Staking might be complicated or simple, depending on how many levels of knowledge you want to master. For a lot of traders and investors, knowing that staking is a method to get compensated for keeping certain cryptocurrencies is the most important takeaway. Even if all you want to do is earn staking bonuses, it’s worth knowing a little about how and why it works the way it does.
What is staking and how does it work?
You can stake some of your cryptocurrency holdings and earn a percentage rate reward over time if it has staking capabilities — current options include Tezos, Cosmos, and now Ethereum (via the new ETH2 upgrade). Typically, this occurs as a result of a “staking pool,” which you may think of as an interest-bearing savings account.
The blockchain puts your crypto to work, which is why it earns rewards while staked. Cryptocurrencies that support staking employ a “consensus mechanism” called Proof of Stake, which is a way for them to guarantee that all transactions are verified and protected without the need of a bank or money transfer processor in the middle. Your digital currency becomes a part of the process if you choose to stake it.
Why do some cryptocurrencies, but not all of them, support staking?
Now we’re getting into the realm of expertise. Bitcoin, for example, does not support staking. You’ll need some prior knowledge to comprehend why.
Cryptocurrencies are generally decentralized, which implies there is no central authority in charge. So, how can all of the computers in a decentralized network agree on something without being told to by a central authority like a bank or a credit-card firm? They employ “consensus technology.”
Bitcoin and Ethereum 1.0 are the most common consensus algorithms, which include Proof of Work. The network uses a Proof of Work mechanism to solve issues like confirming transactions between people on opposite sides of the globe and preventing fraud by requiring users to complete complex computations. Miners all over the world compete to identify the solution to a cryptographic puzzle as quickly as possible. The winner is given the right to post the most recent “block” of verified transactions onto the blockchain, and he or she receives cryptocurrency in compensation.
For a simple blockchain like Bitcoin’s (which works similarly to a bank’s ledger, tracking incoming and outgoing transactions), Proof of Work is an efficient solution. However, for something more sophisticated like Ethereum — which has a wide range of applications that include the whole world of DeFi built on top of the blockchain — Proof of Work might cause bottlenecks when there is too much activity. Transaction times may be longer and costs greater as a result.
What is the Difference Between Proof of Work and Proof of Stake?
The idea of a new consensus mechanism called Proof of Stake has emerged, with the goal of improving speed and efficiency while reducing charges. By not forcing all those miners to solve math problems, which is an energy-intensive operation, Proof of Stake lowers costs significantly. Instead, nodes validate transactions because they are financially invested in the blockchain via staking.
Staking is similar to mining in that it determines who gets to add the most up-to-date batch of transactions to the blockchain and earn cryptocurrency in return.
The specifics differ from project to project, but in essence, users risk their tokens for the opportunity to add a new block to the blockchain in return for a prize. Their staked coins guarantee the accuracy of any future transaction they contribute to the chain.
The network selects validators (as they’re usually called) based on the size of their stake and how long they’ve held it. As a consequence, the most invested people are rewarded. Users can have a certain amount of their stake burned by the network as invalid transactions are discovered in a new block, leading to a slashing event.
What are the benefits of staking?
Staking is often seen as a way for long-term crypto investors to make their assets work for them by producing rewards, rather than collecting dust in their wallets.
Staking has the benefit of helping to secure and operate blockchain projects you support. You make the blockchain more resistant to attacks and improve its transaction processing capacity by staking some of your money. (Some protocols also give “stake tokens” to stakers, which grant stakeholders a voice in future modifications and upgrades.)
What are the dangers of staking?
Staking may require a lockup or “vesting” period, during which your cryptocurrency can’t be transferred for a set length of time. This might be an issue since you won’t be able to exchange staked tokens during this time even if the price changes. It is critical to research the specific staking conditions and constraints for each project you wish to participate in before staking.
How do I get started staking?
Staking is accessible to anybody who wishes to join. That said, becoming a full validator might require a significant investment (for example, ETH2 requires a minimum of 32 ETH), technical expertise, and a dedicated PC that can perform validations 24 hours a day, 7 days a week without downtime. Participating on this level entails some security risks and is a significant duty, as the loss of stake can reduce the validity of a validator.
For the majority of participants, however, there is an easier method to get involved. You may contribute funds you can afford to a staking pool by using an exchange like Coinbase. Staking is a mechanism that allows users to place their tokens in the hands of validators who are verifying transactions and earning fees by putting up collateral. This lowers the barrier to entry for investors, allowing them to start receiving rewards without having to maintain their own validator hardware. Staking is accessible to most Coinbase clients in the United States and many other countries.