Do you know why governments may never embrace Bitcoin? Someone has opined that governments generally hate the idea of Proof of Work. And who knows, that could be why the Proof of Stake (PoS) idea has taken the crypto world by storm, considering how popular it’s become, especially after the September 2022 Ethereum Merge. This article covers all the aspects of the crypto staking consensus mechanism you need to know about.
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Introduction to Staking
Crypto staking involves locking and holding a certain amount of cryptocurrency tokens to a blockchain network to support its proof-of-stake (PoS) operations. People who stake tokens on a blockchain network help validate transactions and create new blocks on the blockchain. As a result, the validator is entitled to rewards or a yield, usually paid as a percentage of the number of tokens they have staked. Staking is essential as it helps improve the blockchain’s efficiency and security, and in some cases, it allows the validator to participate actively in the blockchain’s network.
Validator nodes are participants in proof-of-stake blockchain networks responsible for validating transactions and creating new blocks. The validators are chosen based on the number of crypto tokens they will hold and stake as collateral within the network. The stake-based selection method is designed to incentivize validators to follow the consensus mechanism rules or risk receiving slashing penalties, which involves losing their crypto in case of malicious behavior such as falsifying blocks. Validators staking more significant amounts of crypto tokens are more likely to be chosen since they have more to lose if they act maliciously.
Staking Process
Users interested in participating in the staking process for blockchain networks are required to commit a certain amount of cryptocurrency to the network. For example, the Ethereum network requires stakes to commit a minimum of 32 ETH to the Ethereum Chain. The network then chooses validators from among the stakers to confirm blocks of transactions. As each block is added to the network, the system creates new coins and distributes them as rewards to the block’s validator. As a rule of thumb, the rewards are paid using the staked cryptocurrency.
Crypto staking may still be a new concept, but there are different ways of staking, including:
Delegated staking: Stakers delegate their staking power to a validator node run by another person, and rewards are shared between validators and delegators.
Pool staking: Coin holders pool resources to increase their chances of becoming validators. They share earned rewards proportionately.
Exchange staking. Some crypto exchanges offer staking services on behalf of users and then distribute the earned rewards to participants.
Liquid staking: Participants receive representative tokens in exchange for staking their tokens. The representative tokens are then traded or used to provide liquidity to crypto stakers.
In case you’re interested in adding cryptocurrency to your portfolio so you can generate yield through staking, the following are the steps to follow to make it happen:
Choose a cryptocurrency: Since not all crypto support staking, take the time to choose a relevant crypto token. Most cryptocurrencies that use the proof-of-stake consensus mechanism support staking.
Acquire the cryptocurrency: Visit any cryptocurrency exchanges to buy the chosen cryptocurrency if you don’t have it in your digital wallet.
Choose a staking platform: Selecting a crypto staking platform is the most crucial step in this entire process. Whether you choose a known validator, an exchange, or a staking pool will determine the type of staking you’ll participate in and the potential rewards.
Stake your cryptocurrency: Once you have the relevant tokens within your digital wallet and have selected a staking platform, follow the protocols outlined by your platform to lock up your tokens at stake. Remember, you’ll have locked your tokens for a determined period to earn rewards.
Earn rewards: Once you’ve staked your tokens, sit back and wait for your cryptocurrency to generate more tokens.
Validator Selection
Validators are the engines that run blockchain networks that operate the proof-of-stake (PoS) consensus mechanism. Their crucial role is participating in the consensus process, where they propose and validate blocks of transactions. Validators need a minimum of 32 ETH to operate a full node, which acts as a security deposit to ensure they do their best in the network’s interest. Any attempt to undermine the network can lead to slash penalties if malicious action is discovered. Some of the functions that validators perform include the following:
Block Proposal: Validators are chosen indiscriminately to propose new blocks to the participating blockchain.
Block Attestation: Validators authenticate the validity of any proposed block besides attesting blocks they believe should be added to the network.
