Staking is the process of storing cryptocurrency in a cryptocurrency wallet to support all operations on the blockchain. Essentially, it consists of locking a certain amount of cryptocurrency to receive rewards. In most cases, this process depends on users participating in executing transactions on the blockchain using their personal cryptocurrency wallet. The concept of staking is closely related to the proof of stake mechanism (PoS). This method of validating transactions is used in many blockchains based on PoS or one of its numerous variants. #PoS
Who created Proof of Stake?
Sunny King and Scott Nadal were likely the first to introduce Proof of Stake and staking back in 2012. They described Peercoin as an innovative cryptocurrency based on PoS. Initially, it was based on a hybrid PoW/PoS algorithm, but gradually the project moved away from Proof of Work (PoW). This allowed users to develop and maintain at early stages without fully relying on PoS. In 2014, Daniel Larimer developed the so-called delegated proof of stake mechanism (DPoS). It was first tested on part of the Bitshares network, and subsequently, other cryptocurrencies adopted this model. Notably, Larimer was involved in the creation of Steem and EOS, which also adopt the DPoS model.
DPoS allows users to lock their balance in the form of votes, which are used to elect a certain number of delegates. The elected participants then manage blockchain operations on their behalf, ensuring security and achieving consensus. Stakeholders can still provide their coins as a stake, periodically receiving rewards from holding funds.
The DPoS model aims to reduce latency during transaction confirmations and increase network throughput (the number of transactions per second). At its core, the algorithm allows consensus to be achieved with fewer validating nodes. On the other hand, this generally leads to a lower degree of decentralization, as users rely on a selected group of nodes.
How does it work?
As mentioned earlier, staking is the process of holding cryptocurrency coins to earn rewards by ensuring the functionality of the blockchain. For this reason, staking is widely prevalent among networks that use Proof of Stake (PoS) or one of its variants. Unlike blockchains based on Proof of Work (#POW ), which rely entirely on mining to verify and validate new blocks, PoS chains do this through staking. This allows the system to develop and confirm new blocks without using specialized hardware (ASIC). Thus, instead of competing to mine the next block through heavy computational work, validators on PoS are selected based on the number of coins they hold in the system.
Generally, the more coins you have in your stake, the higher the probability that you will be chosen as the next validator. While mining requires significant financial investments in hardware, for staking, you will need to acquire the necessary amount of cryptocurrency and hold it. Each blockchain operating on the PoS algorithm has its own currency for staking. Block formation through staking allows for increased scalability. This is one of the reasons why Ethereum will eventually transition from PoW to PoS after an upgrade called 'Ethereum Casper'. Some chains use a delegated proof of staking model (DPoS). This allows users to signal their support through other network participants. In other words, a delegate acts on behalf of users during decision-making. Delegated validators (nodes) are individuals responsible for processing transactions and managing the blockchain network. They participate in the consensus-building process and determining key governance parameters.
Network Inflation
For some networks, the reward for staking is determined as a fixed percentage of inflation. This encourages people to realize their coins (rather than just HODL - hold). This process amortizes the operational costs of the network for all token holders. For example, Stellar distributes inflation weekly among users who provide their coins in a staking pool. One of the advantages of this approach is that the network can pay a fixed or controlled interest rate.
As a result, a user who holds 10,000 XLM for one year determines the target inflation in the chain, thus, by signing the transaction, they should expect a reward of 100 XLM. This will happen over the year at a balanced inflation rate of 1% (not taking into account the cumulative consequences). Furthermore, all information is accessible to all users of the network who decide to participate and hold a stake. This approach may incentivize new participants, as it provides a predictable schedule for reward distribution, rather than the probability of receiving a block reward.
Staking pool
A staking pool is formed when several holders combine their resources to increase their chances of being selected as a validator and receiving rewards for verifying a block. Users combine their stakes of coins and share the block reward proportionally to their individual contributions.
Pools are most effective for networks with a relatively high entry barrier, whether technical or financial. Most often, pools require complex setup, development, and maintenance. In connection with this, many pool providers charge a percentage of the staking rewards, which is distributed among participants.
In addition, pools can provide additional flexibility regarding the minimum balance, withdrawal time, and order of obligation cancellation. Thus, this attracts new users and contributes to the decentralization of the network. #staiking
Cold staking
Cold staking is the process of staking on a cryptocurrency wallet that is not connected to the internet, that is, using a hardware wallet. Networks that support cold staking allow participants to hold the necessary stake of coins and participate in block validation while securely storing their funds. However, if a stakeholder withdraws their coins from the cold wallet, they stop receiving rewards. This method meets the needs of large holders as it provides maximum protection for funds while supporting the network.
Conclusion
With the emergence of more opportunities for user participation in the consensus-building and blockchain management process, the growth of staking can influence the lowering of the entry barrier into the cryptocurrency ecosystem. Exchanges strive to support blockchains based on Proof of Stake; for this reason, they provide users with the opportunity to participate in validation by acquiring the necessary stake of coins and subsequently receiving rewards directly on the exchange.
