What Is Staking?

One advantage of cryptocurrency is that it is trustless. Unlike fiat currency, which uses a trusted third party (such as a bank) to verify transactions between bank accounts, cryptocurrency verifies transactions using a consensus mechanism. There are several types of consensus mechanisms but one that yields profit through staking is called Proof of Stake (PoS).

What is staking?

When an investor stakes a cryptocurrency they commit funds into a staking pool which are used to compare and validate other transactions. The funds are locked in for an agreed term period during which the investor cannot access them. In return, the investor receives an annual yield in the form of block rewards, plus the full amount of the funds after the term expires.

The cryptocurrency’s blockchain uses a protocol to prevent double spending to ensure the same coin is not spent twice by the same buyer. Each staking protocol works differently in how it chooses which coins to validate. The more coins that a particular investor pledges to the staking pool, the more likely they are to be chosen at random to verify a new transaction. 

Advantages of Proof of Stake

PoS has some unique advantages over PoW.

1. Lower energy consumption

• While Proof of Work (PoW) is the most popular consensus mechanism, it is energy intensive, requiring many high-powered computers to solve algorithms in order to verify transactions. 

• As such, PoS has become a popular alternative, most notably with the Ethereum Network currently switching from PoW to PoS. 

• Vitalek Buterin, the founder of the Ethereum Network, has stated that when their blockchain merges from PoW to PoS it will reduce the network’s energy consumption by 99.9%.

2. Faster transaction speeds

• Proof of Stake provides faster transactions per second (TPS) than does Proof of Work. PoW uses an expansive network of computers to verify transactions, sometimes taking hours to complete. 

• PoS uses a technology called danksharding that bundles transactions together, verifies them, and completes the transaction at a much faster rate. Solana, another PoS network, executes 65,000 TPS.

3. No special equipment needed

• PoW requires specialized computers to solve highly complex algorithms as more transactions come onto the network.

• These computers, known as miners, can cost as much as $30,000 apiece. 

• PoS does not require this equipment as all transaction verification is done solely through the cryptocurrency’s blockchain network.

Disadvantages of Proof of Stake

While PoS has its advantages it is not without its drawbacks. Some common disadvantages of PoS include the following:

1. More centralization

   • Cryptocurrency is the backbone of decentralized finance (DeFi). However, the nature of staking pools requires that coins be centralized together to verify transactions.

   • The number of transactions and other digital asset trades conducted can put strain on the central network. Solana processes 50,000 TPS and has experienced multiple outages in recent months where the network has shut down, making validators unable to create new blocks.

2. Larger holdings have more influence

   • A validator with a large amount of coins in the staking pool is more likely to be chosen by the protocol to verify transactions, reducing the yield of smaller investors.

3. Security issues

   • Because PoS is more centralized than PoW it's more vulnerable to hacks. 

   • This requires a more complex security system that depends on blockchain developers to maintain. 

Proof of Stake coins

There are only a handful of cryptocurrencies among the thousands on the market today that allows for staking. Below are three of the most popular staking cryptos:

1. Polkadot (DOT) 

   • According to HoldPolkadot, returns can currently fetch a hefty sum but require a minimum deposit of 120 DOT.

2. Ethereum (ETH)

   • Ethereum’s staking requirements are changing with the forthcoming Merge.

   • At time of writing, a staker must commit 32 ETH to be included in the pool.

3. Tezos (XTZ)

   • Currently, a Tezos staker must lock in 8,000 tokens to participate in the pool.

   • It takes 5 weeks before interest returns start being doled out. 

   • Stakers also receive voting rights in the Tezos project’s governance.

Is staking crypto worth it? 

Staking can be a steady source of investment income. However, staking a staking pool is not a savings account where an investor can just ‘set it and forget it’ . Wise investors know that they must watch the saturation levels regularly. Pools that become oversaturated lose block rewards since rewards are split among the pool’s participants.

Staking is profitable for many investors and is best used by those who see cryptocurrency as more of a hedge against inflation than a transactional currency. Rather than holding crypto in a wallet, it can make sense for an investor who is able to stake their coins given the upfront deposit and time commitment of locking in the funds.