What is Crypto Staking and How Does It Work?

What is Crypto Staking?

Blockchains are decentralized but they have transaction verification methods in the form of consensus mechanisms. Proof-of-stake is a type of consensus model where nodes have to commit their virtual currency reserves in the smart contracts in order to become validators. Validators are awarded the unsolved blocks to validators at a random scale.

The more cryptocurrency validators stake, their chances of getting elected by the blockchain increases. Investors can also delegate their governance power to other validators by staking their crypto holdings on a blockchain.

Retail investors can also stake their digital currency holdings in centralized and decentralized exchanges to earn yield income.

Can You Stake Any Cryptocurrency?

Staking options are limited to a few cryptocurrencies with some of the top currencies such as Bitcoin not having this feature. In most cases, cryptocurrencies that have a staking feature is based on their core blockchain infrastructure. As mentioned before, digital currencies that hail from the blockchains using PoS type of consensus model offer staking options.

Bitcoin does not have staking option as it used Proof-of-Work or PoW consensus model that requires miners to use computational power rather than depending on staked crypto reserves. Blockchain projects such as Ethereum, Cardano, Solana, Tezos, and Cosmos are networks that have adopted PoS model.

These blockchains have smart contracts that are automation protocols. These networks and any decentralized protocol token on these platforms can have or integrate staking option for investors.

Working Mechanism of Crypto Staking

Staking is an update form of mining operations. It requires less energy input and increases throughput of a blockchain. In a PoS blockchain, nodes can apply to become validators rather than miners.

Blockchains set a minimum and maximum capacity for staking or locking native cryptocurrencies on the smart contracts. Staked reserves work as warranty that validators are working in good faith for the benefit of the entire community.

In case of any suspicious activity blockchain can confiscate the locked virtual currencies of the validators to maintain transparency and fair market practice.

At the same time, validators who are doing their job are rewarded with new coin rewards and portion of transaction fees from users.

In some cases, nodes can transfer their governance power to an elected validator to help increase chances of getting elected to validate more blocks. Validators distribute their rewards with the contributors.

Meanwhile, cryptocurrency exchanges and decentralized protocols have also introduced staking options for their investors. Any account holder or user on trading platforms or liquidity pools can lock their crypto reserves and earn yield income based on the APR or APY rates.

In this manner, exchanges and other DeFi protocols maintain higher liquidity for their investors and staking parties are able to earn yield income.

Advantages of Crypto Staking

Here are some of the benefits of staking mentioned as under:

Additional Income

Staking is an option that emulates the savings account services of traditional banking institutions. However, the average APR for staking cryptocurrencies is usually much higher in comparison to the traditional banking offers.

However, there are some regulatory concerns around staking services that cryptocurrency investors are currently facing.

Yield Farming

Yield farming is a process of using staking to increase the yield income by many folds. Investors look for staking options that grant them rewards in the form of new tokens. The investors use the token rewards to add to their existing staking positions or stake them in another staking protocol.

As long as the spot prices of the stakers remain positive they can generate substantial passive income. However, they can face the problem of important loss when spot prices go down due to inability to unlock from staking positions.

Byzantine General Problem

The Byzantine General Dilemma was first resolved by Bitcoin blockchain using consensus mechanism.

It deals with ensuring that all independent participants in a system act in good faith and refrain from malicious activities at the detriment of their peers. PoS also address and solve this problem and ensure safety and security for all network participants.

Conclusion

Staking has its pros and associated risks such as potential for transaction fee inflation etc. However, it is among the upgraded type of blockchain verification methods that has given rise to more options and solutions.