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Fundament of the week – What is staking?

Staking can be considered a less demanding alternative to cryptocurrency mining. This includes holding funds in a cryptocurrency wallet (or even on some exchange accounts) in order to support the security and operation of the blockchain network. Simply put, staking is the act of locking up cryptocurrencies for a reward.

To better understand what staking is, you must first understand how proof of stake (PoS) works. In short, it is a consensus mechanism that allows blockchains to operate in more energy-efficient extraction while maintaining a decent degree of decentralization (at least in theory).

How does staking work?

As we already know, Proof of Work blockchains relies on mining which is adding new blocks to the blockchain. In contrast, Proof of Stake blockchains produce and validate new blocks through the staking process. Staking refers to validators who lock their coins so that they can be randomly selected by a protocol at certain intervals in order to create a block. Participants who deposit larger amounts usually have a better chance of being selected as the next validator block.

This allows the production of blocks without relying on specialized mining hardware, such as ASIC. While ASIC mining requires significant investment in hardware, staking requires direct investment in the cryptocurrency itself. Therefore, instead of competing in terms of computational work, PoS validators are selected based on the number of coins they insert. "Stake" is what motivates verifiers to maintain network security. Failure to do so may endanger their entire share.

While each Proof of Stake blockchain has its own specific deposit currency, some networks use a dual-stream system where the rewards are paid in a second token.

At a very practical level, a deposit means only keeping funds in a suitable wallet. This allows virtually everyone to perform different network functions in exchange for certain benefits. It may also involve adding funds to staking pools.

How is staking calculated?

Each network of blockchains can use a different way of calculating staking rewards. Some are adjusted block by block, taking into account various factors. These may include:

  • How many coins the validator inserts
  • How long the validator has been actively trying
  • How many coins are inserted into the net together
  • Inflation rate
  • Other factors
  • For some other networks, staking fees are paid as a fixed percentage. These rewards are distributed by the validator as a type of inflation compensation. Inflation encourages users to spend their coins instead of holding them, which may increase their use as cryptocurrencies. However, with this model, validators can calculate exactly what reward they can expect for a deposit.

    A predictable reward schedule, rather than a probable chance of receiving a block reward, might be unfavorable for some. And since it is public information, it could motivate more participants to get involved in staking.

    What is cold staking?

    Cold staking refers to the process of depositing in wallets that are not connected to the Internet. This can be done with hardware wallets, but it is also possible with "air-gapped" software wallets.

    Networks that support cold staking allow users to deposit while securely keeping their resources offline. It is worth noting that as soon as an interested party moves its coins from the cold wallet, it will stop receiving rewards.

    Cold staking is especially useful for large stakeholders who want to ensure maximum protection of their funds while securing the network.

    Jakub is a crypto trader and founder of Trader 2.0 project, which helps hundreds of traders from central Europe to understand cryptocurrency trading and its challenges. Jakub not o...

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