Your crypto-assets earn while you sleep!
Staking is an umbrella term used to denote the act of pledging your crypto-assets to a cryptocurrency protocol to earn rewards in exchange. Staking allows users to participate in securing the network by locking up tokens. Consequently, users are rewarded for securing the network in the form of native tokens.
The higher the amount of crypto-assets you pledge, the higher the rewards you receive. The rewards are distributed on-chain, which means the process of earning these rewards is completely automatic. All you have to do is to stake them. This means your crypto-assets earn while you sleep!
Every time a block is validated new tokens of that currency are minted and distributed as staking rewards
Proof-of-stake (PoS) assets like Solana, Tezos, etc let you earn rewards on your staked assets. There are two types of rewards that get distributed
Note: I use the terms protocol, network, and cryptocurrency interchangeably. They mean slightly different things but convey the same logical concept
Staking rewards — You stake your crypto-assets with a PoS node (a server running the protocol stack) to validate a block of transactions. If the node you have delegated to successfully signs or attests to blocks, you receive staking rewards — thereby increasing your net crypto-assets. In case your node is unresponsive or malign (double-signing), a portion of the node’s assets, and hence your assets, can get slashed or destroyed.
The staking rewards are, thus, an incentive for these nodes to perform the process of ordering the transactions, verifying them, collecting them in a block, and subsequently validating the block. When these rewards are freshly minted they get the name inflationary rewards.
Every time a block is validated new tokens of that currency are minted and distributed as staking rewards!
Transaction Fee — In addition to the staking rewards, each transaction carries with itself a small fee making it easier for the node to prioritize the selection of transactions to be entered into the block. The accumulated fees from the underlying transactions also go to the node.
Transactions are what make up a cryptocurrency. For different protocols, these transactions could mean different things. They vary from token transfers to smart contract executions. Despite the dissimilarity in transaction types, the common thread is that these transactions always get ordered and clubbed into a new block so that all nodes in a network can agree on the state of the network.
In a centralized institution like a bank, every transaction can be verified by the central authority (bank’s central server). However, the lack of centralized authority in the crypto world requires the verification and subsequent validating of these blocks by the decentralized nodes of the network. These nodes are known by a variety of names — validators, bakers, etc. Their counterparts in the proof-of-work networks are called miners!
If PoS were a democracy, your stake would be your vote!
Staking does seem like a fairly useful investment instrument for anyone whose assets are lying idle in a digital wallet or a ledger. One can perform two roles when participating in staking.
Delegation is the method by which an individual can reap the rewards of staking. However, to understand delegation we will have to get into the details of how proof of stake (PoS) works!
If you already know how PoS works you can skip over to the delegation section.
Proof of stake, just like Bitcoin’s proof of work, is a type of Sybil resistance mechanism used to ascertain participation in blockchain consensus by utilizing assets as collateral. In simpler terms, to become a validator node in such a network crypto-asset holders are required to stake their tokens as collateral, instead of spending electricity as is the case with Bitcoin nodes.
Additionally, validators are selected randomly to create the block. The probability of a validator’s selection is directly proportional to the volume of crypto-assets staked.
This means that PoS is a system where the value at stake is the main determinant of which blocks are added to the blockchain. If PoS were a democracy, your stake is your vote! Participants in a Proof-of-Stake network essentially vote with their assets on blocks of transactions that they deem valid. They get rewarded if the majority of the network agrees and risks losing their stake (deposited tokens) if they try to cheat, e.g. by voting on two different blocks of transactions at the same time. The former encourages a rise in the number of nodes and the latter discourages malicious behavior.
Does this mean that anybody who holds even 1 token can become a validator? The answer is an obvious NO! Generally, the requirements to become a validator are much more stringent and difficult to achieve practically. Let’s take a look at a few of them.
To become a validator some of the hurdles one can possibly face.
These are just a few of the hurdles to become a validator. Not all of them apply to every network but most networks demand steep requirements that an individual may find difficult to fulfill.
Owning a huge number of tokens of a single currency or operating validation infrastructure may not seem worthwhile to a lot of people. Fortunately, most PoS protocols foresee this problem and incorporate ways to enable asset holders to stake their tokens with a validator that they do not run themselves.
The process of staking your assets with a validator without actually sending them your tokens is commonly called delegation.
Delegating your assets means letting them count towards the stake of a validator in return for a share of the reward received. In practice, a delegator deposits tokens in a smart contract specifying the validator whose influence in the network she wants to increase. As a result, the rewards earned in the validation process increase, but instead of only the validator receiving compensation, the rewards are automatically split between the validator and the delegator, usually by applying a simple commission rate as pictured below.
When delegating your assets it is extremely important to put special emphasis on choosing the validator. A more reliable validator will keep your funds secure as well as grow them reliably. Some of the factors for deciding your validator are as follows.
Keeping crypto-assets liquid is a good strategy for the short-term investor but is not wise for those who are in it for the long haul.
The traditional method of crypto-investing was a rather straightforward experience — you obtain the desired crypto asset, store it (or leave it on an exchange), and wait.
Simply holding a PoS token is no longer an optimal strategy now! Many networks reward participation by inflating tokens and handing them out to participants resulting in a dilution of the assets of non-participating token hodlers.
But is staking the best alternative out there for the Hodlers? Let’s take a look at some of the investment strategies.
Keeping tokens liquid is a good strategy for the short-term investor but is not wise or recommended for those who are in it for the long haul.
When staking, an investor has one of the 2 options
Staking is the more reasonable investment for the long-term investor but liquid staking is emerging to be a clear winner among all the strategies. It provides the benefits of reward accrual through staking while hedging the liquidity risk. Liquidity risk mitigation is a huge need that gets addressed through liquid staking and might become the reason for its success.
Chorus One published a comprehensive report last year that turned out to be foreshadowing in many ways. It is worth a read and goes into great detail about what this strategy entails.
Ethereum is moving towards fully migrating to Proof-of-Stake and Lido Finance is providing a liquid staking solution for it. This article by Paradigm covers how a decentralized eth2 stake pool provides liquidity to staked assets:.
Chorus One is also building a liquid staking solution for Solana on behalf of Lido:
medium.com
The benefits of staking come bundled with some risks as well. Let’s take a quick look at that.
From an economic perspective, a rational investor should choose the option with the highest risk-adjusted return. In practice, this means that a token holder should figure out
Let’s analyze risks associated with staking.
The following table compares the risk-reward scenarios for the various strategies available to a crypto investor. Clearly, liquid staking wins across the board.
We are growing quickly and have been entrusted with $1.4 Billion worth of assets!
Chorus One is a provider of staking services and validation infrastructure with a focus on providing the highest degree of security and quality possible. Our goal is to help token holders earn interest on their crypto assets securely and consistently.
We support close to 20 networks and one of the top validators on networks like Solana, Cosmos, SKALE, and many others.
We have been reliably operating for the last 3 years and have been around for longer than most of our competitors. We are growing quickly and have been entrusted with $1.4 Billion worth of assets! We are also venturing into the space of liquid staking with the proposal for Lido for Solana already approved by the Lido DAO.
For more information follow our social media channels.
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Thanks to the editors
