Staking
What is Staking?
Staking in crypto is a method of making the blockchain network more stable, efficient, and secure by incentivizing participants in the ecosystem to participate in the validation and addition of new blocks to a blockchain.
Many blockchain networks operate through decentralized networks of validators who verify and execute transactions, adding “blocks” to a blockchain’s immutable ledger. Networks become more decentralized – and thus more secure from a 51:50 attack – the greater the number of validators participating in the network.
Staking makes networks more secure through a system of financial incentives and penalties that discourage bad behavior. Staking incentivizes people to participate in validation by offering newly created tokens to participants who temporarily delegate or lock up a portion of their crypto assets as collateral to the protocol to support the validation of blocks on the chain. Interested participants with significant technical expertise and dedicated servers can establish their own validator nodes to participate in staking (subject to conditions set by the protocol), or can engage in staking more easily by “delegating” their staked assets to a staking-as-a-service provider who handles all of the technical aspects for a small fee.
Generally speaking, the more tokens a validator has staked, the higher the chance they are chosen to validate and earn rewards for this action in the form of more tokens. Each protocol establishes “lock-up” periods for staked assets to qualify for rewards which can range from a few minutes to a few weeks, after which users are free to again use their assets as liquidity and exchange or sell them for other digital assets. This lock-up time helps to bring stability to a system by discouraging short-term staking.
Staking protocols don’t merely offer rewards – they help enforce compliant validation behavior with built-in penalties leveraging staked assets. Validators’ stakes can be revoked or “slashed” for failing to follow protocol rules — commonly triggered by downtime (when validators are offline for extended periods) and double-signing (double validating a block by the same validator, which compromises the legitimacy of a transaction).
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The enhanced security staking offers comes from the fact that to successfully attack a staked network, someone would need to control a majority of all staked tokens (usually requiring billions of dollars worth of cryptocurrency). Even if a malignant actor could afford this, attacking the network would cause the value of those very tokens to crash, making the attack self-defeating – destroying the value of their own massive investment. Meanwhile, honest participants are rewarded with more tokens for helping secure the network, creating a positive feedback loop where it's always more profitable to play by the rules than to cheat.
Emergent Business Models
Given the importance of supporting reliable and secure validation in blockchain networks, a range of business models have emerged to support staking across the crypto ecosystem. Two key business models have emerged:
Institutional service providers: Institutional providers such as Figment and Blockdaemon offer staking- as- a-service platforms for institutions or collaborate with cryptocurrency exchanges to act as the custodian for funds that are locked up in staking. These providers have also started offering Crypto ETFs (exchange-traded funds) that allow for “liquid staking” that negates the lockup period for retail investors, allowing them to buy and sell staking ETF interests at will.
Retail service providers and cryptocurrency exchanges: There is growing interest among retail investors in staking as a yield generation method, as a form of passive income generated by crypto assets that may not be used often. This is similar to reinvesting compound interest from dividends on a stock while also removing the high fees for transferring crypto to another form of currency. Retail staking services can also yield APRs higher than traditional investing, ranging from 3.1-19.35%. These services are offered via a growing number of retail providers and crypto exchanges including Coinbase and Kraken.
Considerations for Safe Adoption and Industry Growth
As with any new technology, certain measures are needed to ensure safety for consumers and more industry adoption of staking as a reward mechanism. Increased regulatory clarity will support the expansion and adoption of staking, contributing to a more stable crypto ecosystem.
Disclosure requirements will also be essential to consumer protection. While the rewards for staking can outperform other investment classes, there are risks to be considered. Investors interested in staking should consider the potential fluctuations in crypto token prices relative to required lock-up periods. While assets are staked, their price may change based on market conditions.
Case Studies
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Questions/Comments:
Having a little trouble figuring out the requirements for the validators. are there levels of the minimum stake required or other more specific requirements for the validators to meet to become ‘trusted?’
Questions/Comments:
Is there a good explainer on liquid staking Alison would recommend?