Bitfinex launched its cryptocurrency staking service on 7th April 2020. If you’re unfamiliar with how cryptocurrency staking works, we’ve created this quick guide to help give you a better idea about crypto staking, the technology and the philosophy behind it.
Proof of Work vs Proof of Stake
Before getting into cryptocurrency staking, first, we need to understand about the underlying concept that enables it. In blockchain, there are various consensus mechanisms, or more familiar as consensus algorithms. A consensus algorithm is a set of rules that govern how nodes validate transactions that will be added to the blockchain. Each blockchain network has its consensus algorithm, which is determined upon creation.
The consensus algorithm is essential in blockchain as it creates a way for parties who don’t know each other to unanimously agree on something, in this case, whether a block of transactions should be added to the blockchain network.
There are several known consensus algorithms in crypto, but these two – Proof of Work (PoW) and Proof of Stake (PoS) – are known as the oldest and most commonly used.
- Proof of Work (PoW)
What is Proof of Work in blockchain? PoW is the first consensus algorithm created, which is used by many renowned cryptocurrencies, such as Bitcoin, Litecoin, Ethereum, Monero and Dogecoin. In the Proof of Work consensus algorithm, the process to generate a new block in the blockchain network is called mining. To do so, a miner must compete with the other miners to solve complex cryptographic problems as fast as possible. The successful miner will then be rewarded with an amount of cryptocurrency or known as block reward for their efforts; in the bitcoin network, for example, the reward is 12.5 Bitcoin for each new block successfully created.
The process to solve the difficult mathematical puzzle requires a lot of computational power, thus operating a PoW-based blockchain network is very energy-intensive.
- Proof of Stake (PoS)
PoS was created as an alternative to PoW. The PoS mechanism is somewhat akin to standard practices in a business entity, where shareholders get the privilege to make decisions and the bigger the shares, the bigger the influence.
In PoS, new blocks are generated by a validator, also called forger or minter, which is selected according to specific criteria. Several common criteria are the numbers of tokens/coins held and coin-age or the length of time a forger has held the tokens/coins.
In a Proof of Stake consensus mechanism, it is more likely for a participant who owns a large number of tokens for a lengthy period to be selected as a forger. Furthermore, the number of new blocks being minted can’t also exceed the number of tokens held by the forger.
The reward for adding blocks comes from accumulated transaction processing fees. A validator will receive the forging reward and get its staked tokens back only after the block it validates is approved by the other nodes in the network. In the case where the block is deemed fraudulent by the nodes in the network, the validator will not be rewarded. It will also experience slashing, which means the validator loses all or part of its staked tokens. Moreover, the algorithm will mark it as a “bad” node.
Basically, the Proof of Stake consensus encourages and empowers holders to stake in order to be able to forge new blocks to the network. Thus, PoS is considered by some to be “safer” than PoW since the threat of 51% attacks is reduced in a PoS system. Someone who has a 51% hash power in a PoS token network wouldn’t want the value of the tokens to fall. Thus, in theory, they wouldn’t attack the network, although they have the power to do it.
It is from the PoS consensus algorithm that cryptocurrency staking emerges.
Cryptocurrency Staking Explained
So, what is crypto staking? Crypto staking is the act of holding a specific number of supported tokens for a period of time in the hope of earning rewards, and at the same time, contributing to the tokens’ governance. As the term implies, it only applies to tokens that employ the PoS consensus algorithm, such as EOS, Tezos, Cosmos and VSYS.
Why crypto staking?
Staking cryptocurrency is one of the many avenues to increase one’s crypto holdings. However, the most appealing thing about it is probably the fact that it allows you to passively grow your holdings (after you’ve decided where to stake to manage your slashing risk).
What’s more, crypto staking has many other benefits to offer, such as:
- No special machines required
Unlike mining that requires specific equipment, like ASIC, staking crypto only requires you to keep your tokens in wallets or platforms that are always synced to the tokens’ network.
No specific equipment means no excessive electricity power spending.
- No trading required
You earn your rewards for using your tokens up to help with the governance and operation of the protocol on which the token operates. You don’t need to trade..
Despite the sophisticated technology and concept that underlie cryptocurrency staking, in practice, it is pretty straightforward. Here’s how to stake in few simple steps:
- Do your research
Each PoS token has its own staking rewards scheme, terms and conditions, as well as the staking service provider has its fee structure, reputation and rules. Some ill-intentioned tokens, however, sometimes offer staking to incentivize users to buy up their coin as they dump on the markets. So, make sure you are well informed before making any decisions.
On Bitfinex platform, you can use the crypto staking calculator to find out about the potential rewards you could earn for all staking supported tokens.
- Choose the service provider
There are several options as to where you can keep your staked tokens and get rewarded. From digital wallet, crypto exchanges to crypto staking pools. Whichever crypto staking services you choose, make sure that you follow the given instructions and understand how it works clearly since each staking provider has its own set of features and offers.
Bitfinex, for instance, offers extra layers of protection for your staked tokens. We use various methods, such as insurance funds and a network of highly trusted nodes to minimize the risks of slashing and to make sure withdrawal requests can be accommodated.
- Pick the tokens of your choice
Now that you’ve done your research, you can pick the PoS tokens of your choice and start staking. You can purchase them first or use your existing tokens. If you’re interested in Bitfinex’s staking service, you can learn more here and stake with us if the token you’re interested in is on Bitfinex’s staking supported tokens list.
Cryptocurrency staking: There’s more to it than that
Aside from the financial benefits, staking cryptocurrency also means participating in the cryptocurrency governance and operation. Token holders who stake their tokens not only receive staking rewards but also earn the power to vote for the decisions that have an impact on the future of the token.
PoS token holders who stake their tokens have played their part in promoting decentralization, which is the essence of cryptocurrency and the way of the future.