A quick primer on proof-of-stake
Proof-of-stake (PoS) is the term used to describe a class of blockchains that rely on an internal resource (‘stake’) rather than an external resource, such as energy (as with traditional proof-of-work blockchains), to achieve network consensus.
Proof-of-stake represents the next evolution of blockchain innovation. It achieves the same security guarantees as Bitcoin and other proof-of-work networks, but at a fraction of the energy cost. Today, thriving DeFi ecosystems operate on proof-of-stake networks with sustainable environmental usage.
By decoupling from an external source of network security, proof-of-stake networks offer token holders “skin-in-the-game” incentives through staking. What’s more, as the paradigm has grown popular in Web3 ecosystems, more user-friendly implementations have been created to simplify the process. As it stands, prospective stakers have two main paths to entry.
Most proof-of-stake networks support two methods of staking tokens. These are staking and delegating. A number of factors determine which to choose, including a token holder’s level of technical expertise, the number of tokens they have available and the effort they’re willing to invest.
What is staking?
Blockchain networks are decentralized. So, how does a proof-of-stake network remain secure and free from centralized control? Moreover, who decides which blocks get added to the ledger?
The answer to all of these lies in staking.
Staking rewards participation in proof-of-stake protocols. It aligns network security with individual incentives.
Stakers lock their crypto in a blockchain’s validator nodes. Successful validators have the right to bundle and process transactions into blocks on the blockchain. Their efforts are rewarded with the blockchain’s native crypto tokens.
Once tokens are staked, they are locked up and essentially untouchable for a period of time. The time required to unlock staked tokens depends on the network they are locked in. The time it takes for staked tokens to be accessible is variable and should be considered when staking.
The case for staking
Staking was designed as an alternative to the traditional proof-of-work consensus model that some networks, such as Bitcoin, use. It has since become the default model for DeFi blockchains. While most benefits of staking apply to both paths, deciding between staking and delegating is pretty straightforward, as each was created to appeal to a specific kind of participant.
Staking has two primary components: staked crypto and healthy validator nodes.
The setup, security and maintenance of a validator node is not difficult for those with some degree of familiarity with the subject, so the technical barrier to entry isn’t typically high. This makes staking directly an attractive option for retail that’s interested in Web3 and wants to actively participate.
Staking vs. delegating
Staking requires the token holder to set up a validator node and maintain the process themself. This is popular among individuals with the relevant skills who prefer to manage their own validators.
Delegation is a convenient, low-risk alternative for individuals or institutions looking for an easy process without logistical limitations such as node management or operation.
When delegating, a token holder ‘delegates’ their tokens to a trusted validator. This allows the token holder to take a share of the rewards without any of the setup and maintenance. The token holder always retains full control and ownership of their tokens, which are allocated to the validator for staking purposes.
Some delegation platforms also guarantee a node is completely owned by the delegator, just operated by the platform, to preserve the autonomy and influence of delegators over their stake.
Staking will generally provide higher yields than delegation, but it requires significant additional effort and is a more active investment. Delegation will generally provide lower yields but requires very little effort and is a more passive investment.
Delegation is becoming a very popular option across blockchains, as it is the more attractive option for many users.
Energy cost
Compared to its predecessor, proof-of-stake has significantly lower energy costs. Instead of elaborate mining rigs and expensive GPUs, running a proof-of-stake node simply requires the use of your internet-connected computer — and staking pools are even less demanding.
In addition to resource efficiency, proof-of-stake offers a range of use cases that aren’t compatible with a proof-of-work model, like sharding.
Scalability
Sharding is one of the most anticipated features of ETH2’s roadmap. It is a form of database partitioning where large “blocks” are split into smaller, faster blocks. These shards eliminate the need for each node to process the transaction load of the entire network.
Proof-of-work, by comparison, requires each node to process every ever-growing block. Shards work in parallel to maximize transactions per second—requiring less processing power and storage per node. Sharding allows the network to scale its transaction throughput by a multiple of the number of shards a chain uses.
