In the real financial world, the government, through its central bank, owns and regulates the creation, minting, and issuance of fiat currency. This means that the government, and even private entities, need infrastructure. They needs this to create and control the creation and minting of these fiat currencies.
The cryptocurrency world works on the same principle, but somewhat differently. The blockchain network needs infrastructure as well to work in an efficient and secure manner. Though, the key difference between both of them depends on how the infrastructure is actually created.
That said, many blockchain networks look up to the users to provide the resources needed for creating and maintaining the infrastructure. Based on this, blockchain networks have incentive mechanisms that support taking part in maintaining the network and keeping things orderly and smooth-running.
There are two forms of this incentive mechanism, staking and mining.
What Is Staking?
Staking is the purchase of cryptocoins and keeping (holding) them in a cryptocurrency wallet for a particular period of time. This is similar to a fixed deposit in the fiat currency world which rewards you with a fixed interest rate at the end of the stipulated time in the contract.
This brings us to the concept of Proof of Staking (PoS). It is an agreement algorithm for some cryptocurrencies which creates new blocks that you can add to the blockchain. These created blocks are actually staked by somebody who is holding some cryptocoins already and helps to validate a new deal on the platform.
You are able to mine or validate new deals for cryptocoins that are equal to the number of cryptocoins you have really staked. The more cryptocoins you stake, the higher your power to validate transactions. Likewise, the longer you hold your cryptocoins in your wallet, the higher the number of your coins.
In fact, only a handful of individuals understand staking and its benefits when compared to the majority who knows about mining and the equipment related to it.
How Does the Staking Process Work?
Each of the mining nodes that help to maintain the network in the Proof of Stake (PoS) blockchain network must stake or verify ownership of a number of cryptocurrencies. The staked amount shows that the owners of the nodes are investors in the network. It also allows them to take part in the creation of the new block (validation). In the end, they receive any accruing rewards, including newly created cryptocurrency and others.
Staking provides a financial incentive to help build the blockchain network infrastructure and helps to keep the nodes honest. Generally speaking, if a node tries to add a fraudulent deal in a block they are validating, then other nodes in the same network will refuse to accept that block. The fraudulent node will no longer work to validate new blocks and receive the accruing rewards.
In many PoS networks, a node that attempts to broadcast fraudulent transactions will lose any cryptocoin it has truly staked. On a Proof of Staking platform, they choose the block validators or miners at random from a pool by cryptocoin holders. A miner can be easily accepted into the pool when they stake a particular amount of cryptocoins in a bound wallet.
The selected node stakes the cryptocoins in the bound wallet and creates a new block that is equal to the percentage of cryptocoins they stake.
Staking Pools and How They Work
Staking pools come into play when some PoS networks need big amounts of staked cryptocoins to qualify to validate new blocks. What happens is that network users pool their cryptocoins together. Then, they divide block validation rewards equally among each pool member.
Pools operate different rules for each PoS network while the most interesting pools have voting systems. Though, the number of nodes in these systems that can validate new blocks is small. This incentivizes the miners to work in the best interest of the network.
Benefits of Staking Cryptocoins
Staking cryptocoins offers quite a number of benefits to block validators such as:
- It eliminates the need to invest in costly mining equipment such as ASICs or high-end GPUs.
- You can buy cryptocoins and lock (hold) them up in your crypto-wallet instead of purchasing equipment for mining. This leads to value growth.
- The value of cryptocoins staked through PoS does not depreciate with time. Though, the fluctuations in the cryptocurrency price do affect the value of the stake.
- Proof of Stake is more environmentally friendly and energy efficient than the Proof of Work (PoW) used in bitcoin mining projects. It uses little resources for its PoS operations.
- Staking guarantees you a predictable source of income as the value of cryptocoins increases in a predictable manner.
- You don’t need to acquire highly technical knowledge before participating in staking.
The Downside to Crypto Staking
The only drawback cryptocurrency staking has is that they hold the cryptocoins up for a period of time. Furthermore, you cannot sell the cryptocoins until that time duration elapses.
Reward Rates of Staking
In cryptocurrency staking, you can calculate the reward rates based on the maturity period needed to lock the cryptocoins in the wallet. But, every cryptocoin has different rules and rates while the method of operation remains the same.
For staking of 3 months, you will receive a minimum of 20% in your returns. In 6 months though, staking grants you a minimum of 50%, and 12 months staking locks you into a 100% return.
How to Get Started With Staking
There are diverse rules for staking in each PoS network. All you need to do is to buy cryptocurrency, download and install a wallet app on your PC, and keep it open. If you are using small networks such as PIVX, you need to download a copy of the entire blockchain.
Networks such as ARK requires you to vote on a delegate if you want to receive staking rewards. This process is quite simple and straightforward. In fact, you don’t need to download the entire blockchain or keep the wallet open.
In addition, other networks need large amounts of staked cryptocoins and purchasing of expensive computer hardware for mining. While others need a lot of technical know-how to take part in the staking process.
Risk Disclosure
This article should not be taken as, and is not intended to provide, investment advice. Users are ultimately responsible for the investment decisions he/she/it makes based on this information. It is your responsibility to review, analyze and verify any content/information before relying on them. Trading is a highly risky activity. Do consult your financial adviser before making any decision. Please conduct your thorough research before investing in any cryptocurrency and read our full disclaimer.
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