Staking is a crucial part of the Proof-of-Stake (PoS) blockchain ecosystem. It allows users to delegate their governance rights to validators who run nodes and validate transactions on their behalf. However, many delegators don’t fully understand staking and how it works. This lack of understanding can lead to trouble for the entire community. One important factor we often ignore is that delegators have their share of responsibility. In this Cryptopolitan guide, we’ll explain what delegators should know about staking and why it’s essential to be responsible when delegating governance rights.
What is staking?
Staking is a concept in blockchain technology that allows network participants to contribute to the security and maintenance of the network. In essence, staking involves locking up a certain amount of cryptocurrency to participate in the consensus process and earn rewards.
One of the most popular forms of staking is Delegated Proof of Stake (DPoS). Blockchains like EOS, BitShares, and Tron use this consensus mechanism allowing users to delegate their staking power to a trusted party or delegate, who can then use that power to participate in the network’s consensus process on their behalf.
In DPoS, users can vote for a set of delegates who are responsible for validating transactions on the blockchain. These delegates are usually chosen based on their reputation, technical skills, and contributions to the network. Users can earn staking rewards without running their node or validating transactions by delegating their staking power to a delegate.
The delegate, in turn, earns a share of the staking rewards for the users who delegate their staking power to them. The reward incentivizes delegates to act in the network’s and its users’ best interest, as they stand to lose their reputation and potential rewards if they work maliciously.
Benefits of staking
Staking provides various benefits, making it an attractive option for investors, network participants, and cryptocurrency enthusiasts.
- Passive Income: One of the primary benefits of staking is the ability to earn passive income. You can earn staking rewards for participating in the network’s consensus process by staking your cryptocurrency. The process is a lucrative source of income for investors willing to hold their cryptocurrency for extended periods.
- Lower Barriers to Entry: Staking has lower barriers to entry than other forms of cryptocurrency mining, such as proof of work. Unlike mining, staking doesn’t require specialized hardware or high energy consumption, which makes it more accessible to a broader range of participants.
- Network Security: Staking helps to improve the security of the blockchain network. By staking their cryptocurrency, network participants have a stake in the network’s security and therefore have the incentive to act in its best interest.
- Voting Rights: Staking also gives network participants voting rights, which allows them to have a say in the governance of the network. Users vote on proposals and make decisions about network upgrades. Staking provides a more democratic and decentralized approach to network governance.
- Future Price Appreciation: Staking also has the potential to increase the value of the staked cryptocurrency over time. As more participants stake their cryptocurrency, the supply of the cryptocurrency decreases, which can help to increase its price over time.
Staking vs. mining
Staking and mining are methods for individuals to participate in the blockchain ecosystem; however, they differ in various ways.
Mining is the process by which network participants compete to solve complex mathematical problems to validate transactions on the blockchain. The process involves using specialized hardware, such as ASICs or GPUs, to perform the necessary calculations. The first miner to solve the problem earns cryptocurrency, and the validated transactions add to the blockchain. Examples of mined crypto include DogeCoin and Bitcoin.
Staking is less resource-intensive than mining. While mining requires specialized hardware, staking requires holding a certain amount of cryptocurrency. Staking is, therefore, more accessible to a broader range of participants.
Staking is also more energy-efficient than mining and, therefore, environmentally friendly. The energy consumption associated with mining has been a subject of concern, as it has contributed to climate change.
Delegating governance rights
Delegating governance rights to validators is crucial to proof-of-stake (PoS) blockchains. Delegators are responsible for ensuring that the validators they delegate their governance rights to are trustworthy and competent. This way, delegators can help ensure the blockchain remains secure and stable.
Validators who are not competent or trustworthy can put the blockchain at risk by failing to perform their duties properly. Incompetent validators can lead to losing funds for delegators and other blockchain users.
Delegators should take the time to research validators before delegating their governance rights to avoid these risks. They should look for validators with a good reputation in the community and a track record of performing their duties properly. Delegators should also consider the fees charged by validators and choose those that offer competitive rates.
Delegators should also know the importance of voting in PoS blockchains. By voting, delegators can help shape the future direction of the blockchain and ensure that it remains secure and stable. Delegators should take the time to educate themselves about the issues facing the blockchain and make informed decisions when voting.
Researching Validators
When researching validators, there are several things to look for. These include:
- Validator Reviews: Look for reviews of the validator from other stakers and community members; their reviews can provide valuable insights into the validator’s reputation, technical expertise, and reliability.
- Validator History: Look into the validator’s history and track record of participation in the network. A validator’s history can provide valuable insights into the validator’s behavior and reliability.
- Validator Website: Look for a validator’s website, which should provide information about the validator’s technical expertise, fee structure, and other relevant details.
Criteria for Choosing a Validator
- Reputation: A validator’s reputation is essential when choosing a validator. Validators with a good reputation are more likely to act in the best interest of the network and its users, which can help to ensure the network’s security and stability.
- Technical Expertise: Validators with strong technical expertise are better equipped to handle technical issues that may arise on the network. It’s essential to choose a validator who is knowledgeable about the technology and has a track record of reliability.
- Fees: Validators charge a fee for their services. Choosing a validator with a reasonable fee structure that aligns with your staking goals and investment strategy is essential.
