Proof of Stake comes in. Participants can hold their “stake” or coins. The protocol will then randomly assign one participant the right to add the next block. The amount of coins one has determines the probability of being picked. So if one has more coins, their chances are higher.
Unlike with PoW, participants are not chosen depending on their ability to find the solution to a complex challenge. It will depend on the amount of staking coins one is holding.
Some may say that using staking to produce blocks may facilitate a high degree of scalability. The Ethereum network is set to shift to PoS from PoW, this being one of the reasons.
Who Came Up with Proof of Stake?
PoS may have first appeared on Scott Nadal and Sunny King’s Peercoin 2021 paper. It was described as a peer-to-peer crypto design deduced from Bitcoin.
The Peercoin network, initially, began with a PoS/PoW hybrid mechanism. Proof of Work was for minting the initial supply. The network, however, didn’t need it for long-term sustainability. So its importance was gradually reduced. The security of the network actually relied mainly on PoS.
Delegated Proof of Stake: What Is It?
Delegated Proof of Stake (DPoS) is an alternative version developed by Daniel Larimer in 2014. At first, it was a section of BitShares blockchain but the model was adopted by other networks. They include EOS and Steem, also creations of Larimer.
With DPoS, coin balances are committed as votes and the number of coins is proportional to the voting power. Delegates are elected using these votes. They manage the blockchain, ensuring consensus and security on behalf of the voters. The elected delegates receive staking rewards and, in turn, distribute these rewards to the electors based on their contributions.
With this model, a consensus is achieved with less validating nodes and the network performance is improved.
However, it could also reduce the degree of decentralization seeing as the network depends on fewer validating nodes. The validating nodes are in charge of operations of the blockchain. They define major governance parameters.
How Staking Works
PoW blockchains involve mining in order to add more blocks. PoS, on the other hand, uses staking to create blocks.
With staking, validators hold their coins so they can be picked randomly to produce a block. Participants holding more coins are more likely to be chosen as block validators.
This way, blocks are created without depending on special mining hardware like ASICs. Great investment in hardware is necessary for ASIC mining while one has to invest in cryptocurrency for staking. So for the next block, one doesn’t have to compete with computational work. Instead, one stakes coins. Network security is maintained by using stake to incentivize validators.
Every PoS blockchain uses their own staking currency. Others, however, have a two-token system. They pay the rewards in a second token.
Calculating Staking Rewards
The method of calculating may vary from one network to another. Others depend on various factors and are changed on a block-by-block basis. Some of the factors include:
- Inflation rate
- Total coins staked on the network
- The period of time that a validator has been staking actively
- The number of coins a validator is staking
- Other factors
Other networks determine the rewards using a fixed percentage. They then distribute the rewards to validators to compensate for inflation. With inflation, users tend to spend coins instead of staking them. This model, however, allows validators to calculate the staking reward that is in store for them.
Some people may prefer a reward schedule they can predict instead of relying on a probabilistic chance.
A Staking Pool: What Is It?
It is a group formed by coin holders to merge their resources and raise their chances of receiving rewards and validating blocks.
A lot of time and know-how is required to create and maintain a staking pool. Staking pools are typically successful on networks with a high barrier of entry (financial or technical). A fee is usually charged from the staking reward by the pool providers.
Individual stakers may enjoy added flexibility from the pools. The stake is normally locked for a set period. The protocol sets a withdrawal time. There is also a high minimum balance requirement for staking.
Pools don’t have a high minimum balance requirement and they don’t add additional withdrawal times. For new users, a staking pool makes more sense.
This is defined as staking on an offline wallet, that is, one that is not connected to the internet. One can use a hardware wallet or an air-gapped software wallet.
Users can stake while holding their coins securely offline. One should know that moving coins from cold storage will stop the rewards.
Cold staking is more suited for major stakeholders who would like to support the network while ensuring maximum security of their coins.
Staking on Binance
Holding coins on Binance is like having them in a staking pool. You enjoy numerous benefits without fees. You only need to hold your funds on Binance and everything else will be sorted out for you. The rewards are distributed at the beginning of every month.
PoS is ideal for anyone who is looking to be a part of the governance and consensus of blockchains and also earn passive income.
One should know that staking has its risks such as bugs.