Committee Participation: The blockchain network shuffles validators periodically to committees where they vote on proposed blocks to ensure security and decentralization.
The rewards offered as compensation for their contribution and investment to secure the network as validators are usually a percentage of transaction fees and other network rewards. Apart from the risk of incurring slashing penalties, the role of a validator comes with different challenges, like the need for technical knowledge on running nodes or the risk of being offline.
Blockchain networks follow numerous considerations when choosing validators, which factors could differ from one network to another. However, reputation, the amount of crypto they’re willing to stake, and their past performance are critical. In most cases, validators with a strong reputation and track record are considered more reliable in safeguarding blockchain networks and staked assets.
If you’re going to choose a validator or a staking pool, there are essential factors you must never overlook, which include the following:
Reputation and Security: Your staking earning potential depends upon the staking pool or validator you choose. As such, consider selecting only those with a good reputation and reliability. Take the time to research their history, past performances, and whether they are associated with any adverse security incidents.
Performance and Rewards: Calculate and weigh their past performance to know the potential expected returns of the validator or staking pool. Consider what records indicate on how often they’re up and running and whether they’re efficient, but most importantly, how they distribute earned rewards. It’s essential to try and choose those consistently offering competitive rewards to increase your chances of earning more passive income from staking.
Fees and Costs: Carefully consider the expenses that your preferred staking pool or validator charges. Take note of factors such as delegation fees or whether there are penalties when you withdraw your tokens. Carefully compare these costs to find a reasonable balance and avoid a situation where fees and penalties overeat your rewards.
Rewards and Risks
The critical point in cryptocurrency staking is securing and scaling blockchain networks. Nonetheless, those who participate in the process can benefit by earning staking rewards and passive income and, in other cases, taking part in making network governance decisions. By HODLing tokens, staking also reduces the number of tokens in circulation, potentially increasing the token’s value. However, crypto staking also has a share of its attendant risks.
The following are rewards associated with staking:
Block rewards: Block rewards are financial gains blockchain networks offer as an economic incentive for stakers to lock their tokens within the network. The reward is usually in the form of new tokens by the blockchain.
Transaction fees: In cases where delegators entrust their crypto holdings to validators, they can also earn staking rewards representing a percentage of validators’ transaction fees. These rewards are an annual percentage yield (APY) with different tokens’ respective structures.
The Risks Involved in Staking:
Lockup periods: Participants cannot access their staked crypto for the specific period chosen, which could be days, weeks, months, or years. This could affect your assets’ liquidity since you cannot access or use your funds and can only withdraw them once the lockup period ends.
Market volatility: Market volatility is a significant factor in the crypto space. The value of your staked cryptocurrency could rise or fall during the lockup period and affect your investment’s value one way or the other.
Smart contract risks: Smart contracts used for staking can become subject to bugs or other vulnerabilities and potentially lead to losses in rewards or staked crypto assets.
Slashing Penalties: Validators could incur slashing penalties if they become negligent in their duties or act dishonestly. This could lead to losing some of their staked assets for violating protocols.
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Conclusion
As long as you learn how to invest wisely, staking crypto can be a great way to build your portfolio and an excellent source of earning passive income. Staking may also be the future of cryptocurrency, considering that the proof-of-stake (PoS) consensus mechanism is considered greener then the proof-of-work model.
While staking has potential rewards, it is also inherently risky. As the model becomes more popular due to the increased accessibility of participating networks like Ethereum, anyone interested in participating owes it to themselves to learn as much as possible about cryptocurrencies and the different consensus mechanisms. You can conduct your research or contact a crypto expert for help. They can help when you need proper investment advice before deciding.
Disclaimer: All materials on this site are for informational purposes only. None of the material should be interpreted as investment advice. Please note that despite the nature of much of the material created and hosted on this website, HODL FM is not a financial reference resource and the opinions of authors and other contributors are their own and should not be taken as financial advice. If you require advice of this sort, HODL FM strongly recommends contacting a qualified industry professional.
