What is staking?
Blockchains use a variety of consensus mechanisms to secure their networks and validate transactions. Bitcoin, the first cryptocurrency, uses a Proof of Work (PoW) consensus mechanism (Nakamoto Consensus), with specialist computers called miners using processing power to solve complex mathematical problems to validate transactions into blocks and receive block rewards in return—a process commonly referred to as mining.
Proof of Stake (PoS) blockchains differ from Proof of Work as they do not rely on mining to secure their networks—instead, they use a concept called staking. The implementation of staking may vary depending on the blockchain; typically, users put their tokens into validator nodes that process transactions into new blocks and, in return, receive staking rewards for helping secure the network and ensure its stability. Staking rewards contain a share of the transaction fees generated by the networks’ users and new coins generated through the inflation of the total token supply.
There is usually a minimum token requirement to run a validator node, and staking pools allow users with smaller token holdings to pool resources to participate in staking and compete against larger nodes set up by individual users. The chance of validating a block is proportional to the maturity of the node and the amount of staked tokens, and nodes with more significant stakes that have been staked for longer often have a greater chance of validating blocks and receiving rewards.
Staked tokens act as collateral to ensure the legitimacy of new transactions validated onto the blockchain, and many Proof of Stake networks employ ‘slashing’ mechanisms to penalize bad behavior. For example, if transactions within a block are deemed invalid, then a portion of the tokens staked by the validator node that processed the block are forfeited.
There are multiple benefits of staking vs. mining; for example, staking is less energy intensive than mining as it does not require a high amount of processing power to validate transactions. Staking also has a lower entry barrier, as expensive miners do not have to be purchased to participate, and staking pools ensure an easy way to participate in the network.
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