As the crypto world continues to evolve from a proof of work mechanism to the emerging proof of stake model, we are here to help our subscribers understand what this new system is about. Cryptocurrency staking.
Proof of Work
First, let us give a background to this subject by flashing your minds through the more popular Proof of Work (PoW) model- this is the usual way that enables crypto on-chain actions to be assembled into blocks. A linked collection of these blocks is what is known as blockchain.
To ascertain who is next in line to add a new block to a blockchain, miners have to compete with one another to give solutions to complex math puzzles. The point of all these technical jargons is that the PoW is essentially used to enable consensus in a distributed system that is blockchain.
It is Important that you understand the concept of consensus before you continue with this piece as it is one of the underpinning attributes of money. It ensures that a unit of money- in this case cryptocurrency is not spent twice- It nullifies double-spending.
Now the problem with PoW is that it involves a junk load of excess and arbitrary computation. To circumvent the burden of excess computation, high computational cost, and the extremely cumbersome burden of costly mining hardware, the creative humans of this world resorted to the Proof of Stake (PoS) mechanism to enable consensus on a blockchain.
Proof of Stake
The PoS mechanism enables participants to stash their tokens (stake) from time to time on a blockchain and the underpinning protocol randomly gives one of the participants the exclusive right to validate the next block on the chain. The more tokens stashed on the chain, the higher the chance of being chosen as the next validator on the chain.
What is Cryptocurrency staking?
The perk that comes with cryptocurrency staking is that it is less cost intensive when compared to mining cryptocurrencies via the PoW mechanism. As you can already imagine from the background above, it is all about locking funds in a cryptocurrency wallet to facilitate the running and security of a blockchain. What participants or validators do is that they lock their tokens to earn returns on their cryptocurrency investment on the blockchain. Participants get to stake via their trust wallet. Some crypto trade platforms also offer staking products to their users.
In contrast with PoW, on PoS one will see that solving complex math puzzles or hash problems is not what determines who gets to create the next block on the blockchain but how much tokens participants lock in their wallets. The crypto staking mechanism also offers easier scalability for blockchain networks.
Who invented PoS?
It is not unascertainable who the creation of PoS can be attributed to but the earliest use of the innovation is easily linked to Scott Nadal et Sunny King via their Peercoin 2012 writ. In this paper, they qualified PoS as a: “peer-to-peer cryptocurrency design derived from Satoshi Nakamoto’s Bitcoin.”
How does staking work?
As already explained above, Proof of Stake blockchains produce and validate new blocks via cryptocurrency staking. What participants or validators do is that they lock their tokens to earn returns on their cryptocurrency investment on the blockchain. The blockchain protocol randomly selects the next validator that will establish the next block at calculated periods. You can already imagine the odds are more likely to be in favour of participants who lock larger volumes of tokens or cryptocurrency.
With this method, the huge cost of mining, under the PoW model, with capital intensive hardware like ASIC is eliminated. All participants have to do is stake or invest in the protocol’s token or crypto. Having one’s skin in the game- staking one’s hard-earned money on a protocol incites validators to ensure that the Blockchain is secure. No investor who has his skin in the game wants his hard-earned monies to go down the drain.
Validators who desire to earn more rewards may leverage their collective staking power by creating a staking pool via which their crypto holdings are pooled or merged. The rationale behind this is to take advantage of the perks that come with holding large volumes of tokens on a chain. It easily gives them the upper edge when it comes to what participant is randomly chosen to validate the next block. Returns on tokens staked are shared among the participants of the pool either proportionally or according to the participant’s agreement.
Participants of blockchains or protocols that leverage PoS may also cold stake. This is basically stashing monies on protocols that have offline wallets, e.g. a hardware wallet, or a software digital wallet that is deemed air-gapped, and does not use the internet. Protocols that facilitate cold staking enable users stash their money while still taking charge of their funds offline and in a safeguarded manner. Mind you, if perhaps, you decide to dabble in cold staking, take note that once you withdraw your tokens from the cold storage, you will no longer be entitled to receiving returns from it.
Kindly note that this piece is only for informational purposes only and should not be construed as an investment advice. Should you desire to stake your funds, please conduct your due diligence investigation.
Let us know your thoughts, we will be glad to engage with you via the comment section below.