What is Staking in Crypto Definition, Rewards, Risks
What is Staking in Crypto Definition, Rewards, Risks : Hey in this Article you’re going to learn about something called staking but first you probably want to read our article on the proof of work consensus model which is the method that bitcoin uses to keep track of how much money everyone has. it’s a bit difficult to understand but once you get it this proof of stake model which is very similar will be much easier to understand so what is proof of stake well here’s a textbook answer first
What is Proof of Stake is a Blockchain ?
It is Blockchain verification method that is much more energy efficient and less risky than the more common proof of work method. only one miner is chosen at a time to validate the blockchain but that miner must lock up some of their coins as collateral to be chosen the miner is punished for creating any fraudulent transactions by losing their collateral and rewarded for good transactions by the creation of new coins and possibly with the transaction fees the senders paid.
So if you understood that you probably don’t need to read this article but if you don’t understand it read this article and you’ll understand it by the end it took me a while to fully understand what proof-of-stake is and i’ll try my best to put it into layman’s terms for you guys. first i’m going to tell you why proof-of-work sucks in fact we have proof-of-stake to fix the things that proof-of-work sucks at so think of it like this in proof-of-work.
let’s say you have runners lining up for a race all eight racers are racing to the finish line but you have some racers that have an advantage given the amount of resources they have kind of like they have stronger legs or they weigh less or they’ve trained longer even though all racers get to the finish line eventually only one person wins and they get the reward which might be a shiny bitcoin. while the other runners still had to run down the track and those who didn’t win essentially wasted their energy for no reward and with proof of stake all the runners would line up at the starting line and then only a single racer would be selected based on a few factors which we’ll talk about here soon.
this way we don’t waste electricity or energy and nobody runs without getting a reward when it comes to coins that use proof of work like bitcoin many large mining companies compete to solve a blocks reward the fastest proof of work also isn’t fair to the DIY miners who don’t have access to very powerful machines or super computers that can win the puzzle solving task the quickest with cryptocurrencies we want there to be lots of miners so that the coin is truly decentralized and so that the blockchain is safe if those large mining companies join together they could actually start making fake transactions because the blockchain is a majority vote.
if they get even 51 you can lost your bitcoins goodbye so this is a big problem and proof of stake attempts to fix this by only selecting one validator which is the word that proof-of-stake cryptocurrencies call miners the validator or the miner then gets to solve the puzzle and earn the reward. while other validators double check them it’s a lot more fair this way one key thing when it comes to proof of stake is that since only one validator is selected. it’s very important that they solve it correctly because otherwise they’ll have to select someone else wait for them to solve it correctly and it just takes a lot of time and in the crypto space time is money. So to solve this problem we make sure that those participators lock up some of their coins and then other validators can actually double check their work and if those validators were wrong we penalized them and take some of the coins that they locked up this process of locking up their coins as collateral is called staking.
What is Staking Reward ?
So in short to participate in a proof of work coin you have to own some of that coin then you lock it up so you can’t use it and you wait so that the network will pick you to mine when you get picked. if you mine correctly you get what’s called a staking reward usually some of the coin and if you mine incorrectly you actually get penalized and lose some of the coin that you initially locked up moving on the way that we select who gets to be the validator is important too because in many cases proof of stake coins will bias those who are staking.
The most coins because they have the most to lose but sometimes we also calculate in how long they have been locking up those coins because they have them and they haven’t lost them they’re probably making lots of good calculations. if we only select them based on the age of their stake though or who has the most stake we would probably also secretly be biasing the big and rich mining facilities again and to solve this we also add in a bit of a random number picker and i’m not going to go much into that in this articlebecause honestly i’m not completely sure about it either but it is a factor in the validator selection process.
So now you might understand there’s a good incentive for validators to correctly verify the blockchain and a good selection process to reduce energy waste and i hope this clears things up a little bit if it did please leave a like & comment below because it helps our website grow it takes a lot of time to research, write and promote article like this and if it doesn’t clear things up leave a comment below and let us know what’s confusing so maybe we can break it down even further in a future article but now that you kind of know how it works.
What are the Ricks involved in Staking?
So there’s a few risks when it comes to staking your cryptocurrency
- There’s something called the locking period when you go to stake your coin it’ll be moved into what is called a locked state and during this time you will not be able to move your coins you can’t send them and you can’t cash them out sometimes you have to lock them up for a certain amount of time like maybe a month minimum all the way up to a year this is a risk
- Technical knowledge in almost every case it’s not as easy as just downloading some software and then pushing a button you usually have to know how to code how to set up your computer to validate and how to accept rewards into a wallet and if there’s an issue you are responsible to fix it.
- Validator commission so if you don’t want to you don’t have to set up the validation process yourself you can give your coins to someone else who has the knowledge and equipment to do it these platforms usually require a validator commission for the use of their computers and this commission could cut into your profit and they could run awaywith your deposit at any time
- The rewards duration so depending on the network that you choose it could take minutes days and sometimes even weeks to see the payout of your staking position this is why it’s crucial to see the network’s reward payout time last we have
- Bad behavior so proof of stake is built on validators and if the validation turns out to be bad you’ll lose some of that stake there’s a very very small chance that you actually have a true a good validation but the network says that you’re wrong nobody really mentions this because the likelihood is very low but it is still a risk.
Lastly i want to go over
the reason that we would stake because you do get staking rewards
Currently i’m gonna go over four of the most popular staking cryptocurrencies
- Tezos which rewards you around six percent of what you stake per year and coinbase does it for you you don’t have to set up any of that process but they take around one and a half percent of it which lowers your yearly return to 4.6
- Cardano is another coin that does staking they will give out around four to five percent
- Algo coin rewards you with around eight to ten percent a year
- Ethereum which is actually switching to ethereum 2.0 could be up to fifteen percent but more reliably probably around four to seven percent but this won’t happen for at least another year.
So proof of stake has quite a few benefits over proof of work but it has downsides too like it can invalidate DIY gpu miners who want to participate without owning a whole bunch of the coin but maybe i’ll go over more of long-term downsides of proof-of-stake in another article.