Staking sounds like something you might need to understand to defend yourself from a vampire. But, thankfully, in terms of cryptocurrency, staking means something entirely different. Wooden posts are not required.
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Proof of Work or Proof of Stake
When it comes to crypto, there are two main models of operation. The exchange of funds, even in the digital world, needs to be verified. And, while the goal of the entire system is to remain without a single authority, the community agrees there is a need to track and verify what precisely is going on.
To do so, cryptocurrency requires the use of a blockchain.
The Blockchain
The blockchain network is the platform on which a group of individuals (or a group of entities or companies) on which validating transactions can take place. Miners, or those that work on the blockchain to create new blocks, solve computations to create new blocks, thusly creating rewards.
Typically earning such rewards is the overarching goal of the blockchain itself. Users of the network are seeking to earn rewards. Crypto mining is the method in which new potential rewards are created.
Which Power Source: Proof of Work vs. Proof of Stake
The key difference in a blockchain network’s workflow resides in its algorithm. How users validate transactions varies from one model to another.
As it stands, there are two main types of operation: Proof of Work (POW) and Proof of Stake (POS).
The Similarities of POW and POS
While both POW and POS have a goal of creating new blocks in the blockchain networks, they go about it in totally different ways.
However, both focus on verifying transactions. While neither style of blockchain wants there to be any one single authority or entity “in charge,” both models agree that there is, in fact, a need to validate cryptocurrency transactions.
The Differences of POW and POS
In a Proof of Work model, the blockchain operates with miners exchanging power (both computing power and real-world energy like electricity) for coins. Miners in the POW blockchain solve computations in order to create new blocks.
This system rewards work. If a miner chooses to put out the effort, new blocks are created. Gas fees cover the transaction fees (much like your bank charging you for services) in the POW blockchain.
In a Proof of Stake model, the system operates by staking. Staking is to offer up coins as a sort of collateral. In other words, in order to have a chance to mine on a POS blockchain, you must first front some funds in the form of tokens or coins.
After staking, users on the blockchain are randomly selected to have the opportunity to mine.
Crypto Staking
When it comes to the Proof of Stake model of operations, the algorithm needed for verification is done on the blockchain via a method known as “consensus mechanisms.”
A Consensus Mechanism
Consensus mechanisms help to distribute the entries on a database, not to mention keep the database more secure. When it comes to crypto, that database (or ledger) is the blockchain itself. Consensus mechanisms keep the blockchain safer.
With Proof of Stake, the consensus mechanism occurs in a style in which cryptocurrency validators share the task of validating transactions. There are currently no certificates issued in the POS.
Staking Pool
Because funds must be offered up for collateral, in the POS blockchains, you will often find staking pools. These are just as they sound.
Let’s imagine you and your roommates want to invest in a big-screen smart TV. One of you cannot afford it on one’s own. However, if you pool your funds for the greater good, you can go in on the TV together.
By pooling your funds, or placing contributions in the pot, you increase your chances of getting a bigger television. The group benefits from the rewards of the new TV.
Likewise, the staking pool is often used in the POS blockchain. A group of investors may go in together to better the odds.
Each validator’s stake is added to the pile, and the group fronts this collateral cash as its stake together. The group, called a staking pool, increases its chances of “winning” the random selection.
In other words, the group increases its chances of being selected to mine (or create a new block), and thusly a higher probability of the end goal: to earn staking rewards.
Staking Rewards
No matter the style of blockchain, the goal of the network is to create new blocks or to validate transactions. To do so, the overall motivation is financial gain.
Staking rewards are an incentive that the POS blockchains provide to their users. Each blockchain has a set amount of crypto rewards for validating a single block of transactions. When you stake crypto and if you are chosen to validate transactions via the randomized selection process, you will receive those crypto rewards.
Unlike the POW model, which allows any miner to do work (or the computations) to earn rewards, the POS model randomizes the “winner” of the staking rewards. Groups offer up collateral (coins) and random miners are selected.
Earn Staking Rewards
The POS model is much more like that of a large spinning wheel. If you’ve ever gambled at one, you know how this works. You put a casino chip on the board. You pick your color. The wheel spins. If it lands on your color, you win. The amount of reward depends on the odds of winning.
In the same way, a POS blockchain asks its members to post virtual coins or tokens (your casino chips). A randomized selection process occurs (the wheel spins). Some of the stake posters win rewards.
Just like the spinning wheel game, your odds increase the more chips you put down and the more colors you choose (stake pools).
In order to receive rewards, and to start staking at all, users must have stake cryptocurrency. In other words, you need money to make money, as the old adage goes. You cannot start earning rewards, nor begin staking, without first having the specific cryptocurrency the network requires.
Crypto staking works much like the wheel in a casino. Staked assets are posted as collateral (your casino chips) and you gamble at a chance at receiving rewards (money).
