What is staking? — A primer from the Team@Indra Crypto Capital
Following the release of the YieldWallet.io Livepeer transcoder, we received queries from a number of people who are quite familiar with the buying & selling of Cryptocurrencies but not with the concept of staking.
We thought we’d write a fairly short introduction to staking, how it works and how one can get involved with it. This article does assume some level of technical knowledge and familiarity with Cryptocurrencies.
In order to explain staking, we first have to talk about consensus protocols, namely Proof-of-work, Proof-of-stake and delegated Proof-of-stake.
Bitcoin was the first Cryptocurrency and operates using what is called Proof-of-work consensus. Proof-of-work involves nodes that are mining Bitcoin (building new blocks to append to the main chain), expending a large amount of energy and processing power solving a mathematical puzzle. The solution to this puzzle is then tacked onto the block they’ve built as proof of hardness or effort it took to construct that block. The hardness of constructing a block mimics the process of it’s real world counterpart: Mining Gold.
The difficulty of mining is also algorithmically adjusted periodically to ensure that a block is produced approximately once every 10 minutes (this is a function of the hashpower on the network, the greater the hashpower, the higher the difficulty is set to achieve the 10 minute target block time). This leads to the emission schedule or inflation of Bitcoin being set predictably.
It also shows that the nodes have ‘skin in the game’ constructing the block and therefore an interest in participating truthfully. According to recent estimates, it costs about $4700+ of electricity to mine a single bitcoin. Therefore a miner is incentivized to construct a block and earn the Bitcoin that is emitted to it as a block reward, rather than participate fraudulently and risk the block getting rejected by the network anyway, which then just results in a loss of $4700 with nothing to show for it.
The game theory, thus constructed, is the foundation on which Bitcoin is able to achieve it’s decentralization and allow participants from around the world that don’t know each other to join the network and interact with one another. While Bitcoin, in its role as Digital Gold or Hard money benefits from and requires Proof-of-work, there have been subsequent efforts to introduce other mechanisms for networks to be secured, most notably Proof-of-stake and delegated Proof-of-stake consensus.
While the 2nd Cryptocurrency, Ethereum started out using Proof-of-work, they quickly developed a new mechanism called Proof-of-stake. One gets to mine or run a validating node based on putting up a stake of tokens that they own. The theory here is that if one is able to show a sizable stake in the blockchain they are validating, they are incentivized to participate truthfully as they are interested in retaining or increasing the value of their stake. Additionally, they may incur penalties to their stake should they submit fraudulent transactions to the network.
This mechanism is able to do away with the energy expenditure incurred on a Proof-of-work network. While an analysis of Proof-of-work vs Proof-of-stake is the subject for another post, suffice it to say that each does have certain advantages over the other.
Modifications have been made to Proof-of-stake consensus to allow holders of small amounts of the token who don’t have the full stake and/or the technical skills to run their own validating node, participate by voting their tokens to validators they trust. Notable examples of dPOS based blockchains are EOS, Ark and Lisk.
Most of these dPos blockchains also allow the voter to delegate their tokens while retaining control of them, thereby enhancing the security aspects of this type of consensus for the token holder.
By separating out the operational part of running a node or validator from the staking or voting, these networks allow more fluidity, in theory. Support can be moved from non performing nodes to good ones rather quickly, compared to unbonding / withdrawing one’s stake and then moving funds to another validator.
We launched YieldWallet with the objective of pooling our users’ tokens towards running validating nodes, block producers or masternodes on various blockchains. We achieve the dual purpose of helping these blockchains thrive by playing a key role in them, and securing a yield for our users in the tokens of that blockchain.
Being a new entrant to the space, our initial focus will be on coins where our users can delegate to us without losing control of their tokens. As we earn your trust, we will start supporting coins like DASH and Ethereum that will require the user to send their tokens into a pooled wallet maintained by us.
We’ve started out with Livepeer, a decentralized video transcoding network that uses a delegated proof-of-stake consensus protocol. You can acquire Livepeer token on Poloniex and delegate to us easily from Metamask (a browser extension that serves as an Ethereum and ERC20 token wallet). Find out more here and here.
What are the financial risks?
The risk profile for someone investing in Cryptocurrencies and delegating via a service like ours is the price of the token itself. Tokens are notoriously volatile and tend to move in large percentage swings. The yield that one derives by delegating via our service will serve to somewhat smoothen out that risk profile, but by no means does it eliminate it.
The ideal user for us is someone who believes in a particular token or blockchain and planned to hold (or HODL) anyway in the belief of increased value. They can then delegate to us to earn more of the token.
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What’s the next coin that you’d like to see us support and why? Leave a comment below.