The Story of Staking: Perks and Pitfalls

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In the world of Blockchain, Trading and Mining are often considered to be the major sources of income for the crypto-lovers. As the interest around crypto grew, competition for finding blocks has intensified. With the increased demand for electricity and soaring prices of extensive computing power, it became cumbersome for enthusiasts to invest in mining. This barrier gave rise to a new consensus protocol called Proof-of-Staking to ease up things. PoS has been gaining traction in the crypto sphere as an alternative to mining and a source of passive income.

In this post, ChangeHero will give you a brief outline of staking and how it evolved over time.

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The evolution

In simple terms, Staking is the process of delegating your coins or tokens and contribute to achieving consensus in return for rewards or voting power. Though Proof of Work existed way before 2009, it came into limelight with its application in the Bitcoin Blockchain. POW is used to verify the legitimacy of transactions on the blockchain. In order to do this, miners needed serious computing power to solve difficult mathematical puzzles in return for a reward. In this kind of protocol, all the miners compete against each other to find the solution. Bitcoin and Ethereum are few popular platforms which use this Consensus protocol. However, the PoW protocol is often criticized for its outrageous electricity consumption and pricey hardware. Also, energy spent on finding the block would go in vain if the miner is unable to find one.

Source: Tenor

In 2012, Sunny King and Scott Nadal came up with the Proof of Stake and staking as a replacement to the PoW protocol. The major difference of PoS from the former is that there is no competition for the block creation and the algorithm is based on the user’s stake. Instead of miners solving the problem, PoS decides block producer on the number of coins that were held in the wallet. But it falls short in terms of maintaining decentralized governance as the power is vested in the hands of token holders with large amounts of cryptocurrency.

Later in 2014, Daniel Larimer developed the Delegated Proof of Stake (DPoS) mechanism. It was aimed to overcome the limitations of both the PoW and PoS systems and ensure the decentralized nature of the blockchain. DPoS protocol involves a voting system in which the token holders vote for a representative. These delegates are responsible for the confirmations of the transactions and achieving consensus. Rewards are collected by the delegate and then proportionally distributed to the voters. If the selected node is not efficient then it will be expelled and replaced with another one.

Staking

Photo by Keenan Constance on Unsplash

Staking is derived from the concept of PoS and any user holding crypto can stake their funds to create a block or elect the delegates depending on the blockchain. In return, they will be able to receive rewards. Also, staking enables the user to contribute to the governance of the platform and participate in important decision making events. In staking, a user has to lock their funds in a wallet for a fixed period of time. The more coins held and longer the duration, the higher the rewards a user will gain. User will not be able to spend those coins as long as he/she is participating in the staking.

The locked funds will act as collateral and any malicious actors will be losing their funds and kicked out of the chain if an attempt to breach the system takes place. A deterministic algorithm selects the validators usually considering the staking size and how long the coins are being held through a randomization mechanism.

There is another phenomenon called Cold Staking which can be seen where the amount of funds held for staking is huge. In this case, these tokens are held in a hardware wallet and the user receives rewards as long as the funds are not moved from the wallet.

The Pool

The PoS protocol has gained the attention of people as an easy way of making passive income. But in order to maximize the odds of gaining rewards, a user must hold a huge amount of staking power. Staking Pool offers a solution to this by uniting the staking power of a group of people to verify and validate blocks. A pool is managed by an operator and a user willing to join the pool must lock up their funds in a particular hot wallet or cold storage. Though staking pools offer a consistent flow of rewards, they are usually small as the rewards are split among the participants of the pool. In addition, they also levy a fee for the technical setup and maintenance which even reduce the payouts further.

Perks

  • Eliminates the need for purchasing expensive hardware to maximize the chances of finding the block.
  • Reduces power consumption and energy-efficient than mining.
  • Ensures a constant flow of rewards and acts as a reliable source of passive income.
  • Value of the assets doesn’t depreciate with time unlike the computing hardware in the mining.

Pitfalls

Photo by Maria Freyenbacher on Unsplash

In staking, a user has to lock the funds in a wallet and hence it is vulnerable to the volatility. Locked tokens cannot be spent and in a bearish run, it’s price depreciates. Besides, the rewards earned from Staking are small and takes a longer duration for maximum returns.

An Alternative

All in all, staking is a viable alternative to mining and a passive source of income. It is relatively easier to stake as many wallets embed the feature within the application and also bigger players like Binance and Coinbase have staking programs supporting popular cryptocurrencies. Furthermore, DASH’s increased engagement in PoS and Ethereum’s transition into this protocol would significantly impact the ecosystem and bring more people on board. Staking not only yields rewards to the HODLers but also functions as a mechanism to ensure decentralization by vesting the users with voting power to decide on the future of the blockchain.

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The Story of Staking: Perks and Pitfalls was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.