Following a massive rally over the last few years, no one can deny that cryptocurrency is a legitimate contender in the financial markets. The crypto concept is more than just a fad or a pump and dump scheme when viewed as a whole.
While the value of cryptocurrency is obvious, it does not change the fact that it is a complicated system to invest in. Fortunately, one new evolution in the crypto world is making it easier for ordinary investors to tap into the crypto world’s growing wealth.
One new development in the crypto world that has been gaining traction in recent years is staking. This article will explore what staking is and how it works and help you understand crypto rewards and incentive programs.
What is Staking?
Staking is an investment strategy that allows investors to earn rewards for holding onto their cryptocurrency. Users can lock or hold their funds in a cryptocurrency wallet to maintain the operations of a proof-of-stake (PoS)-based blockchain system. Similar to crypto mining, it assists a network in coming to consensus and rewards participants in the process.
The legitimacy to validate transactions is baked into the number of coins “locked” inside a wallet during staking. However, just like mining on a PoW platform, stakers are encouraged to find a new block or add a transaction on a blockchain. The more coins an investor commits, the higher the chances of being selected to validate a block and earn rewards.
Apart from incentives, PoS blockchain platforms are scalable and have high transaction speeds. In addition to incentives, PoS blockchain platforms are configurable and have fast transaction speeds. For these reasons, staking has become a popular investment strategy for crypto investors.
By staking their crypto, investors can earn a share of the profits generated by the crypto project. In other words, staking is a way to earn passive income from your cryptocurrency holdings.
How Staking Works
To understand how staking works, we first need to understand the concept of proof-of-stake.
The proof-of-stake (PoS) consensus mechanism uses validators to verify transactions and maintain consensus in a blockchain network. By running validator nodes and staking their coins, users contribute to securing the network and earning interest on their stakes.
Under this consensus algorithm, instead of miners solving complex cryptographic puzzles to validate transactions and add new blocks, validators are chosen randomly to the number of coins they stake.
The validator then checks the authenticity of the transactions. The validator adds the block to the ledger and gets the block rewards and transaction fees if everything is correct. However, if a validator adds a block with incorrect data, its staked holdings will be penalized.
PoS is known for being more energy-efficient, having lower entry barriers, and being more scalable than PoW. Indeed, the Ethereum PoS model provides improved support for shard chains, one of the most promising scaling solutions.
Back to how staking works.
The process of staking works as follows:
Participants must first pledge their coins to the cryptocurrency protocol. The protocol selects validators from among these participants to confirm blocks of transactions. The more coins you commit, the more likely you will be chosen as a validator.
New cryptocurrency coins are minted upon adding a new block to the blockchain and given as staking rewards to each block’s validator. Most of the time, participants receive the same type of cryptocurrency they stake. Specific blockchains, however, use a different type of cryptocurrency as a reward.
You must first own a cryptocurrency that employs the proof-of-stake model to stake cryptocurrency. Then you can decide how much you want to invest. After that, you must find a staking pool or set up your validator node.
When you stake your coins, they remain in your possession. You’re putting those staked coins to work, and you can always unstake them later if you want to trade them. The unstaking process may take some time; some cryptocurrencies require you to stake coins for a set period.
Staking is not available for all types of cryptocurrency. It is only available for coins that use the proof-of-stake model. The most popular cryptocurrencies that use PoS are Ethereum, NEO, and EOS.
To add blocks to their blockchains, some cryptocurrencies employ the proof-of-work model. The intricacy with proof of work is that it needs significant computing power. As a result, cryptocurrencies that use proof of work consume a lot of energy. In particular, Bitcoin (CRYPTO: BTC) has been rebuked for its environmental impact.
On the other hand, proof of stake doesn’t necessarily require nearly the same time and energy. This also makes it a more expandable option capable of handling larger volumes of transactions.
The key difference between the two models is that proof of stake rewards users based on how many coins they hold, while proof of work rewards users based on how much computing power they contribute.
The main benefit of staking is that it allows users to earn a Passive Income from their cryptocurrency holdings. They can earn rewards in new coins, transaction fees, or interest by staking their coins.
What is Incentive in Staking?
Staking incentive examines the staking participation rate and the most efficient ways to design a proof-of-stake network. Staking rates impact the security and strength of the chain, making it an important metric to monitor over time.
The incentive to stake is twofold. First, stakers earn rewards in the form of new cryptocurrency coins. Second, staking helps secure the network and contributes to its overall health.
Validators earn various types of revenue depending on the stake pool they join and the specific cryptocurrency they are validating. The most common forms of revenue are staking rewards and transaction fees.
Staking rewards is a ratio obtained by dividing the inflation rate by the stake ratio. You can compare inflation to a pie: the newly-minted NOM is the size of that pie. As a staker, you sit at a table where new NOM gets served.
Validators split the pie proportionally with everyone else at their table, so the more people join, the smaller the pie you get. The larger the pie, the greater the rewards for everyone who stakes. The total stake rewards are divided among validators according to their weight in the staking pool. Their rewards are then distributed to delegators in proportion to their stake.
You should note that validators may charge a commission on their delegates before distributing the rewards.
The revenue generated by a validator’s pool gets divided among the validator and their delegators. A validator may charge a commission on the portion of revenue distributed to its delegators. This fee gets calculated as a percentage.
Each validator has the option of determining its initial commission, maximum daily commission change rate, and maximum commission. The parameters that the mainnet enforces each validator sets. These parameters can only be defined when declaring candidacy for the first time, and they can only be constrained further after that.
The Incentive to Run a Validator
Validators make more money than their delegated earn through commission fees. They also get to keep a portion of the rewards that their delegators earn.
- Staking rewards: Validators earn more revenue when more people stake with them.
- Product rewards: Each Onomy Exchange, Onomy Reserve, and Onomy Bridge Hub has its own set of additional rewards for validators in addition to staking rewards.
- Transaction fees– Validators can set minimum gas fees for transactions included in their mempool to prevent spamming. At the end of each block, compute fees get distributed to validators in proportion to their stake.
So, what is the incentive for a user to run a validator? The answer is simple: more money.
Where Can You Stake?
- Polkadot staking– As its consensus algorithm, Polkadot uses nominated proof-of-stake (NPoS). Nominators entrust their stakes to multiple validators they believe to be of good behavior. Regardless of the type of staker, they earn a reward for locking their tokens as collateral. Note that a nominator will incur a loss if they support a malicious validator.
- Ethereum staking– At the moment, there are two types of Ethereum validators: miners and stakers. Miners validate transactions on the execution layer (formerly known as Eth1), while stakers verify blocks on the consensus layer (previously called Eth2). This means that Ethereum stakers will need to move their ETH from the execution layer to the consensus layer before they can stake. Furthermore, you can’t withdraw your ETH until the Ethereum mainnet merges with the Beacon Chain.
- Terra Luna Staking– Users can earn interest on their LUNA coins by staking them on supported wallets like Terra Station. You need to create a wallet, transfer your LUNA, select a validator, and stake your LUNA. There is, however, another way to earn even more money: farming.
When it comes to staking rewards, the number of new coins earned depends on several factors. These include the staking pool’s reward structure, the validator’s stake size, and the network’s overall health.