Staking, about cryptocurrency and blockchain technology, refers to; depositing cryptocurrency into a coinwallet of one’s choice for them to receive a reward after a certain amount of time predetermined by the coin’s network. Primarily, it is supporting a blockchain network by having “locked up” funds.
A staking ecosystem, therefore, is; a set of interconnected nodes that rely on blockchain technology to validate transactions in a cryptocurrency network. The nodes operate and manage the functions and processes of the blockchain network. It is mostly applied in systems that employ the Proof of Stake (PoS) consensus mechanism in which parties involved are selected and assigned a block to be validated while having “staked” their tokens in the process. As such, the higher the stake a single party has in a network, the higher the chances of it being selected to be part of the validation team.
Proof of stake was first proposed in 2011 at a bitcoin talk to buy bitcoin as an improvement on the initially released Proof of work (PoW) which aimed to solve the following problems:
PoW encourages miners to form mining pools, centralizing the network contrary to the goals of a blockchain to decentralize operations.
Security concerns have been arising in the PoW consensus due to hacking, but PoS is considered to be more secure.
How Staking Works
Validators, which are parties in the blockchain network, deposit a certain amount of coins in the system via a coinwallet and these coins are locked up for a while. The algorithm then selects a validator at random out of a pool of validators. The validator is then assigned a code block containing several transactions to be validated. These transactions, once verified and found to be correct, are accepted by the system, and the neighborhood is added onto a chain of previously approved blocks, and the blockchain grows. A reward is released to the validator which is a small percentage of the transaction which has been processed. How much one node contributes to the validation process determines how much reward it gets.
What if validation is done incorrectly? If a fraudulent transaction bypasses the validator and returns to the blockchain after validation unnoticed, the validator may be deducted a certain amount of staked coins. Remember, coins cannot be retrieved until the validation process is complete and has been proven to be true.
If a node decides to stop being a validator, all coins which are staked will be released back to it, and so will the rewards but not immediately. The network needs time to check if the last validation done by the node was real or not. The awards given out by the system effectively leads to an explosion of master nodes.
In recent times, many networks and coinwallets such as coinbase, which offers fixed dividends, are adopting staking as their method of node selection, and this is due to several reasons as follows:
- Greater reward comes to parties with higher stakes, and this is a way to make people deposit more coins in a coinwallet.
- The owner of the coins staked has the power to opt-in or out of the validation process as they may please.
- Staking systems are low risk as the return is almost always assured for the parties involved and, as such, is a good source of passive income for the coin owners.
- Staked coins appreciate with time, likened to a fixed deposit in a bank, as their price is only affected by market fluctuations.
- The staking ecosystem requires less hardware and computing power (a regular laptop computer will do) on the side of the coin owner. It is an efficient and eco-friendly means of maintaining cryptocurrency.
- Setting up a node for a PoS is relatively less expensive, and this encourages more people to join the network and makes it more decentralized and secure.
- In PoS, there are no mining pools; hence, the coin owner has no additional fees paid to a mining pool.
- PoS has a lower depreciation rate since mining rates are constant since hardware and software depreciation does not affect as PoS makes use of coins.
- Depending on the coin, stakeholders potentially have the power to vote towards the development of the network since unlike PoW, and PoS is not open source project
- Illegal activities are done on the system to attract a punishment of being kicked out of the network permanently.
Staking, at the same time, has several risks as follows:
- The 51% ownership problem. If a single node or group of nodes can acquire a majority stake of a network, it can effectively control the system and validate fraudulent networks.
- Selection of nodes cannot be completely random since some factors such as the size of the stake, age of coin as the “rich and old” will be favored and create a capitalist environment there.
- Current offerings of staking services for coins require a stakeholder to deposit a considerable amount of currency, worth more than $10,000 to get significant returns, and this limits the number of people who have such amounts of money to invest.
- A stakeholder cannot access their staked coins as they please even though they are making money regularly.
- Depreciation of coins is still a problem encountered by the coin owners.
- The Return on Investment is relatively slow as compared to traditional methods of investment.
- There’s the risk of a cryptocurrency network dissolving and going off with stakeholders' money.
How Staking Applies In The Real World
Euthereum is working on migrating its network to a Proof of Stake operation and has launched it as Casper and is under testing in its testnet but is still in its development stages
Other coins that are implementing PoS are Tezos, in coinbase, pure coin, lisk, and nxt coins. Blockchain technology is already being used for financial transactions, but staking is expected to revolutionize them in the future.
Staking Ecosystems are taking the crypto world by storm and are being adopted in applications just as fast. It is a promising development in blockchain technology but still needs some adjustments before it is mass adopted in the real world.