Staking has similarities to a range of other things in crypto. It could be remarkably simple or remarkably difficult – it all depends on the degree of understanding that one intends to acquire.
Numerous investors and traders try and learn more about staking because staking is a method that earns one special rewards if one holds certain cryptocurrencies. In this article, we will see why and how staking works the way it does.
How does staking work?
There are several cases wherein a cryptocurrency facilitates staking. A few of the available choices for the same available at one’s disposal are Cosmos and Tezom. Furthermore, nowadays Etherium also facilitates staking through its new ETH2 upgrade.
If an investor stakes a few of his holdings, then over time, he will earn a percentage-rate reward. In most cases, this is facilitated by using a shaking pool. A shaking pool has similarities with a savings account that bears interest.
Crypto earns rewards while it is staked because blockchain sets it in motion. When a cryptocurrency allows staking, it puts a consensus mechanism to avail, which is also known as Proof of Stake. Proof of Stake is but a way to ensure that all transactions taking place are secured and verified. This goes to show that there is no payment processor or bank in the middle. When you choose to stake your crypto, it will become a part of the process.
Why don’t all cryptocurrencies facilitate staking?
This is right where the technical part begins. The most important instance to consider here is Bitcoin, which does not allow staking. Let us dwell on some background to understand why Bitcoin does not facilitate staking.
- Characteristically, a cryptocurrency is going to be decentralized. This implies that the show is not being run by a central authority. So, how is it that each of the computers that make a part of the decentralized network get to the correct answer, even while it has not been fed to them by a credit card company, a bank, or any other central authority? A consensus mechanism is used here.
- In the case of several cryptocurrencies, INCLUDING Etherium 1.0 and Bitcoin, a consensus mechanism called Proof of Work is put to avail. Through the Proof of Work, the network invests a significant amount of processing power towards resolving problems such as validating the transactions that take place among strangers, who may be located on opposite sides of the globe. This way, it becomes possible to ensure that no one spends the same money twice. One of the sections of the process is that miners from across the world attempt to be the first to solve a cryptographic puzzle. The reward for the winner is that he gets an opportunity to add the latest “block” of verified transactions onto the blockchain. In return, the winner receives some crypto.
Bitcoin is a relatively simpler blockchain, on the account of features such as tracking outgoing and incoming transactions. Functioning of Bitcoin has similarities to that of a bank’s ledger.
Proof of Work is a scalable solution. Nevertheless, when we consider something more complex, such as Etherium, then, we see that Etherium has a vast variety of applications, including Defi’s entire world that runs on top of the blockchain. When too much activity takes place, then Proof of Work is likely to cause bottlenecks. So, while the transactions become longer, the fees could also be larger.
What is Proof of Stake?
Proof of Stake is a new consensus method that has now emerged. Herein, the underlying idea is to boost efficiency and speed, even as the fees are lowered. One of the most important ways in which Proof of Stake reduces costs is by not requiring the miners to churn through math problems. This is an energy-intensive process. Instead, it is the people who are literally invested in blockchain by staking that validate the transactions.
- Staking meets the same purpose that mining does. In staking, a network participant gets selected to add the latest batch of transactions to the blockchain. He earns some crypto in exchange.
- The precise implementations of staking vary by the project. But, in essence, users put their tokens on the line. This yields an opportunity for them to add a new block to a blockchain, and this way, they can earn a reward. Their staked tokens will guarantee the legitimacy of any new transaction they add to the blockchain.
- It is the network that will choose the validators. This will depend on the size of their stake and the amount of time for which they have held it. The participants who are most invested are rewarded. If it so happens that the transactions in the new block are invalid, then in some likelihood, users can have a certain amount of their stake burned by the network. This is known as a slashing event.
What advantages does staking bring with it?
Numerous long-term investors perceive staking as a method that makes their assets work for them even better than they earlier used to do. Their assets generate rewards for them. This is better than their assets collecting dust in crypto wallets.
Another important advantage of staking is that it contributes to the efficiency and security of cryptocurrency projects supported by you. When blockchains stake a few of your funds, it empowers them to develop additional resistance to attacks. The ability to process transactions hence enhances.
Some projects award governance tokens as well. This is to stake participants, and the holders hence have a say in an upgrade to a protocol and any future changes.
Does staking come with some risks as well?
In most cases, stalking would call for vesting or a lockup period. Herein, your crypto ceases to be transferred for a certain phase in time. This is going to be a drawback. Trading staked tokens during this period are not going to be possible even in the event the prices fall.
So before going ahead with staking, it becomes important to research the rules for each project that you are going to be associated with, alongside the specific staking requirements as well.
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