What is Proof-of-Stake (PoS) and Why is it Essential for Crypto?
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Crypto players are exploring alternative consensus mechanisms to the original Proof-of-Work (PoW) consensus, which has been part of the crypto space since its early days. Among the most popular alternatives are the Proof-of-Stake (PoS) consensus and its variations. This guide will explain proof-of-stake, its strong points, and some of its downsides.
While cryptocurrency and all its major aspects are paperless, mining tokens is energy-intensive and requires sophisticated machinery to solve complex algorithms and confirm each transaction. In the Proof-of-Work (PoW) model, which has been in use since 2009, transactions are added to a particular blockchain network. The confirmation of transactions requires advanced computers to solve cryptographic puzzles.
This process is highly competitive, energy-intensive, and leaves behind too much carbon footprint. Against this backdrop, many crypto players are moving to the Proof-of-stake model of authenticating cryptocurrency transactions and mining new tokens.
What is Proof-of-Stake (PoS)?
Proof-of-stake (PoS) is an alternative consensus mechanism used for confirming crypto transactions and is known for minimizing the computing resources required to authenticate transactions.
Thus, unlike the Proof-of-Work model, the PoS approach is more environment-friendly.
For that reason, but also for increased scalability, the Ethereum network is set to undertake a major software upgrade aiming to slash the energy required to mine new coins and confirm transactions. The upgrade is known as the "Merge" and is set to replace the PoW model Ethereum has been using since its invention.
How Proof-of-Stake Works
In crypto, a consensus mechanism is used to validate and keep entries into a database secure. Since cryptocurrency uses blockchain as its database, the consensus mechanism should secure the blockchain.
The Proof-of-Stake model embraces a simple idea: instead of mining power, the odds of creating a block and receiving the associated reward depend on the user's stake in the system.
For instance, an individual stakeholder with X number of coins in circulation can create a new block with X probability. Users with the highest stakes in the system are the most interested in maintaining a secure network. This is because they hold the highest level of risk if the price and reputation of the cryptocurrency suffer due to attacks.
The stakeholders, also known as validators, are chosen randomly based on different factors, including the number of coins they have locked up in the blockchain network. This process of locking up crypto coins in a given blockchain network is known as crypto staking. The locked-up coins are used as collateral; each time a participant validates a transaction, they receive a reward.
Several validators must agree that a transaction is accurate, with enough nodes to verify it before it goes through. Overall, the PoS approach is more energy efficient than the PoW model.
However, the basic PoS model seems like a whale paradise to some. Yet, the modern implementations of this consensus mechanism include a rule to prevent the same staker from being chosen several times in a row, giving more chances to other participants.
The conditions to qualify as a validator vary from one project to another. In some, you have a minimum stake required; in some, you have a fixed stake. For example, Ethereum's "stake" is fixed at 32 ETH.
Proof-of-Stake Variations
Nowadays, the PoS consensus mechanism is available in different forms. Here are five of its variations:
1. Proof-of-Stake (PoS)
The basic Proof-of-Stake is the foundation of all other variations. The original Proof-of-Stake consensus mechanism was developed in 2012. This model uses validators to generate and confirm blocks of transactions through staking. The main advantages of Proof-of-Stake are energy efficiency and lower transaction fees.
2. Pure Proof-of-Stake (PPoS)
This Proof-of-Stake variation uses randomly selected validators to verify blocks using a "selection seed" per block. The validators are chosen secretly according to the number of coins they can stake. Algorand is an example of a popular blockchain that uses the Pure Proof-of-Stake model.
3. Delegated Proof-of-Stake (DPoS)
This Proof-of-Stake variation involves delegating or electing validators according to the votes they get from stakeholders. Stakeholders on a DPoS blockchain can pass their funds on to third-party validators who can use the funds to boost the chances of generating or confirming a new block.
Stakeholders vote for the candidate they trust the most. Some of the popular blockchains using the Delegated Proof-of-Stake mechanism include EOS, TRON, and Steem, among others.
4. Hybrid Proof-of-Stake (HPoS)
The Hybrid Proof-of-Stake model embraces the main benefits of both Proof-of-work and Proof-of-Stake mechanisms. It uses miners who only generate new blocks and leave them for the validators to verify. Combining PoW and PoS blocks miners from holding all the hash power within a given network.
