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What Is Proof-of-Stake?

Last updated 29th Nov 2022
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Proof-of-stake (PoS) is a secure and less energy-intensive consensus mechanism where the validators stake their crypto capital into the smart contract of the blockchain network to gain eligibility to verify transactions and making sure that the new blocks propagated over the network are authentic.

The staked crypto capital work as a collateral that can be incinerated if the validator does not behave honestly.

There are two consensus mechanisms - Proof-of-Work (PoW) and Proof-of-Stake (PoS). Proof of Work is the oldest and is used by coins like Bitcoin, while Proof of Stake PoS is new, more environmentally friendly, and energy-efficient to operate. However, there are many differences between both consensus mechanisms that would be beneficial to understand.

This guide covers everything you need to know about proof-of-stake, from the basics to the top platforms for staking and a few cryptocurrencies you can start staking right now.

Key Takeaways

  • Proof-of-stake takes consumes less energy to run than proof-of-work.

  • Investors can earn interest on coins by staking them into the contract

  • Staking is readily available on most cryptocurrency exchanges.

  • Validators are selected randomly, but those with higher staking positions have a better chance of being chosen.

  • Proof of Stake PoS was created to be more energy efficient than Proof of Work.

How Does Proof-of-Stake Work?

The objective of a consensus mechanism in a decentralized blockchain protocol is to enable the verification of the new blockchain transactions, adding them to the blockchain network, rewarding the validators, and introducing new tokens into the circulation.

While there are many consensus mechanisms, the way they work is where you will find the difference. As far as proof-of-stake is concerned, the validators stake (lock) their crypto funds into the smart contract to gain eligibility of verifying transactions on the network. For example, Ethereum requires 32 ETH to be staked before becoming a validator.

The validators are randomly selected to confirm or validate transactions presented for the verification. The higher the amount staked into the contract, the higher is the probability of being selected to verify the transaction and earning the rewards.

Proof-of-Stake Versus Proof-of-Work

The main difference between Pos and Pow consensus mechanisms is that Proof of Work consumes a lot of energy for computing power, while PoS uses substantially fewer resources. Also, they both have built-in consequences that penalize malicious actors.

With proof-of-work, miners submitting incorrect information will waste their money on hardware and time mining. On the other hand, with proof-of-stake, bad actors will lose a portion of their staked coins as a penalty. Here are some more differences between the consensus systems:

Key Differences Between PoS and PoW

This table discloses the key differences between Proof of Stake PoS and Proof of Work PoW.

Proof-of-StakeProof-of-Work
More energy efficientLess energy efficient
Security is achieved through community control and governanceOutstanding security due to network of miners
Investors must buy coins to stake for earning rewardsInvestors must buy mining rigs and energy to mine
Stakers receive transaction fees as rewardsMiners acquire block rewards

Negatives of PoS and PoW

Both consensus mechanism have their drawbacks, which affects their scalability, long-term potential, and security. These are the main negatives that you should know:

PoW Negatives

  • Entry Barrier: Proof of Work requires expensive and powerful computers capable of processing significant computational power to solve mathematical puzzles and verify the transactions.

  • Energy Consumption: Proof-of-work demands a lot of computational power and expensive hardware to run. In comparison, proof-of-stake uses less than 99% of the power and doesn’t need GPUs to solve cryptographic puzzles, making it a viable long-term solution.

PoS Negatives

  • Governance Issues: Some participants can stake a significant amount of funds to improve the odds of getting selected and earning maximum rewards followed by more control of the network. This can potentially lead to a centralization of the cryptocurrency.

  • Vulnerability: Proof-of-stake is more vulnerable to an attack than proof-of-work due to the potential centralization aspect. Individuals, groups, or businesses with a lot of money can theoretically own the network simply due to capital.

Should You Stake?

Staking provides the opportunity to earn interest on your cryptocurrency with little risk. In our opinion, it’s definitely worth a try to explore the staking options, especially if you plan to hold long-term since you won’t be able to use your coins anyways because of their locked state.

In addition, some established coins offer airdrops, which are rewards distributed for holding a specific cryptocurrency for a time period. In some cases, if you are staking you’ll earn significantly more airdrop rewards.

Anyhow, the answer should depend on your research into the subject as you are responsible for your investments. Cryptocurrencies are highly volatile so you may lock your coins and witness the price fall without having the option to withdraw. Therefore, you should never invest more than you are willing to lose. Note: Not a Financial Advice (NFA).