- Network Participation: Validators who actively participate in network governance and decision-making are likely to act in the network’s and its users’ best interest. Choosing a validator engaged in the network’s development and administration is essential.
How to Delegate
The process of delegating can be confusing for those new to staking. The exact procedure may vary across blockchains, so it is essential to visit their website/ documentation for the precise method. This section explores the general steps involved in delegating your staking power.
Step 1: Choose a Wallet:
The first step in delegating your staking power is to choose a wallet that supports delegation. Several wallets support delegation, such as Ledger and Trust Wallet. Make sure to select a wallet that is compatible with your staked cryptocurrency.
Step 2: Choose a Validator:
Once you have chosen a wallet that supports delegation, the next step is to select a validator. As discussed earlier, several factors are to consider when choosing a validator, such as reputation, technical expertise, fees, and network participation.
Step 3: Delegate Your Staking Power:
Once you have chosen a validator, the next step is to delegate your staking power. This process will vary depending on the wallet you are using, but in general, you will need to navigate to the staking section of your wallet and select the option to delegate your staking power. You will then need to enter the validator’s address or choose the validator from a list of available validators.
Step 4: Confirm the Delegation:
After selecting a validator and entering the necessary information, you must confirm the delegation. Double-check the information you have entered to ensure that it is accurate. Once you have authorized the delegation, your staking power moves to the validator, and you will start earning staking rewards.
Step 5: Monitor Your Delegation:
Monitoring your delegation is essential to ensure the validator acts in the network’s and its users’ best interest. Keep an eye on the validator’s reputation, technical expertise, and engagement in the network’s governance process. Additionally, diversify your delegation across multiple validators to mitigate the risk of centralization and counterparty risk.
Diversification helps to mitigate the risk of centralization and counterparty risk. By staking with multiple validators, you reduce the risk of a single validator significantly impacting the network’s decision-making or governance. Additionally, diversification helps to mitigate the risk of a single validator being compromised or engaging in malicious behavior.
High-staking APR could be viscous
Staking APR stands for Annual Percentage Rate, the percentage interest earned on staking a cryptocurrency annually.
High APR can be bad for staking. Analysts argue that APR is the inflation rate of the blockchain in question. Inflation means that the asset’s value drops, and so does the user’s share in the blockchain’s governance as new tokens get released into circulation. The core problem here, however, is that people tend to disagree on what this value means. To many people, the value is measured in the exchange rate of the coin to USD. This kind of user is mainly after the quick buck, and they don’t give much thought to what sort of blockchain they’re investing in by staking their coins. The real value of a coin, however, is in the power it grants its holder to influence the direction the blockchain takes and, therefore, its success. The more successful a blockchain is, the higher its token’s value in USD.
For instance, if a PoS blockchain offers an APR higher than 20%, its model is likely flawed and seeks to attract more users rather than create a sustainable model. The flaw is apparent when their customer base growth seriously lags behind the APR, leading to accelerated value dilution and eventually devaluing the blockchain.
How exchanges ruin blockchain
Exchanges play a significant role as validators since most offer staking services for their users. What is not apparent to the users is that these exchanges do not grant them voting rights.
Exchanges pursue their interests, and providing staking opportunities is just one more revenue stream for them. While holding many user assets in custody, they effectively control them and prevent users from exercising their voting rights through a representative. An exchange can vote if it pleases. Or it can ignore all voting altogether. They can just neglect their nodes for days. In theory, an exchange can destroy a blockchain by voting or not voting on behalf of many people who would have wanted otherwise. In the real world, we call it usurpation. In the crypto world, stakers often act as if it’s just the way things must be.
Risks of delegation
While delegation is a valuable tool for staking participants, it has risks.
- Centralization: Delegation can lead to centralization of the network if a small group of delegates or staking pools control a significant portion of the staking power. Centralization can create a situation where a few entities have considerable control over the network’s decision-making and governance, which can cause concern.
- Slashing: Delegates who act maliciously can have their staking power “slashed” as a penalty. Slashing happens if a delegate fails to fulfill their duties or engages in fraudulent behavior. If you have delegated your staking power to a delegate who gets slashed, you may lose a portion of your staking rewards as a penalty.
- Counterparty Risk: Delegating your staking power to a third party involves counterparty risk. If the delegate or staking pool you have delegated to is compromised or engages in malicious behavior, your staking power and rewards may be at risk. You can mitigate the risk by choosing a reputable delegate or staking pool with a track record of reliability.
- No Control: Delegating your staking power means giving up some control over your staked cryptocurrency. Once you have delegated your staking power, you depend on the delegate or staking pool to manage your staking rewards and maintain the network’s security.
Final Thoughts
Staking allows users to delegate their governance rights to validators responsible for maintaining the network. However, delegators must be aware of their responsibilities as well. They should understand that owning a coin on a PoS blockchain grants them the right to influence its further development and progress through voting. They should also be aware that the community is responsible for ensuring the blockchain remains healthy and sustainable. Delegators should look beyond the Annual Percentage Rate (APR) when choosing a validator and focus on the fundamentals of the blockchain’s operation. The real value of a coin is in the power it grants its holder to influence the direction the blockchain takes and, therefore, its success. The more successful a blockchain is, the higher its value; ignoring this aspect harms their money-making plans.
