Staking

Concept

Staking is the process whereby network participants can earn rewards (or returns) by locking their cryptoassets and other digital assets in wallets. Decentralized finance (DeFi) applications and protocols require a certain level of liquidity to ensure transactions are carried out in a smooth and efficient manner. As a distinct asset class, cryptoassets are increasingly staked, and nowadays provide an attractive means to earn passive investment income on such assets, whether individually or as part of an investment scheme. Staking utilizes a mechanism known as a proof-of-stake (PoS) consensus, being an alternative consensus mechanism to proof of work (PoW) for blockchains. Unlike coins that operate on a proof-of-stake mode, Bitcoin is a blockchain that operates on a proof-of-work model. Instead of consuming computing power to validate transactions, validators (miners), using proof of stake mechanism (on proof-of-stake blockchains), must provide a proof of ownership of staked coins (or assets). This mechanism substantially reduces the power consumption required for mining (as staked assets are already available), and also improves decentralization, security, and scalability.

Modus operandi

In proof of stake, validators (miners) don’t rival to solve cryptographic puzzles. Instead, the network distributes block production in accordance with the percent stake a participant has proved to have in the network. For example, if a participant has 1% stake in the network, he or she will get approximately 1% of the block reward. Ownership of tokens and similar crypto assets will be used to reflect stake as distributed via rewards. Participants put down a deposit (stake) for a chance to be selected as validator (and hence, miner) of a block. The higher (more valuable) the deposit, the greater the chance a participant will have to validate. Proof of stake model is used on respective blockchains, such as Solana and Polkadot, where holders of the blockchain’s native cryptoasset can stake or pledge their assets to the network. While staking is in process, the staked assets get restricted- that is, they cannot be disposed of or traded freely. Staking allows the asset owner (or its representative) to participate in validating transactions and to earn staking rewards in the form of newly minted tokens. Staked assets are, however, exposed to a certain type of risk (of loss), known as slashing– i.e., the possibility that these assets might be confiscated for not abiding by the blockchain’s requirements and either burned (i.e. removed from circulation) or redistributed to other participants staking on the network.

Example

In order to stabilize the value of transactions, stablecoins can be instrumental in entering the DeFi space, allowing holders of cryptoassets to lock their holdings in liquidity pools, and receive their respective portion of the fees generated in their liquidity pool. If a blockchain network offers a 3% reward for a staking period of 15 days. A user (an investor) may decide to lock up and stake a certain number of tokens in the network (e.g., 100 tokens). After 15 days, the staked tokens will be freed up and the investors receives 3 additional tokens being the staking reward.