The Investor's Guide to Staking

A quick primer on proof-of-stake

Proof-of-stake (PoS) describes blockchains that rely on an internal token (‘stake’) to achieve network consensus. This is different from traditional proof-of-work blockchains, which rely on mining with computational power and use an external resource, such as energy, to achieve network consensus.

Proof-of-stake uses a fraction of the energy cost that proof-of-work (PoW) uses, enabling thriving DeFi ecosystems to operate with sustainable environmental usage.

By decoupling from an external source, proof-of-stake networks offer token holders “skin-in-the-game” incentives through staking. As the paradigm has grown popular in Web3 ecosystems, more user-friendly implementations have been created to simplify the process.

Most proof-of-stake networks support two methods of staking tokens:

1. Staking

2. Delegating Factors determining which to choose include a token holder’s level of technical expertise, the number of tokens they have available, and the effort they’re willing to invest.

What is staking?

Blockchain networks are decentralized. So, how does a proof-of-stake network remain secure and free from centralized control? Moreover, who decides which blocks get added to the ledger?

The answer to all of these is staking.

Staking rewards participation in proof-of-stake protocols. It aligns network security with individual incentives.

Stakers allocate their tokens to a validator node. Once tokens are staked, they are locked up and essentially untouchable for a period of time. The time required to unlock staked tokens depends on the network they are locked in. The time it takes for staked tokens to be accessible is variable and should be considered when staking. Successful validators have the right to bundle and process transactions into blocks on the blockchain. Their efforts are rewarded with the blockchain’s native crypto tokens.

The case for staking

Staking is an alternative to the traditional proof-of-work consensus model that networks such as Bitcoin use. It has become the default model for many blockchains, including Ethereum, Solana, and Avalanche. While most benefits of staking apply to both staking and delegation, deciding between the two paths is straightforward, as each was created to appeal to a specific kind of participant. The setup, security, and maintenance of a validator node are not difficult for those with some degree of familiarity with the subject, so the technical barrier to entry isn’t typically high. This makes staking directly an attractive option for retail that’s interested in Web3 and wants to participate actively.

Should you choose staking or delegating?

At a high level, staking generally provides higher returns than delegation, but it requires significant additional effort and is a more active activity. Conversely, delegation generally provides lower yields but requires minimal effort and is a more passive activity.

Staking requires the token holder to set up a validator node and maintain the process. This is popular among individuals with relevant skills who prefer to manage their validators.

Delegation is a convenient, low-risk alternative for individuals or institutions looking for an easy process without logistical limitations such as node management or operation.

When delegating, a token holder ‘delegates’ their tokens to a trusted validator. This allows the token holder to take a share of the rewards without any of the setup and maintenance. The token holder always retains full control and ownership of their tokens, which are allocated to the validator for staking purposes.

Some delegation platforms also guarantee a node is completely owned by the delegator, just operated by the platform, to preserve the autonomy and influence of delegators over their stake.

Delegation is becoming a very popular option across blockchains, as it is more attractive for many users.

Energy cost

Compared to its predecessor, proof-of-stake has significantly lower energy costs. Instead of elaborate mining rigs and expensive GPUs, running a proof-of-stake node simply requires using your internet-connected computer — and staking pools are even less demanding. In addition to resource efficiency, proof-of-stake offers a range of use cases that aren’t compatible with a proof-of-work model, like sharding.

Scalability

Sharding form of database partitioning where large “blocks” are split into smaller, faster blocks. These shards eliminate the need for each node to process the transaction load of the entire network.

Proof-of-work, by comparison, requires each node to process every ever-growing block. Shards work in parallel to maximize transactions per second—requiring less processing power and storage per node. Sharding allows the network to scale its transaction throughput by a multiple of the number of shards a chain uses.

Ease of operation

Running a blockchain node can be complicated for beginners, but proof-of-stake minimizes this complexity.

You don’t need banks of mining nodes, you only need to run a single validator. Plus, accessible solutions like Blockdaemon’s node management platform simplify things even further. You just need enough cryptocurrency and the right infrastructure partner to start securing rewards.

