Ever wondered what “proof of stake” means? Find out here—and learn how you can get involved, too.
5 min read
The following statements do not constitute investment advice or any other advice on financial services, financial instruments, financial products, or digital assets. They are intended to provide general information. The following statements do not constitute an offer to conclude a contract for the purchase or sale of financial instruments and financial products or an invitation to submit such an offer and to buy or sell any particular digital asset. Cryptocurrencies are subject to high fluctuations in value. A decline in value or a complete loss are possible at any time. The loss of access to data and passwords can also lead to a complete loss.Let’s start with the basics: what is crypto staking? Staking is part of the process that certain cryptocurrencies use to verify transactions. It's all part and parcel of a consensus mechanism called “proof of stake.” This sees blocks of transactions added to a blockchain, an indelible string of “blocks” of transactions, by people who already hold a certain stake in that blockchain's native currency. The process is similar to the mining, used to add blocks to the blockchain of proof-of-work blockchains such as Bitcoin. The difference is, in the case of proof-of-stake blockchains (such as Cardano), the process is called forging (or sometimes "minting”), and the people who do it are called validators or forgers rather than miners.If you have some proof-of-stake crypto, you have the chance to earn coins in exchange for your stake, with the specific amount depending on the currency at hand and just how you stake your coins. But staking isn’t without its risks—which we go into in more detail about below.
What is proof of stake?
So what is this proof-of-stake thing that everyone’s been talking about? Well, proof of stake is a consensus mechanism for processing transactions and creating new blocks in a blockchain. In the proof-of-stake system, validators process transactions and create new blocks of a blockchain just like miners do in a proof-of-work blockchain (such as Bitcoin). The difference is that to gain the right to create a block, instead of racing to be the first to complete complex mathematical problems like miners do, in the proof-of stake system, nodes (computers that participate in building the blockchain) do so by setting aside (or “staking”) a certain amount of their holdings. A validator is then semi-randomly chosen for each block from all those who have staked a minimum amount of coins. After that, this validator creates (forges) the block and other validators validate it. The validator gets a reward for creating the new block in the form of the native coin of the blockchain (e.g. ADA on the Cardano blockchain), but if the block turns out to include a fraudulent transaction, they lose some or all of their stake! (And so does any validator who validated it.)
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To choose who the next validator to verify the block will be, the proof-of-stake algorithm uses factors including how long the validator has held the stake, how big the stake is and a sprinkling of randomization. This takes far less computing power and electricity than it takes for the proof-of-work system's miners to win the right to create a block by being the first to solve a complex math problem. For this reason, proof of stake is both a greener and a more efficient process than proof of work, and often leads to transactions being validated more speedily.
Which cryptocurrencies use proof-of-stake consensus?
Not every currency uses proof-of-stake mechanisms—Bitcoin, for example, operates on a proof-of-work model. There are lots that do, though, including:
ADA (Cardano),
SOL (Solana), and
AVAX (Avalanche).
In addition, Ether's blockchain Ethereum is in the process of switching over to a proof-of-stake mechanism, and plans are afoot to complete the switch by the end of 2022.
How does staking cryptocurrency work?
There are many ways you can get involved with staking coins that are much easier than setting up as a validator yourself. These include staking on a cryptocurrency exchange or joining a staking pool.
Staking on a cryptocurrency exchange
Staking via a cryptocurrency exchange means that you make your crypto available via an exchange for use in the proof-of-stake process. In essence, it enables holders to monetize their crypto holdings that would otherwise lie idle in their crypto wallet. In this approach, the exchange does much of the administrative work for you, seeking out a node for you to join so you don’t have to do it yourself. It's not completely risk-free, though—you do have to run the risk of entrusting your coins to the exchange and node in question.
Joining a staking pool
A staking pool enables stakers to earn block rewards by sharing their resources, similarly to a mining pool. These pools tend to follow a two-tier system, with an administrator overseeing the work of the validators and ensuring things run smoothly. When rewards are earned, they’re split between the pool operator and pool delegators , but some pools do additionally charge entry and membership fees.
What are the advantages of staking crypto?
There are all kinds of reasons to stake crypto, including:
The potential for high returns (depending on the specific cryptocurrency you’re staking!).
The satisfaction of playing a key role in a project you believe in—proof-of-stake currencies simply couldn’t function smoothly without their stakers.
You don't need any equipment for staking.
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Staking isn’t a risk-free exercise, however. You could run into some of the following risks of staking crypto:
The value of your staked crypto isn’t constant—as crypto prices are often highly volatile, your assets could plummet in value with little warning, making it a much less profitable endeavor.
Some proof-of-stake cryptocurrencies have lock-up periods, which means you won’t be able to access your crypto for a certain amount of time.
Depending on the approach you take, you might need to entrust your crypto to an exchange so it can be staked, which can lead to security risks.
Continue your crypto journey with N26
To stake or not to stake? That is the question—but while we’ve focused on looking at the question of “what is crypto staking?”, there’s much more to crypto than just staking! When it comes to understanding the nuts and bolts of cryptocurrencies in general or finding out all the details of particular cryptocurrencies, such as Bitcoin, N26 has all the information you need to progress on your crypto journey.
Staking is a way to earn rewards by making your crypto available for use in the cryptocurrency's validation process. Not all cryptocurrencies offer this option, but if they do, you can deposit your coins and earn long-term rewards, similar to a fixed-term deposit. The blockchain will use your deposit to verify and secure transactions. This process is called "Proof of Stake" and is part of the overall approval mechanism. Essentially, it's a way to benefit from the currency you already have, while also contributing to the system's security and the efficiency of the blockchain.
A staking pool lets you come together with other stakers and combine (or “pool”) your resources with others—including others with coins to stake and people with the necessary computing power and technical knowledge to act as validators or run the pool. This will earn you a share of the rewards from forging the blocks of a proof-of-stake blockchain.
Nothing is ever 100% risk-free—and staking crypto is no different. While staking crypto has many benefits to offer, there are some risks to be aware of, such as price volatility and lock-up periods.
Only cryptocurrencies operating on a proof-of-stake model allow staking. There's no staking involved in proof-of-work cryptocurrencies, such as Bitcoin.
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