What is Staking?

Staking is the process of holding or locking cryptocurrencies in a target wallet for a specified period of time in exchange for rewards and crypto passive income. These locked funds help support the security and maintenance of certain blockchains. It is a process comparable to Bitcoin mining, but much less resource-intensive. While Bitcoin relies on Proof of Work (PoW) for its consensus mechanism, other popular coins such as Cardano (ADA), NEO (NEO), and Ontology (ONT) employ the Proof of Stake (POS) mechanism.

Proof of Work V.S. Proof of Stake

How does PoW work?

As a quick refresher, Bitcoin’s Proof of Work system involves having miners solve complicated mathematical puzzles to create blocks of verified transactions that are then added to the blockchain. These cryptographic problems are so hard to solve that miners must use specialized hardware capable of producing substantial computing power. In fact, the process is so costly that malicious actors are deterred from attempting any attacks.

It is simply more cost-effective and rewarding to participate as a legitimate miner. This is because each time a miner successfully solves a puzzle and adds a new block, the system rewards them with a certain amount of Bitcoin. The solution or “proof of their work” is then shared and verified by other miners as they add the same block to their copies of the distributed ledger.

How does PoS work?

The Proof of Stake model is an alternative designed to counter the extreme resources and costs associated with PoW. Rather than relying on excessive levels of arbitrary work in the form of computations and complex calculations to secure the network, this option only requires participants to store and lock away some of their funds.

Let’s take a step back. Both models face the same challenge, transactions must be verified before they can be added to the blockchain. Where Bitcoin has miners to take up this task, a PoS crypto has validators. Miners are unlikely to attempt any malicious actions given the significant resources and costs this would take. Instead, it’s easier for them to profit by receiving legitimate mining rewards. Similarly, validators that do not perform their required services appropriately risk losing some of their staked funds.

Staked coins essentially function as collateral against bad behavior. On the other hand, validators that play by the rules and verify blocks honestly are also compensated. Each time a block needs to be verified, the system will randomly assign the task to one of the validators. How likely a validator is to be selected depends on how much they have staked. The more funds they’ve locked up, the higher the probability that they will be selected. In other words, just as miners with more computing power are more likely to solve a block’s mathematical puzzle, validators with more coins staked are also more likely to be granted the right to verify a block and receive a reward.

Rules and conditions for validators vary across different PoS blockchains. Each project has their own preference in terms of technical requirements, minimum stake amounts, lockup periods, methods of selection, and reward calculation formulas. Nevertheless, they all share the same advantage over PoW systems. Because PoS does not require huge amounts of energy or specialized hardware, the mechanism is much more scalable. In fact, the Ethereum network is currently in the process of migrating from PoW to PoS through its ETH 2.0 upgrade.

proof of work vs proof of stake

What is Delegated Proof of Stake (DPoS)?

Delegated Proof of Stake is a popular variation of the mechanism that turns locked up funds into votes. Rather than having users with staked coins taking on the role of validators themselves, these users instead elect delegates to perform the necessary services on their behalf. The more funds staked, the more voting power one has. Staking rewards are then given to delegates who in turn distribute these to their electors. This model allows a smaller number of validators to represent a large number of participants.

The result is increased efficiency, lower entry thresholds for electors, and lower power consumption or increased sustainability. However, there are some notable disadvantages as well. Because the network must rely on a small group of validators, this means more centralization. Another potential challenge arises with users that have very small stakes who may feel that their vote is too insignificant to count and choose to forego active participation entirely. Nevertheless, many prominent projects such as EOS (EOS), Tezos (XTZ), and Tron (TRX) have adopted the protocol and see a promising future with it.

How to Make Money Staking?

As a potential user or investor, staking is an excellent option to generate a crypto passive income. It is akin to depositing money into a bank account that earns you interest.

Staking Vs. Mining

Unlike mining, it requires very minimal technical knowledge and setup.  The first step involves choosing one of the many Proof of Stake coins available.

Top Proof of Stake Coins

The following is a list of all the Proof of Stake coins available on Phemex.

  • Cardano (ADA)
  • NEO (NEO)
  • Ontology (ONT)
  • EOS (EOS)
  • Tron (TRX)
  • Tezos (XTZ)

Let’s walk through the process with one of these popular options.

Staking Tezos (XTZ)

As mentioned multiple times in this article, staking involves holding a cryptocurrency in a certain wallet to earn rewards. One such wallet is Ledger.

  1. To start the process you must first own a Ledger device and have the Ledger Live application installed on your computer or phone.
  2. Install the Tezos app on your ledger through the Ledger live manager. 
  3. Follow the in-app instructions to add a Tezos account. 
  4. Purchase some XTZ through a popular exchange such as Phemex and transfer to your Ledger. 
  5. Click the “Earn Rewards” button in the account section of your Ledger app and follow the procedures (delegate, choose a validator, and confirm).
  6. You’re done. Tezos’ current annual yield through ledger is about 6% minus fees. Of course, your final earnings will depend on how much you choose to stake. 

What are Staking Pools?

Staking pools are essentially groups in which coin holders combine their resources. They stake as a unit and consequently have a higher chance of being selected as a validator and earning a reward. If a reward is received, it is then distributed to group members proportionally based on how much each participant added to the pool. Because organizing and maintaining a pool requires significant resources, pool providers will charge a fee that is collected from a participant’s share of staking rewards. Offsetting this extra cost is the flexibility that coin holders gain by joining pools. Staking as an individual means adhering to a project’s minimal lockup times and required balances. Both of which are likely to be quite high. Staking pools on the other hand generally do not have any withdrawal time limits and allow participation with much smaller initial balances.

Conclusion

The Proof of Stake mechanism is not only less resource-intensive and more scalable than Proof of Work, it also encourages more participation. By simply locking up funds for a period of time, users can begin to take part in the consensus and governance process of blockchains. In addition, it offers participants an easy method to generate a passive income without the need for sophisticated technical know-how and a large investment in specialized equipment.

Nonetheless, anyone interested in staking must perform their own due diligence to find the best option as this technology relies much more on trust. Of particular importance is the smart contract that a project employs. It must be free of any critical bugs that could lead to the loss of funds.


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