Rewards

Staking lets token holders secure rewards on tokens that would otherwise be idle. Because of that, it is a popular investment model.

While a number of factors can affect your expected reward, it’s common to gain 6% to 12% returns across DeFi protocols. This is advantageous for both finite-supply assets and for outpacing inflation on higher-issuance assets and fiat currencies.

Airdrop eligibility

Airdrops, or ‘stakedrops’, are a fun and lesser-known advantage of staking. New projects often airdrop tokens to validators on their chain. This means that stakers on popular chains are often the first beneficiaries of innovation.

Boost network security

The more holders that stake, the more secure the network becomes. With more validators processing transactions and checking other validators’ work, malicious actors and modified blocks can be dealt with increasingly efficiently.

Participate in governance

Depending on each blockchain’s specific implementation of PoS, validators hold varying degrees of network influence. Typically, there are consistent stake benchmarks that grant validators a specific amount of power. For example, to run one node on the coming ETH 2.0, one must stake 32 ETH per node.

With staking pools, those nodes can be broken down into smaller portions split between all participants that pool their resources to operate nodes together.

How to start staking

The first step in becoming a validator is to decide which network to stake on. This decision depends on which assets and networks you believe will thrive in the long term and which align with your investment ethos.

Once decided, a prospective validator can set up a node, stake their tokens on their chosen blockchain and enjoy the benefits.

Delegating to a trusted validator

For institutions looking for scale or for users unfamiliar with the technical processes and security standards of staking, delegating stake to an established validator makes the process simple.

For example, Blockdaemon has validator nodes for more than 50 blockchains and supports quick and secure delegated staking on protocols like:

● Solana ($SOL) – High-performance blockchain that lets builders build and use dApps globally – start staking

● Cosmos ($ATOM) – Ecosystem of interoperable and sovereign blockchain apps and services – start staking

● Livepeer ($LPT) – Platform for decentralized video streaming – start staking

Using a liquid staking solution

Traditional staking locks a validator’s crypto in a smart contract that has a chain-dependent delay in unstake time. To ensure validators can unstake and access their crypto freely, liquid staking solutions have been developed by different protocols and companies.

Liquid staking allows delegated validators to shoulder the unstake wait times and grant users instant access to funds instead of making them wait. This way, users can enjoy both the yield-farming benefits and the flexibility of instant fund access.

Examples of Liquid Staking Protocols

Osmosis Superfluid Staking – “Reverse” liquid staking using tokens already circulating in DeFi protocols
Acala Liquid Staking on Polkadot – the first liquid staking product in the Polkadot ecosystem
Lido Liquid Staking for Ethereum & Solana – multi-platform liquidity for staked assets
Blockdaemon and StakeWise Institutional Liquid Staking Solution – fully compliant institutional-grade staking on ETH2

Final Considerations

All investment models should be carefully weighed against one’s risk tolerance and ethical convictions, but staking has a few method-specific risks:

Slashing

The biggest risk to staking is slashing or losing your principal staking amount due to being pegged as a “bad actor” on the network. When a smart contract detects an attempt to manipulate the blockchain or network, it programmatically punishes perpetrators by forfeiting their staked amount.

Validators not attempting to maliciously change or exploit the network should have nothing to worry about, but with different expectations on each network, it can be tricky to remain compliant. Additionally, validators who fail to perform their functions (due to internet outages, for example) may also be at risk of slashing mechanisms, depending on the blockchain.

Slashing insurance has been introduced by delegated validators, like Blockdaemon’s 100% slashing insurance guarantee, to resolve the risk of slashing.

Lockups

Lockups are the default staking mechanism for most blockchains. With some lockup periods taking days or weeks to withdraw from, fund accessibility is important to consider. Liquid staking solutions resolve this risk.

Get educated. Check out The Investor’s Guide to AVAX, The Investor’s Guide to Music NFTs, The Investor’s Guide to DeFi 2.0 and The Investor’s Guide to Avalanche.

The content of this webpage is not investment advice and does not constitute any offer or solicitation to offer or recommendation of any company, product or idea. It is for general educational purposes only and does not take into account your individual needs, investment objectives or specific financial circumstances.