What is Staking?

This is the first piece in our educational series on staking and its significance to the blockchain ecosystem. Staking is a process in which token holders can earn rewards by helping to secure a blockchain network. Start your learning journey by reading our crypto staking basics.

How Does Staking Work?

Staking is a foundational concept in the world of cryptocurrencies and blockchain technology. Essentially, staking allows for a holder of digital assets to participate in the consensus mechanism of a given blockchain network, and thus securing that network’s operations. This process typically requires stakers to lock up their tokens while they are contributing to the network’s consensus functions, including mining new blocks and validating transactions.

In return for securing the network, stakers earn rewards in the form of tokens and/or transaction fees generated by the network. Staking not only incentivizes network participation but also helps ensure the integrity and security of the blockchain. It has become an attractive option for cryptocurrency holders to earn passive income and actively participate in the growth of their chosen blockchain projects.

While staking is an effective way to earn passive income and increase network participation, there are important risks to consider including slashing. Slashing can occur if a validator misbehaves or is offline for too long. When PoS blockchains enable this mechanism, it can result in the staker (also known as a validator) losing a portion of their staked tokens.

Before we dive into the different types of staking, we’ll explore why an individual or an organization would choose to use staking-as-a-service, including how the above risk may be mitigated by using a staking provider.

What is Staking-as-a-Service?

A staking provider offers staking services as a third party service, allowing individuals or entities to participate in the process of staking cryptocurrencies through a platform. Staking providers ideally offer a user-friendly interface that simplifies the staking process, reduces slashing risk through professional management, and may enable higher staking yield through more performant infrastructure.

Validation Cloud, for example, is a staking provider that offers a reliable and secure platform for users to engage in staking. We are different from other staking providers in three key ways:

1. Deep and broad network coverage: we support a wide range of blockchain networks, with more networks being added on a regular basis, often due to client demand. Having more options allows users to trust a single provider for all their assets and engage with promising emerging networks in addition to well-known networks.
2. Automated deployment and management of validators: stakers do not have to worry about the technical aspects of staking. Validation Cloud takes care of everything, from setting up the validators to monitoring their performance.
3. Deep expertise in blockchain technology: we have been operating as institutional validators in emerging ecosystems, helping shape network design. This gives us the knowledge and experience to help our stakers maximize their staking rewards.

Stay tuned for an in depth blog on staking providers and how Validation Cloud’s platform sets itself apart from other providers. For now, let’s jump into different types of blockchain staking and what the future of staking holds.

Types of Blockchain Staking: Proof of Stake (PoS) and Delegated Proof of Stake (DPoS)

Proof of Stake (PoS): Proof-of-stake (PoS) is an alternative consensus mechanism that emerged to address some of the limitations associated with Proof of Work (PoW). In PoS, validators are chosen to create new blocks and validate transactions based on their “weight,” or the amount of tokens staked with that validator vis-a-vis the rest of the network. By staking their tokens, validators power network consensus and are incentivized through rewards and transaction fees. Stake serves as a security deposit, ensuring good behavior from validators as networks will slash tokens to punish bad actors. Unlike PoW, PoS significantly reduces energy consumption since it doesn’t rely on intense computational calculations. Additionally, PoS allows for greater scalability and lowers barriers to entry as it doesn’t require expensive mining equipment. PoS has gained significant popularity as it offers a more eco-friendly and accessible method for participating in blockchain networks while still ensuring their security and efficiency.

Delegated Proof of Stake (DPoS): Delegated Proof of Stake (DPoS) Delegated Proof of Stake (DPoS) is a variant of the Proof of Stake (PoS) consensus mechanism that introduces a delegation model to enhance efficiency and scalability. It enables token holders to vote for delegates who will validate transactions and create new blocks on their behalf. These delegates, known as “witnesses” or “block producers,” are selected based on their reputation, technical expertise, and stake in the network.

By delegating the block production and validation process to a limited number of elected witnesses, DPoS achieves high transaction throughput and low latency, making it ideal for applications requiring fast confirmation times and scalability.

Other forms of PoS: A number of other networks deploy their own unique consensus mechanisms that are quite similar to PoS. For example, Solana utilizes Proof of History, Avalanche leverages the Snow consensus protocol, and Cosmos Network uses Ignite (formerly known as Tendermint) to name a few. These networks usually have validators and node operators, but may refer to them with different terminology.

Staking Incentives: Rewards and Transaction Fees

There are two types of incentives in staking: rewards and transaction fees. Staking rewards are a kind of income paid to crypto owners who help regulate and validate a cryptocurrency’s transactions. The amount of rewards that a validator receives depends on the amount of cryptocurrency that they stake and the number of blocks that they validate. Rewards are paid in the cryptocurrency that a person is staking. Transaction fees are paid by other stakers who are sending cryptocurrency on the blockchain network. These fees are used to compensate stakers for their services. The amount of transaction fees that a staker receives depends on the number of transactions that they validate. Both rewards and transaction fees are paid in the cryptocurrency that a person is staking.

The overall market size is quite massive, the sector has a $315 billion market cap. According to Staking Rewards, the average yield of a blockchain is 7.29%, which means revenue associated with the staking ecosystem exceeds $23 billion per year. Another interesting factor is that most blockchains have 40–70% of their total token supply staked. Ethereum is a bit of an outlier to this, with only 17% staked as of July 2023, showing the potential for growth in the newest PoS chain.

The Future of Staking

Liquid Staking: Enabled by Ethereum 2.0, liquid staking creates a tokenized version of the staked funds that allow users to use the liquid staking token to participate in DeFi. Liquid staking solves the problem of illiquidity, removing barriers to unstaking since tokens are typically locked up in networks. Several DeFi protocols like Lido, Rocketpool, and Stader now exist to allow liquid staking solutions on top of networks like Ethereum, Solana, Polkadot, and Avalanche. The liquid staking market has grown close to $20 billion and is the fastest growing segment in DeFi.

Restaking: Restaking is a process that allows users to secure projects by restaking their ETH into an Ethereum smart contract. The purpose of restaking is to more quickly build stake on a network from scratch by securing multiple projects with the same pool of ETH. Protocols such as EigenLayer are enabling restaking, which makes it easier for projects to launch by leveraging the massive amount of security dedicated to the Ethereum protocol. Through restaking, users contribute to the security and stability of the project while earning potential rewards. Restaking, alongside other staking-related innovations, showcases the continuous evolution and experimentation happening in the blockchain space.

In summary, the future of staking in the blockchain industry continues to gain momentum. As more blockchain networks adopt PoS and similar consensus mechanisms, staking will become even more prevalent and accessible to a wider range of users. Staking offers a unique opportunity for crypto holders to earn passive income while actively participating in the growth and development of blockchain projects. As the ecosystem evolves, we can expect to see further innovations in staking mechanisms and the emergence of new ways to engage and incentivize participants in securing blockchain networks.

Resources

• How-To Guide: How to Stake and Unstake Validators with Validation Cloud: A Step-by-Step Guide
• Validation Cloud Docs
• Blockworks: Validation Cloud launches platform for institutional stakers

About Validation Cloud

Validation Cloud is a Web3 data streaming and infrastructure company that connects organizations into Web3 through a fast, scalable, and intelligent platform. Headquartered in Zug, Switzerland, Validation Cloud offers highly performant and customizable products in staking, node, and data-as-a-service. Learn more at validationcloud.io| LinkedIn | X | Medium