Understanding Staking

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Cryptocurrency apart from its numerous qualities has now evolved as an additional source of income. If we just look a few years back, one can earn from cryptocurrency is either by buying, selling, or mining. The blockchain platform has allowed new ways through which the traders and investors can make a profit by staking their crypto assets. Cryptocurrency staking is a way of generating a passive income to coin holders.

Staking allows the coin holders to lock up their coins so that they can be randomly selected by the underlying protocol to become a validator to create a block at specific intervals. Participants having large stake values have a higher chance to be chosen as the next block validator. These block validators are responsible for checking the validity of transactions.

This process involves holding funds in a cryptocurrency wallet that supports the operations of a blockchain network through a reward-driven process.

Staking means holding a digital currency in a wallet for a fixed time and receiving rewards for the stake.

Staking is gaining quite an attention because unlike mining it neither requires extensive hardware to solve mathematical puzzles nor consumes a high amount of electricity. Apart from giving rewards to the users it also allows them to expand their portfolio and one can easily see a sharp hike in adopting staking features by the big exchanges also.

But it is not the reward system that one should always focus on, the primary focus should be to build a powerful governance system and strengthen network security by encouraging and maintaining good behavior and decision making practice which in turn results in making the staked coin more stable in future.

Advantages

One of the biggest advantages of staking is that even a naive user who doesn’t have many assets can opt for stake whereas incase of mining one needs to have costly hardware and requires high power consumption which makes it beyond the capacity of simple users.

Now let’s see what other advantages staking coin offers

· Coin holders can validate transactions on the network.

· Staking offers rewards that are an additional source of income.

· Staking is an energy-efficient process i.e it doesn’t require huge amounts of electricity.

· No specific hardware requirements, like ASIC.

· Reduces the 51% attack commonly experienced by miners

Working Mechanism

The concept of staking came with Proof of Stake consensus mechanism. Coin holder stakes their asset to gain the power to produce and validate new blocks. PoS block validators are chosen based on the number of coins they have staked. The more number of staked coins, the more chances of being chosen as a validator. The coins are locked in a wallet for some time and upon maturity, more coins are added to the wallet as a reward.

In the year 2012, Sunny King and Scott Nadal first introduced it in a whitepaper introducing the peer-to-peer cryptocurrency, Peercoin (PPC), as a form of reward for the Proof of Stake consensus algorithm. Since then, several other cryptocurrencies have adopted and implemented the Proof of Stake algorithm into their system as a method of transaction validation.

One should observe the coin value or price deeply before staking a coin. It is recommended to invest in coin with low volatility (Inflation rate). High volatile coin experiences a rapid fall in value resulting in no profit overall.

Find the full list here

Disadvantages / Risks

· The value of the staked coins is dependent on market trends and can experience a rise or fall according to market value.

· Staked coins are locked for some time. Users are allowed to sell their holdings after the lock-in period.

· One can lose all the staked coins if the project doesn’t succeed. Users need to understand the projects with prospective risks and flaws before investing. The project should be back up by a strong technical and leadership community.

· Users can suffer loss or may lose their coin completely if the platform that they are using for staking i.e the exchange or the wallet goes out of business.

How are staking rewards calculated?

Users earn rewards as an incentive when they stake their cryptocurrencies for a bonding period. Users can opt for staking and they start receiving the rewards once the bonding period is over. Different blockchain networks use a different method of calculating staking rewards.

The rewards are calculated based on the following criteria:

· Numbers of staked coins

· Duration of staking

· Total number of coins staked on the network

· Inflation rate

· Other factors

Some networks provide staking rewards as a fixed percentage. As of compensation rewards are distributed to validators. The validator then distributes the reward among other users in a proportion of their stake value.

What is a staking pool?

A staking pool allows the users (coin holders) to form a group where they can contribute their assets. Thus merging resources from multiple participants increases stake value thereby increasing their chances of becoming the block validator. If chosen as a validator, the rewards earned from staking are sent to the pool operator who then distributes it among the pool users in a proportion of their stake value.

The process of configuring a staking pool is quite complex and it requires a lot of time, effort, expertise in maintenance, and operation. Staking pools are suitable for the network which are too complex (both technical or financial level) to be understood by users to invest directly. Pool providers charge their service fee from the staking rewards before distributing it to the participants.

If you are a new user then it is advisable to join a staking pool rather than staking alone on your own. Many staking pools offer a low minimum balance with no withdrawal time limit.

Exchanges such as Binance, Crypto.com, and Kraken run staking pool programs where user can deposit their asset that can be used for staking.

Cold Staking

Cold staking is a process through which the users can stake on a wallet without connecting to the Internet by using a hardware wallet or with an air-gapped software wallet.

With Cold staking, one can delegate their staking powers to a cold staking node and the node then stakes on the user’s behalf without spending the coins. Thus it allows the users to hold their coins offline securely. Users stop receiving rewards once they move their coins out of the cold storage.

This method allows users to have complete control of their funds. It is mainly useful for large stakeholders who want to ensure maximum protection of their funds while supporting the network.

Factors that affect Staking Rewards:

Staking offers guaranteed and regular rewards to the participants but certain factors could impact the exact amount of rewards to be distributed. These changes were sometimes imposed by the underlying network or any other external factors.

1. Coins cannot be moved or traded during the locking period.

2. The rewards earned from the wallet is comparatively more than the reward earned from exchanges due to the associated service cost with it.

3. The value of the staked coin is dependent on market fluctuations and are quite volatile.

4. Operational costs, maintenance costs, and validator commission need to be clearly defined.

5. Rewards distribution timeline is not fixed. Some network pays out reward after a fixed time interval but it can also get delayed. Hence it is always recommended to check the reward distribution criteria with the validator.

6. A Slashing penalty has been charged by the staking mechanism of the network whenever the network goes down. This penalty is covered from the tokens staked by the validators or from the users. There are several instances when slashing may occur:

a) Liveness fault (IRISnet, Cosmos): the validator node is penalized if it does not participate in the network consensus for an extended period and misses numerous blocks;

b) Governance fault (IRISnet, Cosmos): The validator node is penalized if it votes various times on the same consensus process, and these votes differ from each other;

c) Security fault (IRISnet, Cosmos, Tezos, and many other protocols): Cosmos and IRISnet refer to it as double signing whilst Tezos refers to this as double-baking or double-endorsing. This happens when the same block is validated twice or more.

7. Staking rewards return rates may change over time.

8. Some network requires a minimum holding requirement to receive the staking reward.

Things users should check before choosing to stake

· Do extensive research in selecting projects. The project should be backed by a strong technical and leadership community and should cater to real user need.

· Read and Understand the term and conditions carefully regarding the following

o Locking period.

o Staking service charges

o Wait period

o Minimum holding.

o Minimum holding period or initial holding period.

o Staking reward yield

o Any promotional rewards.

o Geographical or Jurisdiction restrictions.

· Do not put all your money in a single place. It is always advisable to diversify your asset in different good quality projects through reputed staking service provider i.e exchange or wallet.

· The safety and security of staked coins should be the primary focal point. Shout out for any kind of negligence, scam, or hack.

Conclusion

Nowadays, Staking cryptos is becoming one of the important sources to increase your crypto assets as well as gaining money using Blockchain. But like any other business, it has its own set of demerits. Users are advised to do extensive research and gain complete knowledge about how it works, what staking protocol has been used, associated rewards and the minimum stake value, etc before opting for staking. Complete knowledge about the associated risks would help in taking measures to reduce asset loss.


Understanding Staking was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.