What Is Staking and How Does It Work?
September 1, 2022
Staking is a unique feature of blockchains and cryptocurrencies, and in particular of Proof-of-Stake protocols. Learn what staking is and how it works, both technically and practically.
What is Staking?
Staking is defined as the process of validators or people locking a certain amount of tokens (stakes) in special software on the blockchain, and receiving rewards for validating transactions or delegating the validation process.
Staking is specific to blockchains that use the Proof-of-Stake consensus mechanism.
As opposed to mining, PoS does not require any special hardware. You just have to deposit and hold a variable amount of tokens, take part in the validation process, and at the end you’ll receive your compensation.
Here are the main advantages of Proof-of-Stake over Proof-of-Work:
- Significantly more energy efficient
- Speed and scalability of transactions
- Decentralisation of the accessibility to the validation process
The staking is incentivised by payment in the form of the blockchain’s native token. Staking benefits the blockchain because it’s part of the Proof-of-Stake mechanism that enables its security, decentralisation and scalability.
Furthermore, staking also has an impact on the tokenomics, as it requires a large percentage of the token supply to be staked for long time periods, therefore affecting its supply and demand on the market. While the option of staking usually stimulates the token’s market demand, the actual staking of a token cushions sale pressure.
How does Staking work?
A key element in the functioning of a blockchain is its consensus mechanism, i.e. the way in which the entire network processes and validates transactions. This task is performed by the validator nodes, which are chosen randomly and in proportion to their stake. The validation process generally consists of three main stages:
- Attestation. The new blockchain block’s validators are randomly selected. Any validator not selected will still have to attest the selection of the other validators and check that everything is in order.
- Cross-linking. Once the validators reach the sufficient consensus, a new block containing the new transactions is generated.
- Finality. This term indicates the moment when the new block can no longer be changed, as it is already cryptographically registered on the blockchain. If any node tried to change the newly generated block, it would lose the entire amount of tokens it had staked.
These three stages are generally found in almost all PoS algorithms, but may differ depending on the specific implementation of the actual Proof-of-Stake algorithm.
Requirements for staking as a Validator
There are technical requirements for staking your cryptocurrencies, which are designed to increase the blockchain’s security, reliability and decentralisation. The first thing to do is to check what these requirements are and whether they are met.
- Minimum amount of tokens. This is generally one of the most stringent requirements. It refers to the minimum amount of tokens you must have to start a node, but this can vary over time according to changes to the specific protocol’s rules.
- Connection. To open a node, you need to be constantly connected to the internet 24 hours a day. The nodes need to be in constant synchronisation in order to communicate with each other and exchange information, and if you lose your connection, the whole time you are offline you cannot be selected for transaction validation and generation of a new block.
If you decide to become a validator and therefore stake directly on the blockchain, you have to take into account the costs of maintaining the node, as well as the minimum amount of tokens you’ll need to lock for the whole duration of the process.
How to start staking?
How does staking work in practice, for an everyday user? First of all, you can do it on any cryptocurrency whose blokchain conforms to the Proof-of-Stake. Depending on which cryptocurrencies you choose to stake, you’ll need to consider the minimum amounts or specific requirements to actually benefit from it.
As with trading, buying and selling, staking can be done through centralised (CeFi) or decentralised (DeFi) platforms. They each have their pros and cons and should be assessed according to your needs and expertise:
- Centralised exchanges are the simplest and most user-friendly tools, and are well suited to beginners. Apart from simplicity, their main advantage is that they offer the possibility of committing cryptocurrencies based on different blockchains and, as intermediaries, they are able to manage or avoid most of the risks involved in staking or similar features. On the other hand, the rewards are somewhat lower than those awarded by decentralised tools.
- Decentralised exchanges’ layout and usability in some cases is similar to CEXs, however they do not include custody, so you need your own wallet to use them. Generally the rewards are higher, but fiat currencies are not supported. Usually, you can only stake the protocol’s own native cryptocurrency. In fact, the other reward systems often offered by DEXs are linked to yield farming strategies, such as liquidity mining, lending and similar, which are often defined, improperly, as “DeFi Staking”’. The risks of staking on DEXs are of a technical nature as there is generally no guarantee against theft, hacks or smart contract bugs.
- Staking Service Providers are intermediaries or aggregators, either centralised or decentralised, that specialise in allowing their users to stake different cryptocurrencies. The most centralised ones handle the more complex and technical part of staking, simplifying procedures for inexperienced users, and provide token custody.
Blockchains are increasingly moving away from classical mining to Proof-of-Stake precisely because the need for scalable and efficient networks is increasing. Therefore, it is likely that we will see more and more cryptocurrencies, both new and already on the market, available for staking. At the same time, the applications and interfaces used for staking are becoming more intuitive and user-friendly, promoting the adoption of DeFi to larger and larger groups of people.