What is stake?


You might think staking is a less resource-intensive alternative to mining. Credit is kept in a wallet for cryptocurrencies to support the security and operation of a blockchain network. Simply put, staking means holding back cryptocurrencies in order to receive rewards, and in most cases you can stake your coins directly into your crypto wallet, such as the Schilling wallet. On the other hand, many exchanges offer staking services to their users. 

To better understand what staking is, you first need to understand how Proof of Stake (PoS) works. PoS is a consensus mechanism that allows blockchains to be more energy efficient while maintaining (at least in theory) a reasonable degree of decentralization. Let's dive into what PoS is and how staking works

What is Proof of Stake (PoS)?

If you know how Bitcoin works, you are probably familiar with Proof of Work (PoW). It is the mechanism that makes it possible to collect transactions in blocks. These blocks are then linked together to form the blockchain. More specifically, miners vie to solve a complex math puzzle, and whoever solves it first gets the right to add the next block to the blockchain. Proof of Work has proven to be a very robust mechanism for facilitating consensus in a decentralized manner. The problem is that it involves a lot of arbitrary computation. The puzzle that miners are vying to solve serves no other purpose than to keep the network secure. One could argue that this in itself justifies this excess of computation. At this point you may be wondering: are there other ways to maintain a decentralized consensus without the computational burden? Welcome to Proof of Stake. The main idea is that participants can block coins (their "stake") and at certain intervals the protocol randomly assigns one of them the right to validate the next block. Usually the probability of being selected is proportional to the number of coins - the more coins deposited and blocked, the higher the chances.

So, unlike the proof of work, it does not depend on their ability to solve hash calculations in deciding which participants will create a block. Instead, it depends on how many coins you are staking in the process; some might argue that staking blocks of blocks allows for a higher degree of scalability for blockchains. This is one of the reasons the Ethereum network is said to be migrating from the PoW to the PoS, which is to be done in a series of technical upgrades known as ETH 2.0.

Who developed Proof of Stake?

A first mention of the Proof of Stake concept can be attributed to Sunny King and Scott Nadal in their 2012 post for Peercoin. They describe it as a "peer-to-peer cryptocurrency design derived from Satoshi Nakamoto's Bitcoin." The peercoin network was introduced with a hybrid PoW / PoS mechanism, where PoW was mainly used to mine the first inventory . However, it was not required for the long-term sustainability of the network, and its importance has gradually been reduced. In fact, most of the network's security relied on PoS.

How does staking work?

As we discussed earlier, Proof of Work blockchains rely on mining to add new blocks to the blockchain. In contrast, Proof of Stake Blockchains create and validate new blocks through the process of staking. When staking, validators freeze their coins so they can be randomly selected by the protocol at certain intervals to create a block. Usually, participants who stake larger amounts have a higher chance of being selected as the next block validator. This allows blocks to be made without relying on specialized mining hardware such as ASICs. While ASIC mining requires a significant investment in hardware, staking requires a direct investment in the cryptocurrency itself. So rather than computationally competing for the next block, PoS validators are made based on the number of coins they stake , selected. The "stake" (the stake in coins that is held) is the incentive for the validators to maintain network security. If you don't, your entire stake could be at risk. 

While each Proof of Stake blockchain has its own currency for staking, some networks use a two-token system where the rewards are paid out in a second token.

At a very practical level, staking just means that the money is kept in a suitable wallet. This essentially allows anyone to perform various network functions in return for staking rewards. This may include adding coins to a staking pool, which we will cover shortly.

How are staking rewards calculated?

There is no short answer here. Each blockchain network can use a different way of calculating staking rewards. Some are adjusted block by block, taking into account many different factors. This can include:

  • how many coins the validator staked 
  • how long the validator has been actively staking 
  • how many coins are staked in total in the network the 
  • rate of inflation 
  • other factors 

For some other networks, staking rewards are set as a fixed percentage. These rewards are distributed to the validators as a kind of compensation for inflation. Inflation is encouraging users to spend their coins instead of keeping them, which can increase their use as a cryptocurrency. So, with this model, the validators can calculate exactly what staking rewards they can expect. A predictable reward schedule, rather than a probability-based chance of receiving a block reward, may seem more attractive to some. And since this is public information, it could attract more participants to join the staking.

What is a staking pool?

A staking pool is a group of coin owners who pool their resources to increase their chances of validating blocks and earning rewards. They bundle their influence in staking and divide the rewards proportionally to their contributions in the pool. 

Setting up and maintaining a staking pool often takes a lot of time and expertise. Staking pools tend to be most effective in networks where the barrier to entry (technical or financial) is relatively high. As a result, many pool providers charge a fee from the staking rewards that are distributed to participants.

In addition, pools can provide additional flexibility for individual staking participants. The staking stake typically has to be blocked for a certain period of time and usually has a payout or "unbinding" or exit time specified in the protocol. Additionally, a significant minimum amount of staking is almost certainly required to stop malicious behavior. 

Most staking pools only require a small minimum balance and don't add any additional withdrawal times. Therefore, participating in a staking pool instead of participating in staking on your own could be ideal for newcomers. 

What is cold staking? 

Cold staking refers to the act of staking in a wallet that is not connected to the internet. This can be done with a hardware wallet, but it is also possible with an isolated software wallet (offline).

Networks that support cold staking allow users to stake while securely keeping their funds offline. It is worth noting that if the stakeholder gets their coins from cold storage, they will no longer receive any rewards. 

Cold staking is particularly useful for large stakeholders who want to ensure maximum protection of their assets while supporting the network.