What is staking cryptocurrency
We’re going to go through what proof of stake actually is, how it works under the hood and the mechanisms behind it, which is obviously important to know, and then what investors should do if you own a proofof stake. Cryptocurrency staking is obviously going to get you some staking rewards and, as an investor, you might want to go ahead and do that.
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First of all, why would anyone stake their cryptocurrency and what does that actually mean? Well, really simply, what happens is you can actually earn a yield from staking. So pretty simply, if you’re an investor, you want to make returns, well how about making 2%-10% as a passive income as a yield on your cryptos? You can do that through all of these cryptos except This particular one one’s a little bit different. This is Bitcoin. It works on proof-of-work mining, which means you can earn a yield from it. You have to go and mine it. You have to buy a computer. It’s known as an asic. It has to mine the Bitcoin. You have to use energy, but you can do that,if you want to become a miner. These ones are different. These are proof-of-stake cryptocurrencies, meaning that the yield you can get right here actually comes from investing your coins into the network, which means you don’t have to be a miner. All you have to do is invest and you will get those rewards. So that’s the difference between a proof of stake crypto and a proof-of-work crypto like Bitcoin.
PoW vs PoS
Staking rewards essentially keep proof-of-stake cryptocurrencies secure. They keep it running just like mining rewards in Bitcoin. So here’s kind of the difference between proof-of-stake and proof-of-work, but they really have the same goal of keeping the network secure. With a Bitcoin transaction, you will obviously send your BTC to a node which checks the transaction. They then send that transaction bundled with many others to the mining network.So, you have miners right here who use energy to hash out some random numbers, and then whoever wins that kind of competition essentially gets rewarded with some Bitcoin. Then what happens is that goes over and over again, obviously with the next round of transactions that Bitcoin and all of thosetransactions get sent through. So miners use energy to keep the network secure and they get rewarded in BTC.
How a proof of state cryptocurrency works is a little different. You don’t have miners. The way you keep the network secure is by using the coins of investors. So for something like Cardano, you take your Cardano. This will be a transaction. You will send that transaction to a node, but the node is actually called a stake pool.
The Cadano network is essentially a collection of many investors’ coins. The investors put their coins up for sale at the node. The node is incentivized to run the network to make sure that transactions are going through and they collect everyone’s coins. The Cadano network will pay the investors,let’s call it 4% in ADA tokens. Now the node right here is incentivized to run the network because he can take a fee from it, so let’s say he takes 5% of the amount of money that he has in terms of ADA coins that people give him. The only reason you know why coins are given out at stake rewards is because no one’s going to do that for free. They aren’t going to run a node in their house or in their basement on a computer for free. They need an incentive to do that. You need to incentivize people to run the network and keep it secure with BTC mining. That’s Bitcoin for miners with proof-of-stake. You reward node operators by letting them collect people’s investments and giving the coins out to investors; 4% goes to the investor. The node operator or the stake pool also charges a fee, so they get a reward for running the network and keeping it secure. Staking is just a method of rewarding market participants for running the network and keeping it secure over time.
Staking really is just a reward mechanism where investors can give their coins over to the people that run the network and the people that run the network, as long as they are good. If they actually run the network properly, they get a bit of that reward now.
The downside for them, the punishment for them, is that if an investor stakes their coin with the node and they do a bad job, then that stake actually gets slashed. That’s like punishment, and the coins get taken away. If they are bad actors and they try and input a wrong transaction or somehow try to do something that would damage the network, they get their punishment, which is the coins taken away. If they run the network properly, they get a bonus. Everyone’s happy and the network runs in a proper and safe way.
That sounds really great, but where exactly are these rewards coming from and how are they paid? You can’t just create coins out of nothing and pay people, because obviously those coins have to have value, and the only way they have, if there’s some scarcity involved.
The way that the USD does is just keep printing money and money over time. So the value of each dollar goes down because more and more are in circulation. That’s obviously not good, right, because that’s just a death spiral down and the value of that currency just becomes close to zero in real terms against other assets.
So that’s something that you just can’t do to have a proper functioning system in crypto.
For example, if ADA pays people 3%, more Cardano for keeping the network secure. That’s great, but it’s inflating the supply by 3%. If everyone gets 3% more all the time, you don’t actually have more value, you just have more coins. The project is worth the same. This can be kind of compared to something like a piggy bank with shares.
Let’s say there are two investors and they have one share of an apiggy bank each. So they have 50/50. The piggy bank has a $1,000 in it, so 50/50 they obviously get $500 each. So you can see they have two shares each of the piggy bank now, but the piggy bank still has a $1,000 in it. So they still only have $500 each in value. So you can see that just printing coins out of nowhere increases the supply, but it doesn’t increase the value of what people have. This is known asinflation, of course. The supply, you know, the staking rewards, has to come from basically somewhere else, right? You can’t just keep printing tokens over and over again, so a lot of the stake yields have to come from a reliable and profit-making ecosystem, essentially from fees.
The situation we are in right now means a lot of token rewards and staking rewards come from inflation, which is the printing of new coins. Right here in Cardano, you can see. I’m using them. As an example, a country with higher inflation at the beginning, but over time that inflation goes down goes down to essentially almost nothing.
In fact, what we can see here is that Cardano has a cap on its supply, and so do most other coins as well. You can look at the total supply of something like CoinGecko.The total supply for Galano is 45 billion coins, and there are currently 33.8 billion in circulation.
