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Just like Bitcoin mining has nothing to do with pickaxes, crypto staking has (almost) nothing to do with vampires.
The Bitcoin blockchain is secured by hundreds of computers solving complex computational tasks.
While this is decentralised and secure, it requires immense energy consumption. Some estimates have shown that Bitcoin miners burn through more power than entire countries – even Australia.
So, blockchain enthusiasts got to work on an alternative. They needed to create a method that secured a decentralised network but was far more efficient than mining.
Enter staking.
What is staking?
The term “staking” comes from a consensus mechanism known as “Proof of Stake.”
This process is how different nodes – devices running a copy of the network – agree data is correct on a blockchain. Without this agreement, transactions can’t happen.
While Bitcoin relies on complex, energy-draining algorithms, Proof of Stake blockchains have a far more sustainable solution.
Participants in the blockchain – known as validators – lock up (or stake) a certain amount of the network’s native token.
So, for example, validators on Ethereum would have to stake ETH.
How does Proof of Stake work?
The Proof of Stake mechanism maintains a decentralised, secure network – like Bitcoin – without the immense energy consumption.
This is because people staking on a network run a copy of the blockchain on their device. This uses some power, but far less than a computer pushing trillions of outputs per second, like one mining Bitcoin.
Each time new data is added to a Proof of Stake blockchain, the network randomly selects a validator (or staker) to verify the transaction.
The selection criteria can be completely random or weighted to certain factors (like the amount of crypto staked) depending on the blockchain’s code.
If a validator misbehaves and tries to exploit the network, they risk losing their locked-up cryptocurrencies – often worth tens of thousands or more.
These two factors ensure the network remains decentralised and difficult to compromise.
How does staking generate new cryptocurrencies?
Why would someone lock up thousands of dollars of cryptocurrencies on a network?
Well, yeah, it does help keep the blockchain secure and operational. But most people aren’t doing it out of the kindness of their hearts.
Rather, stakers that are selected to add the next block to the chain (and verify data) are rewarded with newly minted cryptocurrency. Sometimes, they even get a share of that block’s transaction fees.
Each Proof of Stake network has its own way of distributing rewards.
Most networks have a ‘delegate’ system. If an investor doesn’t have enough resources to run their own staking node, they can delegate it to someone else. The delegator usually gets a slightly lower reward rate. The extra fees are paid to the validator running the staking node.
Delegate staking can be done via centralised exchanges, TradFi businesses, DeFi platforms and even within crypto wallets.
Benefits and disadvantages of staking
Benefits
- Much more environmentally-friendly than mining.
- Far more accessible for the average investor – especially through delegate or pooled staking.
- Less complexity means Proof of Stake blockchains are often faster.
- Democratic governance with votes often distributed among stakers.
Disadvantages
- Large stakeholders may have too big of an influence over a blockchain, leading to a centralisation risk.
- Some staking protocols also require you to lock up your tokens for a certain timeframe, leading to a lack of liquidity.
Popular staking cryptocurrencies
Ethereum (ETH)
Ethereum began life as a Proof of Work blockchain in 2015, but underwent a major upgrade in 2022 and transition to a Proof of Stake network. This allowed ETH holders to begin staking their Ether and earning passive rewards.
Solana (SOL)
Solana has emerged as a significant player in the DeFi space and offers attractive reward rates for stakers on the network.
Interestingly, Solana uses a hybrid model that involves Proof of Stake and another mechanism called Proof of History.
Cardano (ADA)
As part of Cardano’s evolution into a fully decentralised ecosystem, the blockchain implemented a Proof-of-Stake mechanism in 2020. ADA holders can contribute to one of several stake pools, or run their own pool if they have enough tokens.
Swyftx: Start your crypto investing journey
Swyftx is an Australian-based crypto exchange with over 750,000 users. Start your investment journey off with $20 of free Bitcoin when you sign up and verify.
We’ll be back next week with Part Two, looking at emerging technologies in crypto.
Disclaimer: The information provided by Swyftx is for general educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any assets.
It has been prepared without regard to any particular investment objectives or financial situation and does not purport to cover any legal or regulatory requirements. Customers are encouraged to do their own independent research and seek professional advice.
Swyftx makes no representation and assumes no liability as to the accuracy or completeness of the content. Any references to past performance are not, and should not be taken as a reliable indicator of future results.
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