An Introductory Guide to Staking Cryptocurrencies
Similar to traditional financial ecosystem where strict guidelines govern the way new fiat currencies are minted by central banks, the decentralized world of blockchain-based cryptocurrencies have several consensus algorithms (proof-of-work (PoW), proof-of-stake (PoS), delegated-proof-of-stake (DPoS), and others which leverage different principles to mint new coins, secure a distributed ledger and partake in governance.
In the following guide, BTCManager will take a deep dive into the proof-of-stake (PoS) consensus mechanism and the promising feature known as coin staking.
In 2008, anonymous Japanese programmer and cryptographer, Satoshi Nakamoto created the proof of work protocol for achieving consensus between a vast array of devices on a distributed network.
The proof of work algorithm which powers bitcoin and numerous altcoins reaches consensus by enabling “miners” (nodes on the network) to confirm transactions on the Bitcoin network and mint new coins by solving complex cryptographic puzzles.
As of November 2018, the mining reward for adding a block of transactions to the Bitcoin ledger was 12.5 BTC (less than $50K at the time). Back in the day, it was even possible for miners to carry out mining activities right from their bedrooms with their personal computers.
However, the mining difficulty has surged significantly ever since, making the Bitcoin mining business profitable for only big whales like Bitmain and others who can afford to set up mining rigs loaded with expensive Application Specific Integrated (ASICs) machines.
Besides the fact that ASICs are expensive, this Bitcoin mining equipment consumes a massive amount of electricity and Bitcoin critics have always argued that the heat and carbon monoxide generated from bitcoin mining operations contribute significantly to global warming.
Proof of Stake Consensus Algorithm Is Born
While Bitcoin’s proof of work consensus has proven for a decade that it can safeguard a blockchain against 51% attacks or double spending, the limitations of PoW have motivated other cryptographers to formulate alternative algorithms to achieve the same ends, but in a more cost-efficient and environmentally friendly way.
For the uninitiated, a 51% percent attack is a situation whereby a miner or a cryptocurrency mining pool controls at least 51 percent of the total computing power of a given blockchain and creates fraudulent blocks of transactions that make the transactions of other miners invalid.
In 2011, pseudonymous programmer, Sunny King, developed the proof-of-stake (PoS) consensus algorithm. In 2012, King’s Peercoin (PPC), which is currently the 249th largest cryptocurrency on the CoinMarketCap table, became the first distributed ledger technology (DLT) based virtual currency to implement the PoS consensus algorithm.
Since that time, a good number of cryptocurrencies have adopted the PoS consensus algorithm, including Lisk (LSK), Pundi X (NPSX), Cardano (ADA), Dash (DASH) and the Ethereum project is also making active plans to move away from PoW to PoS.
Earning Passive Income in the Cryptospace
Apart from buying and holding cryptocurrencies to earn huge profits when the price of the coin appreciates, there are several other ways by which crypto enthusiasts earn passive income these days, including mining, lending, and staking.
Since we briefly talked about mining earlier on, it will be helpful to shed more light on lending before moving on to our primary area of focus, coin staking.
Cryptocurrency lending is slowly gaining traction in the digital assets ecosystem. To earn passive income this way, interested crypto holders are required to send their idle coins to a credible lending platform which will, in turn, lend their cryptos to clients, including margin traders.
The lending services usually share a part of the interest they charge their clients with the original owners of the cryptoassets.
Interestingly, some cryptocurrency exchanges such as Bitrue, offer interest programs that allow users to earn interest on their cryptos deposited on the platform.
What Is Coin Staking?
While PoW blockchains validate transactions via mining, PoS networks achieve that same objective through a process called staking. In PoS systems, the higher the number of coins a user holds, the greater the chance that the user is participating in transaction validation.
For instance, if a set of potential validators (miners) was made up of Chris, who holds 40 tokens of a given PoS blockchain, Angela with 30, Tom with 20 and Liam with ten, there will be a 40 percent chance of Chris being chosen to validate the block and Angela 30 percent, with Tom and Liam on 20 percent and ten percent respectively.
In other words, in a PoS network, the creator of the next block is chosen by a randomized process influenced, in part, by the number of the native cryptos that a user holds, or, in some cases, how long they have been holding the digital asset
Staking is the process whereby people deposit their PoS-based altcoins on specific cryptocurrency wallets or staking services and leave it there for a certain fixed period, to earn more coins as rewards.
How Staking Works
Crypto staking can be compared to a fixed deposit investment in the traditional financial system. The longer the staking time, the higher the reward a user gets at the end of the tenure.
To stake coins on most PoS networks, prospective “stakers” are required to operate or join a node or a masternode.
Staking systems also support the delegation feature. Delegation makes it possible for people holding PoS-based cryptos to delegate their voting rights and earned coins to a trusted party, usually a staking service.
This process gives the delegate more validation power and it will, in turn, pay its loyal supporters dividends (coins) for their vote.
Presently, there are several PoS wallets and platforms offering users robust coin staking services, including Trust Wallet, which allows users to stake VeChain (VET), Callisto (CLO), TomoChain (TOMO), and Tezos (XTZ).
As reported by BTCManager on March 30, 2019, Coinbase Custody announced the launch of its Tezos (XTZ) staking service for institutional investors.
Top PoS Coins to Stake
Some of the most liquid coins for staking include NEO (NEO), Dash (DASH), VeChain (VET), Neblio (NEBL), Komodo (KMD), Nav Coin (NAV), PIVX (PIVX), ReddCoin (RDD), Pundi X (NPXS), OmiseGo (OMG), and Lisk (LSK).
NEO, for instance, pays users between two to five percent interest in GAS tokens annually, Neblio (NEBL) stakers can earn up to ten percent interest per year, Komodo holders can get up to 5.1 percent per year, and Pundi X reportedly pays holders 7.316 percent of their staked coins per month.
Pros and Cons
Just like in the real world, coin staking has its own advantages and disadvantages.
PoS consensus eliminates the need for coin holders to purchase expensive crypto mining equipment to mine new coins. Also, the dividends earned from staked coins never depreciates with time. Comparatively, the older an ASIC miner is the less competitive it becomes over time, thus damaging the returns on the initial investment.
However, the downside is that coins must be held in hot wallets until the staking contract expires, predisposing users’ funds to hacks and people can potentially lose vast chunks of their investment during a severe bear market, since they cannot sell off their coins or convert it into a stablecoin. More often than not, their staking profits may not be enough to cover their losses.