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Crypto 101

What is Staking and How Does it Work?

Staking is central to Proof of Stake (PoS), the newer consensus mechanism that powers blockchains.

Staking is the act of buying and setting aside a certain amount of digital asset tokens to become an active validating node for a blockchain network. In simpler terms, staking is a way to earn rewards for holding crypto assets. By holding digital assets, a buyer becomes an important part of a blockchain network’s security infrastructure and receives rewards. Staking is central to Proof of Stake (PoS), the newer consensus mechanism that powers Ethereum and other blockchains. While mining powers Proof of Work (PoW) blockchains, participants contributing to a PoS network are selected to add new data blocks to a blockchain based on the assets they have staked.

Proof of Stake Blockchain Validation

Here’s how PoS validation works. When a new block needs to be added to a PoS blockchain, individuals known as “validators” contribute - or “stake”- their digital assets. In return, validators have the opportunity to validate new transactions, update the blockchain, and earn rewards. The selection of validators by the network is based on the amount of native digital assets the validator has staked in the asset pool, and the length of time they have been staking. The staked crypto assets earn rewards while held because the blockchain puts the assets to work. Generally, participants with more assets staked have a higher likelihood of being chosen as validators and rewarded with crypto in exchange for their efforts.  

What are the advantages of staking?

Many long-term digital asset holders view staking as a way of increasing ROI on their digital assets through reward generation rather than having the digital assets simply sit in their portfolios. Staking rewards are similar to dividends in a stock market account in that they are passively earned through the ownership of the asset (stock or cryptocurrency).

Staking also contributes to the security and efficiency of blockchains. Lower energy consumption by the PoS blockchain consensus mechanism is achieved through the selection of validators. By staking, individuals enhance the strength of the blockchain and make it more resistant to attacks.

Are there risks associated with staking?

Staking typically requires a “vesting” period, where your assets can’t be transferred for a certain period of time. This can be a drawback, as individuals will not be able to trade staked assets during the vesting period, even if prices shift. Each coin has unique requirements and rules associated with staking. We recommend researching the assets you are considering staking to understand any minimums, time commitments, and vesting restrictions involved.