Staking will dominate the cryptocurrency space

Anywhere from the medical industry to forward-thinking eCommerce businesses, the blockchain is gaining a foothold in our everyday lives, and showing no signs of slowing down. As it continues to extreme utilization conditions, there is a significant amount of uncertainty about how it can be most effectively utilized. The utilization of resources is one of them.

If you know Bitcoin, you may also be familiar with the concept of Proof-of-work consensus and the role of miners. Mining involves the process of solving complex mathematical puzzles, the first to solve, wins the right to add a new block to the blockchain. These blocks contain transactions. This mechanism is known as Proof-Of-Work. It ensures blockchain ledger includes correct transactions. Since it requires resources (hardware and electricity to run operation), it is expensive. To know more about Bitcoin mathematical puzzles, read here.

Proof-Of-Stake protocols on the rise

Proof-Of-Stake is an alternative to the Proof-Of-Work system. Instead of consuming resources (electricity), Proof-of-Stake requires validators (alternative to miners) to stake protocol’s tokens in the staking wallet in order to engage in proposing the next block or governing the network. 

Instead of competing to solve puzzles, the protocol randomly selects validators on the basis of the amount they have staked. Once selected, they reach a consensus on a block, and it’s added to the blockchain. 

Why staking capital is important in PoS protocols

A consensus mechanism helps to achieve the necessary agreement among distributed systems or participants on a single data value or a single state of the network. 

In PoS protocols, validators vote on the latest block. For validators not to manipulate their vote, the process is made expensive by asking them to lock their assets in a wallet and place a bet on their proposal. If found dishonest during the validation process, their stakes are smashed. 

Attractiveness of running as Validator node

Today many popular blockchain protocols are considering Proof-Of-Stake as the underlying mechanism for consensus. Examples – Cosmos, NEAR, Polkadot, Solana, etc. As of August 2020, nearly 60% of Proof-Of-Stake protocol’s market capitalization is locked in staking nodes i.e. more than $16.8 billion. Source: StakingRewards. 

The exact annual reward for staking varies from protocol to protocol. Usually validators earn upto 5% to 30% passive income from staking. Annualized staking reward for top blockchain protocol:

The entry threshold to run as a validator node is not as high as the cost of running a mining rig. However, it requires validators to have software know-how and hardware requirement to ensure the uninterrupted functioning of their nodes. If they disconnect, they lose all their daily income. This can be difficult for many crypto users.

Popularity of staking pools as a service

As the validators ecosystem in PoS protocols expands, so is the competition. Therefore, to increase the chances of selection, validators pool their stake together. A staking pool allows multiple stakeholders (or bagholders) to unite their stakes to increase their chances of earning the block rewards.

Using the service of the staking pool can be attractive to a wide range of crypto users. The pools take care of maintaining the node. All you need to receive annual interest is to delegate your PoS tokens to a staking node. It is as simple as having a bank deposit.

In these staking pools, everything from rewards to risk is shared among the participants of the pool, thereby minimizing the risk for a user. The biggest advantage of this solution is that the users can stake any amount, which allows for wide participation.

Downsides of Staking and Mitigation plan

• Liquidity crunch: While you lock your coins in the wallet, you can’t transact or sell them at a specific time. If exercise unstake, it may take 24-48 hours to get the tokens back to the user’s wallet. Unplanned liquidity shortages affect the users’ longevity to maintain their position as a Staker. Many DeFi developers are introducing lending/borrowing protocols for staked tokens to solve this problem. Using these services, users can get up to 50% of their stake value as a loan. More about these DeFi protocols, here.

• Inflation risk: Since cryptocurrencies are more susceptible to excessive price swings, there is a higher risk of inflation. Currently, blockchain protocols such as Cosmos adopt an adjusted-staking reward mechanism to allow for a flexible inflation rate determined by market demand. To keep a balance between market liquidity and stake supply, the stake rewards are adjusted between 5% to 40%.

• Bad Behaviour: For validator nodes, node uptime is a crucial factor. If the node encounters problems or downtime, they are subject to a slashing penalty. This is why it is important to choose a professional staking service provider. Staked.Us, Dokia, Cryptium, etc are some of the professional service providers who have years of experience and maintain nodes for several blockchain projects.

Closing remarks

With Ethereum moving from PoW to PoS by 2021 and a growing number of new blockchain entrants using PoS to govern their network security, it’s expected that the total value locked in the staking wallets (or nodes) from the current level i.e. $16.8 Billion will increase to $75 Billion by 2023. 

With the ease of using services from staking providers (decentralized or centralized) to generate passive income, staking pools will be the major contributor in setting this trend.