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What Is Cryptocurrency Staking, And How Does It Work?

What Is Cryptocurrency Staking, And How Does It Work?

The two main significant processes of adding new blocks or validating transactions on the blockchain ecosystem are ‘proof-of-work’ and ‘proof-of-stake.’ This article sheds more light on what crypto staking is, how it works, and its benefits, and how you can earn passive rewards through crypto staking.

What is crypto staking?

Crypto staking is defined as a process of locking some of your cryptocurrency to be selected as the next validator of a block and ultimately earning rewards for it. Picture a situation where you form a group with a few others and pull your resources together for a bet. However, the winner of this bet would be chosen based on the group with the most significant resources, among other factors (betting experience).

Winning this bet would mean receiving some money that gets shared with everyone in your group who has contributed to the money pool. You would realize that the larger your group, the smaller your winning share. Losing this bet (i.e., not winning) doesn’t mean you lose your resource either.

It only amounts to a waste of time since you could not put your money into any good use during the betting period. You join a pool and lock in your cryptocurrency in the crypto case. The system chooses the next validator among different mining pools. You win if your pool is chosen and lose if it's otherwise. Does it sound clearer? Now let's move to how staking works in the crypto world.

How does crypto staking work?

Crypto staking was created as a process to substitute the previous “proof-of-work” mechanism. This is because it conserves energy, among other reasons. It works by forming different mining pools that compete to be chosen as the next validator of a blockchain transaction.

Explicitly, the nodes on the blockchain have interconnected functions. This makes it super hard to tamper with. A new transaction on the blockchain would need adequate verification; this is where staking comes in. A group of investors comes together to form a “pool.” They put their coins at “stake” to be chosen as the validator of the next transaction. These coins are “locked-in,” so they cannot be used during this period. The coins serve two functions:

1.  As a stake to be chosen as the next validator, the higher the coins in a pool, the higher the chances of getting selected.

2.  As collateral for being a validator. Part of these locked-in coins will be lost if the validators approve a fraudulent transaction.

If a pool gets selected and it validates the transaction seamlessly. The pool will be rewarded with some cryptocurrency, either in the cryptocurrency it puts at stake or in other cryptocurrencies. This is dependent on the crypto ecosystem the staking takes place. The reward will be distributed to every member of the pool.

What is proof of stake?

Recall that when staking, you are locking your crypto coins alongside others to be chosen as the next block validator, with every transaction going into your pool. This is the ‘Proof of stake'. The proof of stake is the main item a pool puts forward to compete with other pools to be chosen as the next validator.

Cryptocurrencies that currently use Proof-of-stake for node validation include Ethereum, Cardano, Solana, Algorand, Mina, Tezos, etc.

What are the advantages of crypto staking?

The advantages of crypto staking are two-dimensional. These are advantages to the investors who join pools to stake and benefits of this process to the systems that validate transactions using proof-of-stake.

  • For the system: The proof-of-stake mechanism through crypto staking has been proven to be energy conservative, unlike the popular and indigenous proof-of-work method. Proof of work consumes an enormous power supply in computing- enough to power a country like New Zealand. Only the selected pool gets to validate a block in staking, hence its power efficiency. Staking also allows investors to earn while growing their cryptocurrencies since you have to possess some coins to be able to stake
  • For the Investors/ Validators:

The significant advantage of crypto staking here is earning passive income. Crypto staking for an investor is a low-risk trade, where losing won't cost you your coins, and winning doesn’t require a vast effort. It's simply you keeping cryptocurrencies in your wallet and making it grow.

Advantages of crypto staking

Are there risks in crypto staking?

It will be exaggerated profitability if there's no risk in crypto staking. Virtually every profitable venture comes with its own risk, though the chances are higher than the others. There are risks in proof of stake. The risks are:

  • For the systems:

The main risk here is argued to be a long-range attack. This is the vulnerability of the nodes to attack from previous validators who have nothing at stake anymore (or nothing to lose)

  • For the Validators:

The main risk here is the possibility of losing part of the stake by validation wrongly when your pool is selected. This, however, is unlikely. It might also be that the system rejects your validation even though it's correct; this is also highly unlikely. The most common risk you're likely to encounter here is time waste.

If your crypto mining pool doesn't get selected, you lose time making some valuable trades. This is because your crypto coins were locked in staking, and you couldn’t make use of them. It could also take some days for you to unstake your crypto coins from the pools so that you may lose out on other essential coin transactions. Also, validators can lose their stake to hacks.

Risks of crypto staking

Disclaimer: This article should not be taken as financial or investment advice. Making an investment or financial decision is a choice. Do your research!

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