The Pros and Cons of Staking

If you’re having a difficult time deciding whether or not to stake, here are some pros and cons:

Pros

You do not need to purchase mining hardware. The only monetary cost is your initial investment into the coin.
It’s easy to stake through crypto exchanges like Binance, Kraken, and Coinbase.
Cryptocurrency exchanges like Binance, Kraken, and Coinbase make it effortless to stake.
You can stake on decentralized and centralized exchanges.

Cons

Cryptocurrencies are highly volatile. Therefore, you may stake and end up at a loss due to a price downfall in the coin’s value.
To unstake before a predetermined date set by the exchange, you’ll likely have to pay a fee.
There are few rewards for staking established coins like Ethereum.
Not worth it if you have a short-term investment strategy and want to sell your coins quickly.

Top Cryptocurrencies to Stake

There are several established cryptocurrencies you can stake. However, before staking any coin, you’ll need to buy it first. Therefore, we’ve created this table that discloses the top cryptocurrencies to stake, where to buy them, and the top exchanges for staking.

CoinSymbolLearn How to BuyWhere to Stake
EthereumETHBuy EthereumCoinbase
CardanoADABuy CardanoBinance
PolkadotDOTBuy PolkadotBinance
AvalancheAVAXBuy AvalancheBinance
AlgorandALGOBuy AlgorandCoinbase

Staking Step-By-Step Guide

Here’s a simple step-by-step guide on how to stake on an exchange. Most platforms follow a similar process, so the steps will be generalized:

  1. Create an Account: First, select an exchange that supports the staking of coin of your interest and sign up.

  2. Verification: Provide your personal details like name, age, location, and email. Then verify your identity by uploading a picture of your government-issued document.

  3. Deposit: Next, deposit cryptocurrency or fiat currency into your account. If you’ve transferred fiat currency, spot trade to acquire the coins to stake.

  4. Stake: Open the investments section and select “Staking”. Now choose the coin you would like to stake.

  5. Quantity: Finally, type in how many coins you want to allocate and lock and then press the “Stake” button.

Staking Risks

Cryptocurrency staking is generally considered a wise investment choice as you gain “free” rewards that are quantified based on the APR offered. However, there are many risks associated with staking that you should know about before committing your capital. Here are some of them to consider:

Locked Staking

Exchanges can provide staking assets requiring you to lock your tokens for a specific amount of time. If the price of the coin was affected drastically, you wouldn’t be able to withdraw and must wait until the staking period ends to retrieve the funds. Staking without a lockup period is an excellent way to mitigate risk, although the rewards are relatively smaller.

Market Volatility

Perhaps the biggest risk is “market volatility” since prices constantly rise and fall. Therefore, you may begin positive staking at the start of the year and end down -50% by the end. Therefore, you must strategically pick out the cryptocurrencies you want to stake. Ensure they have a long-term value and do not go solely based on huge APY/APR numbers.

Hacked or Stolen

There is always a risk of leaving your funds on an exchange because they are huge targets for hackers. Ideally, you’ll want to stake through a DEX because you own your private keys. Not your keys, not your crypto.

Risk of Liquidity

Small altcoins seem attractive to buy and stake for their huge APY. However, you can face liquidity issues if it's a micro-cap cryptocurrency. This means there isn’t enough trading volume and liquidity to sell. You can check out websites like CoinMarketCap that disclose this information and make an informed decision if the coin is healthy enough to stake.

Final Thoughts

To summarize, proof-of-stake is a consensus mechanism for validating transactions on the blockchain. It’s more efficient than proof-of-work in terms of energy consumption and scalability. However, it has potential centralization issues if a single party stakes more than the rest of the community.

Staking is a brilliant part of the PoS consensus mechanism that lets investors earn interest on their crypto. By allocating your stack of coins to the staking pool, you are supporting the network, validating transfers, and earning rewards. Note that the reward size depends on how many coins you commit to the staking pool.

What is PoS systems simple explanation
What Is Staking?
Where Can I Stake My Cryptocurrency?
Are There Risks With Crypto Staking?
Can I Stake Using a DEX?
Should I Do Locked Staking?

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Idil Woodall

Idil Woodall

Idil is a writer with interests ranging from crypto and politics to fintech and media. She spent several years in publishing before becoming a full-time writer in the technology space, and learning the inner workings of an industry she loved ignited her interest in economics. As an English graduate, she cultivated valuable research and storytelling abilities that she now applies to make complex matters accessible and understandable to many. When she’s not writing, she can be found climbing or watching a movie.