Pledging your own digital currency to be eligible to be picked randomly to validate a block on a blockchain and earn the block rewards
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Crypto staking is locking up cryptocurrency that you already own in order to earn rewards in a blockchain that uses a Proof-of-Stake (POS) consensus protocol. The protocol then randomly assigns the right to validate the next block and earn the block rewards associated with adding that block to the blockchain to a user who has locked up the required amount of cryptocurrency.
In simple terms, it’s almost like pledging an asset so that you can be entered into a lucky draw where the winner gets the prize of writing the next ledger entry, or block, to the distributed ledger (called the blockchain), and the fees for doing so.
You don’t lose the asset you pledge, regardless of whether you are chosen or not, and the more coins you pledge, the higher your chances of being selected as the lucky winner. Some systems even offer a small reward for staking your cryptocurrency.
Staking is NOT used for a cryptocurrency that relies on Proof-of-Work (POW) protocols, the most famous being Bitcoin. In POW systems, validators (also called “miners”) race against each other to solve a complicated mathematical puzzle to earn the right to validate the next block. The computational power and energy required are much more than in a POS system.
Crypto staking means to pledge a digital currency that you already own in order to be eligible to be picked randomly to validate a block on a blockchain and earn the block rewards.
Staking occurs only in a Proof-of-Stake-based cryptocurrency and NOT in a Proof-of-Work protocol, where block rewards are granted to successful miners.
Hundreds of cryptocurrencies allow staking, but the largest is Ethereum, which is expected to become fully Proof-of-Stake starting sometime in 2022.
In addition to block rewards for staking, called “minting’, staking offers several other benefits.
Which Cryptos Can Be Staked?
A quick search shows a few hundred cryptocurrencies that run a POS protocol. The largest and most well-known of these are BNB (Binance Coin), Cardano, and Solana. Each one has different requirements as the amount of crypto required to be pledged, as well as the minimum amount of time the crypto, is locked up.
However, the biggest change is expected to come in August 2022, when Ethereum will completely move from its current POW protocol to a new POS protocol. More precisely, Ethereum will merge its old blockchain with a new one called the Beacon Chain. After this upgrade, the old POW blockchain will begin operating more slowly, incentivizing existing miners to become stakers on the new blockchain.
The reason that Ethereum is moving to a POS protocol has to do with two factors: 1) reduced environmental impact and 2) bottlenecks. As Ethereum’s blockchain was designed to allow for smart contracts, the network has experienced vastly increased traffic from new innovations that are built upon the Ethereum blockchain, such as NFTs.
In a POW system, it means bandwidth limitations. And as a result, POS competitors like Solana have emerged as faster, less resource- and energy-intensive, and more secure alternatives.
Why Stake Crypto?
The advantages of staking in crypto are, firstly, the reward that is received from staking your tokens in the form of block rewards and other fees paid by users of the blockchain who want to prioritize their transactions before others. Since the block rewards are not given for solving a puzzle (or “mining”), you sometimes hear the generation of block rewards by a validator in the POS system called “minting.”
The minting rewards that one can receive when staking tokens can be quite large and lucrative; further, different protocols may compete by providing larger staking rewards than their competitors.
In addition, by staking, you are supporting the blockchain project in question by increasing its efficiency and security. It increases the project’s ability to handle transactions and makes it more secure from attacks.
In some systems, stakers are asked to perform tests of proposed blocks when not chosen to validate, which is basically agreeing that the block looks correct. Testers and validators both earn rewards.
Since all stakers have pledged cryptocurrency, it serves as a way of incentivizing good behavior as anyone who attests to malicious or wrong blocks or deliberately collaborates with bad actors loses their stake. You may also lose part of your stake if you fail to carry out your validation duties, say by going offline.
Some projects additionally issue governance tokens to those who stake; a governance token is a token that gives the owner the right to have a say in future decisions and changes to the protocol or project that is being staked in.
Some cryptocurrencies operate a Delegated Proof of Stake (DPoS) protocol, such as Steem and EOS. In a DPoS protocol, users are allowed to commit their coin balances as votes, where voting power is proportional to the number of coins held.
The votes are then used to elect a number of “superdelegates,” who manage the blockchain on behalf of their voters, ensuring consensus and security. Usually, the staking rewards are then distributed to the superdelegates, who then distribute part of the rewards to their electors in proportion to their individual contributions.
Staking in crypto can also come with risks, including a vesting period, which means your investment is locked up for a specific period.
Lastly, we see more and more staking pools being offered by Cryptocurrency Exchanges and Crypto Brokers. They are similar to mining pools in a POW protocol in that users contribute to a shared pool – in a mining pool, it would be processing power, and in a staking pool, it would be cryptocurrency you already may own.
The exchange or broker will stake your cryptocurrencies and act as a validator on your behalf. If the exchange or broker successfully validates a block, they charge a commission (as much as 25%), and the remaining reward is split among all staking pool participants.
Thank you for reading CFI’s guide to Crypto Staking. To keep advancing your career, the additional CFI resources below will be useful:
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