For many investors staking is becoming an attractive alternative to trading. But how does staking work? What profits are possible and are there risks involved? Before we dive into this we will first have to introduce what consensus mechanisms such as Proof-of-work and Proof-of-stake are.
What is Proof-of-Work and Proof-of-Stake and why are they important?
Record keeping on conventional centralised systems rely on a single source of trust, for example banks will dictate what your final balances are, and if this record is tampered with, clients will be left with incorrect information. Blockchains overcome this weakness by recreating the information, in the form of a digital ledger across multiple computers (nodes). Since it is shared, any new transactions to be recorded need to be accepted by all the nodes on the network. Therefore consensus algorithms are necessary in blockchains to maintain a unified database in a decentralized structure. Proof-Of-Stake (POS) is a relatively new consensus algorithm in many blockchains. It was introduced as an alternative to Proof-Of-Work (better known as 'mining'), the consensus algorithm of cryptocurrencies such as Bitcoin.
Every time a transaction is made it has to be validated before being included in the overall blockchain ledger. With Proof-of-Work (PoW) consensus algorithm, miners race so they can find the solution to a cryptographic function (called a hash) in order to validate the new block of transactions that will be recorded in the ledger. The miner is then recompensed with BTC (just like with gold they are "mining" BTC from the reserve). On the other hand with Proof-of-Stake (POS), blocks of transactions to be validated are designated to validators (amongst a pool of node operators) based on the amount of validation rights they hold. I will explain more about this in the next section.
What is Staking?
As Mining and Miners are for POW, Staking and Validators are for POS. Each coin/token in a POS network holds rights to participate in the validation of transaction blocks.
Cryptocurrency staking is the process of holding coins/tokens (stake) in order to earn rights to participate in the validation of transaction blocks, and in doing so Validators are recompensed with rewards.
Validators, like P2P Validator, are in charge of running nodes to stake. To qualify and sustain a successful node requires a minimum amount of stake and a team that has apt technical capabilities to maintain and operate reliable software 24/7. Usually the greater stake a Validator owns the more blocks of transactions that will be allocated to them. Validators that validate transactions accordingly are rewarded with coins/tokens, and those that do not, are punished either by banning the validator or by having their balances reduced in a process called slashing. Since validators must hold “stake” in the network they validate and their actions have financial consequences, they are incentivized to conduct themselves to high standards, making POS consensus algorithms secure.
Staking for POS blockchains is significantly more environmentally friendly than mining and instead of requiring expensive hardware, it requires investing in the network´s token. More and more networks have been using POS.
Among the most popular cryptocurrencies for stakers are:
Unlike trading coins, staking is more of a long-term project. By participating in staking you are securing and supporting the network, with the additional benefit of compounding your stake!
What is Delegated Proof-of-Stake
Decentralization, scalability, and security are concepts that blockchains attempt to maximize, but increasing one without compromising the other is difficult. With POS, the more node operators exist the lower the concentration of power but the slower the network will be. To solve this trade-off between centralization and scalability, a Delegated Proof of stake system was developed. Any individual can “delegate” their token´s rights to validate to validators who they trust will act accordingly and support their vision through governance voting. This creates a more democratic system while allowing fewer node operators to exist to ensure quick network throughput.
Proof-of-stake and coin staking: advantages and disadvantages
Staking enjoys several advantages that make it a popular tool. Among the most important advantages are:
You can compound your tokens while hodling.
Much more energy efficient than POW.
No high investment in hardware required.
The risk of 51% attacks is reduced with POS, as it would be much more costly and thus less profitable for attackers.
It's relatively simple, all you need to do is purchase coins, place it in a wallet and delegate it to a validator.
Especially during a bear market, many investors swear by staking coins.
Nevertheless, there are also some disadvantages and risks with this model:
The Coins may be blocked for a time period set by it's network's protocol. Thus, they are sometimes not available and cannot be sold. For Ethereum and Terra we offer "liquid staking" which ensures your funds are always available (for more information check out: lido.fi)
If node operators do not behave by experiencing down time or by double signing for example, they will be slashed or punished as pre-determined by the network's protocol. That is why its important to chose a reputable validator!
If you are interested in staking but do not have the infrastructure and experience to run a node successfully, you can still participate in staking by delegating to a validator. It's actually very simple! For more information about P2P Validator please refer to our next article What is P2P Validator?
For more information on staking with P2P Validator, visit https://p2p.org/.
For additional introduction to staking support , visit the getting started support center.
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