Ease of operation
Even though blocks are added by a different mechanism than in proof-of-work, proof-of-stake networks still use nodes to achieve consensus. Running a blockchain node can be complicated for beginners, but proof-of-stake minimizes this complexity. You don’t need banks of mining nodes, you only need to run a single validator. Plus, accessible solutions like Blockdaemon’s node management platform simplify things even further. You just need enough cryptocurrency and the right infrastructure partner to start earning.
Earn yield
Staking lets token holders earn yield on tokens that would otherwise be idle. Because of that, it is a popular investment model
While a number of factors can affect your expected yield, it’s common to earn 6% to 12% APY across DeFi protocols. This is advantageous for both finite-supply assets and for outpacing inflation on higher-issuance assets and fiat currencies.
Airdrop eligibility
Airdrops, or ‘stakedrops’, are a fun and lesser-known advantage of staking. New projects often airdrop tokens to validators on their chain. This means that stakers on popular chains are often the first beneficiaries of innovation.
Contribute to decentralization
Proof-of-work was designed to power decentralized blockchains, but the high investment needed leads to a centralization of network power.
Proof-of-stake is more conducive to decentralization, as the entry barrier is nearly nonexistent. You can use staking pools to participate, even with small amounts of crypto. Institutions and those that want to validate at scale also benefit more than with proof-of-work. There isn’t a sunk-cost requirement of building mining rigs and expending power, and validation is shared by all participants, instead of requiring competition.
Boost network security
The more holders that stake, the more secure the network becomes. With more validators processing transactions and checking other validators’ work, malicious actors and modified blocks can be dealt with increasingly efficiently.
Participate in governance
Depending on each blockchain’s specific implementation of PoS, validators hold varying degrees of network influence. Typically, there are consistent stake benchmarks that grant validators a specific amount of power. For example, to run one node on the coming ETH 2.0, one would need to stake 32 ETH per node.
With staking pools, those nodes can be broken down into smaller portions split between all participants that pool their resources to operate nodes together.
How to start staking
The first step in becoming a validator is to decide which network to stake on. This decision depends on which assets and networks you believe will thrive in the long term and which align with your investment ethos.
Once decided, a prospective validator can set up a node, stake their tokens on their chosen blockchain and enjoy the benefits.
Delegating to a trusted validator
For institutions or investors looking for scale, or for users unfamiliar with the technical processes and security standards of staking, delegating stake to an established validator makes the process simple.
For example, Blockdaemon has validator nodes for more than 50 blockchains and supports quick and secure delegated staking on protocols like:
Using a liquid staking solution
Traditional staking locks a validator’s crypto in a smart contract that has a chain-dependent delay in unstake time. To ensure validators can unstake and access their crypto freely, liquid staking solutions have been developed by different protocols and companies.
Liquid staking allows delegated validators to shoulder the unstake wait times and grant users instant access to funds instead of making them wait. This way, users can enjoy both the yield-farming benefits and the flexibility of instant fund access.
Examples of Liquid Staking Protocols
- Osmosis Superfluid Staking – “Reverse” liquid staking using tokens already circulating in DeFi protocols
- Acala Liquid Staking on Polkadot – the first liquid staking product in the Polkadot ecosystem
- Lido Liquid Staking for Ethereum & Solana – multi-platform liquidity for staked assets
- Blockdaemon and StakeWise Institutional Liquid Staking Solution – fully compliant institutional-grade staking on ETH2
Final Considerations
All investment models should be carefully weighed against one’s risk tolerance and ethical convictions, but staking has a few method-specific risks:
Slashing
The biggest risk to staking is slashing, or losing your principal staking amount due to being pegged as a “bad actor” on the network. When a smart contract detects an attempt to manipulate the blockchain or network, it programmatically punishes perpetrators by forfeiting their staked amount.
Validators not attempting to maliciously change or exploit the network should have nothing to worry about, but with different expectations on each network, it can be tricky to remain compliant. Additionally, validators who fail to perform their functions (due to internet outages, for example) may also be at risk of slashing mechanisms, depending on the blockchain.
Slashing insurance has been introduced by delegated validators, like Blockdaemon’s 100% slashing insurance guarantee, to resolve the risk of slashing.
Lockups
Lockups are the default staking mechanism for most blockchains. With some lockup periods taking days or weeks to withdraw from, fund accessibility is important to consider. Liquid staking solutions resolve this risk.
