What is "Staking"?
Updated: Apr 15, 2021
Image Source - Staking
In a sentence - “Staking is a viable way to earn passive income by locking cryptocurrency in a Proof-of-Stake secured blockchain”.
Currently, the regular Joe who is excited by cryptocurrencies is usually just a HODler. With staking, it’s possible to earn interest as you wait for your cryptos to increase in value.
Before getting into what Staking is, it makes sense to spend some time understanding the problem that it solves.
The big daddy among cryptocurrencies, Bitcoin, is secured by a consensus mechanism called Proof-of-Work (POW). Here miners solve complex math problems for a chance to build the next block of the chain, and as compensation are awarded block fees + transaction fees.
POW is clearly a powerful technology that has proved capable of securing a decentralized network. However, it comes with several problems that have proved intractable:
It uses up too much energy and,
It limits the scalability of the network.
Proof-of-Stake (POS) is thought of as a solution to the problems of POW. It uses less energy and increases scalability.
How is POS different from POW?
In any blockchain, you need someone to verify transactions. That “someone” must be selected through an unbiased/random selection process.
In POW, that “someone” is a “miner” who is selected from among other miners solving hash problems. In POS, that “someone” is a “validator” who is selected from among other validators who stake cryptocurrency.
So what is Staking?
Staking is when a validator locks her cryptos to a POS secured blockchain. The blockchain randomly picks a validator, from among those who have staked their cryptos, to create the next block. The higher the cryptos one stakes, the higher the chances of being picked. Blockchains impose restrictions like the minimum quantity of cryptos to be locked and lock-up periods.
For creating the next block, the selected validator gets rewarded with block fees + transaction fees. Validators are incentivized to build blocks honestly because if they don’t, the blockchain can confiscate their locked cryptos (i.e. slash their stake)
A validators job doesn’t end with staking cryptos. Their real responsibility is to validate transactions and secure the network. This means that they must comply with all technical and financial standards as required by the particular blockchain and run block-validating infrastructure that is secure, stable, and available 24/7.
How can the regular Joe stake his cryptos?
To stake your cryptos and validate blocks, one needs sound infrastructure. There are penalties for those who stake cryptos but don’t provide stable infrastructure. Therefore, it might be best for you and me to delegate our coins through professional “staking pools” even if it costs us a fee.
Which blockchains have a POS consensus mechanism?
Tezos, EOS, Cosmos, Komodo, ICON, are examples of POS consensus mechanisms. The big entrant expected later this year is Ethereum 2.0, when Ethereum moves from POW to POS. It is likely to be launched with at least 524,288 ETH staked (16,384 validators * 32 ETH each). At today’s exchange rate that is almost US$200 million.