5. Proof-of-Validation (PoV)
The Proof-of-Validation (PoV) variation is a more secure version of the Proof-of-Stake mechanism. It allows every validator on the platform to own a copy of each completed transaction. Besides, each validator has a list of all stakeholders on the network, identified by their public key addresses. Two-thirds of the system's validators must agree to confirm a new block.
Proof-of-Stake Advantages and Disadvantages
According to crypto and blockchain experts, Proof-of-Stake delivers more advantages than the Proof-of-Work model. It offers faster transaction speeds and more energy efficiency. With these advantages, the Proof-of-Stake model supports more scalable blockchains, making it easier for more users to join the networks.
Additionally, the Proof-of-Stake model creates opportunities to earn more crypto. It allows users to stake their crypto assets in a liquidity pool to earn more coins as rewards in return.
Yet, it is generally thought to be less secure.
In summary, here are its pros and cons:
Significantly less energy intensive;
More financial opportunities;
Faster transaction speeds;
Improved scalability.
Generally considered to be Less secure compared to PoW;
Depending on implementation, it's less decentralized;
The entry-level for staking can be quite high;
Some conditions may impose stake slashes.
How to Make Money Staking Crypto
In the Proof-of-Stake model, the validators, also known as "stakers," put their assets into a smart contract embedded in the blockchain. The blockchain algorithm picks validators to verify each new data block according to how many coins they have staked and other factors.
The validators that successfully confirm transactions are rewarded either with newly created coins, network fees, or both depending on the algorithm.
Validators who verify only good transactions can earn more interest on their assets. However, validators who approve potentially fraudulent transactions that don't conform to the network's rules can lose some of their assets as a penalty.
But generally, staking rewards vary from one platform to another depending on the rules governing the network. The staking rewards can also change according to the number of validators involved and the size of the reward pool.
How to Get Started With Staking
According to experts, crypto holders looking to earn rewards through staking can get started on various crypto exchanges instead of setting up their own nodes. This is because those platforms offer staking rewards on multiple coins, which opens up more opportunities for earning rewards. Even so, crypto owners can explore more options, such as DeFi lending and staking-as-a-service platforms.
Getting started on a crypto exchange is easier. After buying coins, you just need to inform the exchange of your interest to participate in its staking program. Usually, you can access it from the user interface.
All the rewards earned are deposited straight to your account according to the governing rules of the exchange.
Mainstream crypto exchanges are already offering proof-of-stake coins and DeFi lending coins. In DeFi lending, users lend stablecoins like Tether (USDT) to earn profits. Stablecoins are backed by real assets like the U.S. dollar, bonds, or gold. This gives a more robust valuation than other cryptocurrencies like Bitcoin or Ethereum.
Some potential risks of staking
While it offers a credible way of earning crypto, crypto staking has its share of downsides:
Volatility of the underlying cryptocurrency
Some potential rewards may be hyperinflationary
The platform or the cryptocurrency could be hacked
Users may lock up their crypto for a long period
Some staking platforms are insecure and fraudulent
Proof-of-Stake Cryptocurrencies
Currently, nearly 80 cryptocurrencies use the Proof-of-Stake mechanism. Some of the notable coins using the mechanism include:
ADA owners can lock up their assets on the Cardano network and earn rewards according to the size of their stakes. The ability to delegate or pledge a stake depends on the governing rules of the Cardano network.
Recently, the Polkadot staking dashboard was launched, and it's already getting hits with thousands of visits every week. The platform urged validators to benefit from the new app as early as possible and reap its potential.
The Ethereum platform has made staking since long before the Merge. To get started, validators should lock up at least 32 ETH to allow them to earn rewards.
The original idea behind the Proof-of-Stake consensus mechanism is to improve scalability and reduce environmental sustainability concerns witnessed in the Proof-of-Work protocol. While the PoW mechanism is more secure and offers a competitive approach to authenticate transactions, it's more energy intensive and raises many environmental concerns.
The Proof-of-Stake protocol aims to solve these problems by replacing computational power with staking. The network picks validators randomly to verify transactions, leading to a massive reduction in energy consumption.
Before getting into staking, new and casual crypto investors should also consider other core metrics like market capitalization, trading history, and price mechanisms of the crypto they chose.