Staking is as essential to the blockchain ecosystem as mining. It's a well-known fact that all blockchain transactions need validation. However, a lesser-known fact is that there are other forms of validation apart from mining. These processes are known as consensus mechanisms. Proof-of-Stake is a consensus mechanism that has different variations and hybrid models.
This article will look at the concepts of staking, delegation, and validation. To fully grasp these concepts, you need to understand how Proof-of-Stake works. In theory, Proof-of-Stake allows the blockchain network to operate more energy efficiency while maintaining a degree of decentralization.
What is Proof-of-Stake?
This consensus algorithm was first implemented in 2011 to solve the problems of the mining algorithm, Proof-of-Work. While both algorithms share the goal of reaching a distributed consensus in the blockchain, their approach is quite different.
Proof-of-Stake is on the concept of validating block transactions according to how many coins an individual owns. It uses an incentive scheme that requires users to stake their coins to get the chance of selection in validating blocks of transactions.
The main idea is to get users to validate other people's transactions while maintaining integrity and getting rewarded at the same time.
How Does PoS Work?
The validators of a new block get chosen in a random selection process created by the algorithm. The first element considered in the selection is how much coin the user is staking. Every validator owns a stake in the network, and the more they stake, the better their chances of being selected.
The algorithm further randomizes the validators using a formula that finds the lowest hash value. The chosen picked users then validate the next block and get rewarded, usually in a payout in the form of transaction fees. Therefore, the algorithm encourages more direct investment in cryptocurrency.
What is Staking?
Staking is the action of locking a certain amount of cryptocurrency in a unique wallet to earn a reward. The stakers are randomly selected to secure, validate, and produce blocks on the blockchain network and, in turn, receive an interest. The PoS algorithm requires its users to stake their coins in the system to reduce the chances of fraud. Therefore when a user decides to manipulate the system, they risk losing their coins.
The minimum amount of coins bound in a suitable staking wallet depends on the type of cryptocurrency owned. The longer you keep your coins locked up, the higher the chances of getting chosen to approve transactions and ultimately getting rewarded. Stakers also have the option of joining staking pools and sharing the reward depending on the pool's terms and conditions.
However, one drawback of having your coins bound for long periods is vulnerability to crypto price volatility. Coins that are locked up can lead to losses when the value of the currency depreciates.
Cold staking is staking using a cold wallet, a wallet that's not connected to the internet. An individual using cold storage can stake while securely holding their funds offline. Networks that support cold staking intend to reward long term, coin holders. They also ensure maximum asset protection for those holding large amounts of coin.
However, once a user removes their coins from cold storage, the system stops rewarding them.
What is Delegation?
Delegation is the process of picking validators for the hybrid PoS known as DPoS. During a delegation, token holders vote for other users they want to validate a transaction. The weight of a vote depends on the number of stakes owned by the voter. Therefore, token holders with large stakes get to pick a user they trust to maintain the network.
The system allows the token holders with varying amounts of stakes the chance to become a delegate. The users who get high votes can start validating transactions and collecting rewards. At the same time, the users who don't have the skill or desire to run a block get to participate in the system.
Rewards in the system are proportionate to the user's delegated stakes. The validators share their rewards with those who entrust their stakes to them.
What is Validation?
Validation is the process of verifying transactions before being added to the blockchain. The process includes the collection of transaction data, determining whether the transaction meets protocol requirements and doesn't have malicious manipulations.
Validators are required to stake their holdings in the system to dissuade them from validating fraudulent transactions. Otherwise, they'd be at risk of losing their holdings and losing future right to participate. They are incentivized with rewards to encourage them to validate only correct transactions.
A valid transaction is one where the sender has an initial balance in their wallet equal to or greater than the amount they are sending. Invalid transactions occur when fraud, double spending, rules, and protocols of the system get broken.
The Proof of Stake algorithm is quickly becoming the best alternative to the more popular Proof of Work. Its energy efficiency increased security, and increased participation in the consensus are just some of the positive attributes of this system. Therefore as PoS continues gaining momentum in the cryptocurrency world, be sure to familiarize yourself with these key terms and more.