Many people are familiar with the term “mining”. It is a method through which miners can earn cryptocurrencies such as Bitcoin. However, there is another way using which users can earn cryptocurrency called staking.
Cryptocurrency mining is based on Proof-of-Work (PoW) mechanism, a mechanism that allows users to participate in verifying the network’s security and be rewarded by cryptocurrency. But what does it mean? Let’s dive into this concept before we explain what staking is, and how it works.
Satoshi Nakamoto, Bitcoin’s founder, conceived the need for verifying Bitcoin transactions to prevent the “double-spending” problem. It is a situation in which a Bitcoin owner spends the same Bitcoin more than once. This problem is unique to digital currency because, with physical currency, you no longer have it once you spend the paper currency. Spending fake money is also not easy because each paper currency has its unique serial number which is traceable. On the other hand, digital information can be reproduced relatively easily. Therefore, the purpose of validating transactions is to keep Bitcoin users honest and secure the legitimacy of Bitcoins. Each miner checks transactions to make sure that no user has illegitimately tried to double-spend the same Bitcoin.
So what miners do is that they dedicate their hardware (computational power) to the Bitcoin blockchain so that the network can verify transactions by solving mathematical problems. Each miner that verifies a block, which is equivalent to 1 MB worth of bitcoin transactions, is eligible to be rewarded with a quantity of Bitcoin. However, it is not a certainty because this process is based on some luck. In other words, a miner must be the first miner to arrive at the right answer, or closest answer, to a mathematical problem in order to be rewarded by Bitcoin. This process is known as Proof-of-Work or PoW.
Although this mechanism can verify the network’s security, it is highly energy-intensive. What’s more, miners need to invest substantial money to buy specialized mining hardware, such as ASCIs. These drawbacks motivated developers to look for alternative ways. As a result, many new blockchains use Proof-of-Stake (PoS) mechanism to verify transactions.
What is Proof-of-Stake?
As mentioned above, transactions in a blockchain must be verified. In PoS algorithm, participants can lock their cryptocurrency (their stake) in a wallet, and at certain intervals, the blockchain will randomly choose one of them to validate the correctness of transactions. Those who lock their coin to participate in operating the blockchain are called validators. The same as the PoW algorithm, the validators are rewarded with new coins for their provided service to the blockchain.
This algorithm does not require expensive and energy-intensive mining hardware. Therefore, participants only need to invest in the cryptocurrency itself rather than significant investment in hardware, and operating and maintenance costs.
How does staking work?
Different blockchains that work based on the PoS algorithm have different rules for their validators. These rules specify the requisite financial and technical requirements for participants to become a validator. For example, validators need to stake a minimum amount of coins (stake size), and the stake is locked up for a certain amount of time (lockup period), and these factors are defined by blockchains’ rules. Moreover, the algorithm that randomly selects validators to verify the next block, or the algorithm for rewarding validators are determined by blockchains’ rules. Typically, validators with a larger stake size have a higher chance to be selected for verifying the correctness of transactions. The duration of a validator’s activity in operating the blockchain can be another factor for validator-selecting algorithms.
It is noteworthy that validators put their stake at risk in this process. To ensure an efficient and secure blockchain, validators will be punished by losing their stake if they show dishonest or malicious behavior.