At some point in the future, there will be no new coins minted and Staking yields will not come from new coin issuance. In fact, many coins have a long-term plan to do this. They pay take rewards through fees and not through token issuance.
So, for example, the way that Ethereum does it is essentially burns tokens to make sure that the total max supply doesn’t increase in terms of ADA. Like I said, 45 billion coins in terms of BNB, 168 million is the max supply. Matric has 10 billion coins and Ave has 16 million coins. Staking rewards can be paid by coin issuance. For example, if MTIC only has five billion in circulation. They have another five billion that they can print to reward users early on to get people into the system. When this amount is in circulation and they physically cannot print anymore, then all of the stake rewards will come from fees paid on the blockchain.
Interestingly, RV is not a blockchain.But it’s actually an application, You can think of stakerewards here as the profits that this business makes as a lender. They charge fees for people that borrow, and so those fees can actually go back to the holders in the form of staking rewards. This is essentially like paying a dividend to shareholders.
One of the downsides of stake as an investor is that when you give your coins to a validator or a node, there’s usually a lock-up period. This isn’t great. For example, matic, I think nine days, but you can see there’s a seven to 21-day lock up for most coins, which isn’t great. This means that you give your coins over and you will hopefully get the rewards.If he validator isn’t good, you’ll get your coins slashed, which obviously isn’t great, and you can’t take them out for a certain period of time. This is, you know, the downside of staking.
Investors do not want to lock up their coins, of course, so there are service providers that let us invest and get rewards, but we don’t have to lock up the coins. These are known as “collateral.” Here’s how they work. You have an investor that wants to get a staking yield on his coin. In this instance, polygomatic, he will give his coin over to a service provider like LIDO.
Now LIDO goes ahead and stakes his matic with validators. You can actually see them right here. These are the validators on polygons. Many people running nodes in the network can see that they take a fee and the checkpoint sign is a hundred.
That obviously means they’re reliable validators and they’ll be paying those staking rewards, but obviously we don’t want that nine-day lock-up, so what to do is create a different token called a liquid staking derivative. This one is called StMatic. This token they pass the, let’s say, 9% yield back, they get that from the validator. Then they pay that to this token. So your token is not locked up with the validator. But the staking yield that LIDO gets from all of these different investors goes back to the liquid staking derivative that they have given you.
Now the benefit here is that you don’t have to lock up your coins with the node over here, but you do get the staking rewards, and you may think well. These guys are locking up their coin how come my coins aren’t locked up. Well, essentially, if there’s a billion dollars’ worth of coins invested, there may only be a million dollars’ worth of redemptions per day, and Solido may keep a float of coins that are getting redeemed every single day. So they can essentially, you know, pay the people that want to redeem them. But really, this coin can always be redeemed for the staked coin, meaning that the market participants will not allow this coin right here to deviate from the value of the staked coin because it’s alwaysredeemable one for one for that stakedcoin. So, even though a trader or a market maker or market participant may have to wait nine days.If he can buy at a little bit of a discount, let’s say one percent or something, he’ll make 1% over nine days because he can buy your liquid staking derivative for cheaper and then nine days later get it on a one-for-one basis. So that keeps this liquid staking derivative the same price as the staked coin but it’s liquid and it’s earning the yield.
In fact, you don’t even have to stake your coins anymore. You can just buy these lsds on the market.For example, if you I go to select a coin right here and then I look at the staked matic. You can see that it’s stMATIC. If I have one stMSTIC trading basically on a one-to-one basis, it’s actually trading at 98 cents, meaning that there’s a two-cent difference between the stMATIC and MATIC. So if I want to go ahead and buy some stMATIC, I have to spend one token. I’m hoping that those staking rewards.Market arbitrages will come in here and make sure that these two coins trade around about par because this statement can always be redeemed formatically one for one, so they’re basically an arbitrage. We get a better deal. We get these staking derivatives that earn income, and we don’t have to toss our coins specifically with validators and have them locked up.
Liquid staking derivatives
Most blockchains do, or will in the future. Some blockchains don’t need them. For example, in Cadano, the way it’s created initially doesn’t need lsds, it just does it automatically, but here are some considerations. Firstly, staking provides rewards for blockchain participants, both node operators and investors. It keeps the system true to the capitalist framework, actually keeping it running. Staking rewards are paid via emissions, meaning more tokens are created to incentivize everyone to actually run this network over time. Stakeyields in the future should come from transaction fees and smart contract fees.Essentially, it’s a business that charges fees and those fees should be paid back to you.
The staking rewards that you get will only be an actual yield when the token emissions are lower than the staking yield. If you’re getting 5% as a staking yield but the system is creating 25 new coins every year, you’re actually losing 20% because you’re getting diluted by 20% every year and not earning 5%.
Right, think of staking as getting paid dividends in the future. Essentially, all staking yields should come from just people paying fees to that blockchain business so everyone is getting rewarded for keeping it running. You can stake on the blockchain. Every blockchain has a wallet that you should be able to stake in. You can use service providers like Lido, or you can just use exchanges.
Each one has different trust assumptions, and ease of use staking can be pretty complex. But essentially, it’s just a yield that is paid to investors to make sure that the system is running smoothly. We do not want stake paid off in the long term via the creation of new coins, which is inflation. That’s not the actual yield. We want a limited supply of coins and the fees paid to pay our staking rewards.
[This article is a transcription of a video made by MoneyZG]
Original video: https://youtu.be/1vuFid1Zu74]