Staking - passive income or high risk?

What is Staking?

Staking! Proof-of-Stake (PoS)! Terms that you read very often in the field of blockchain and cryptocurrencies. But what is it anyway? If you translate the English verb "to stake", you can choose between "to support", or "to risk". "To stake someone" is translated as "to support someone financially." So we are getting closer to the point.

With staking, one can definitely speak of "staking" one's capital - in the form of cryptocurrencies or coins. This stake involves a certain risk, which in turn is rewarded with Staking Rewards.

Where do you stake the coins? Staking or Coin Staking is an essential part of the Proof-of-Stake consensus mechanism. The Coins are used in a PoS Blockchain, to support the network. And for supporting it, you get rewarded.

That's a very simplified description. Let's take a closer look.

Proof-of-work - the first blockchain.

The first blockchain application ever is Bitcoin, which has been around since 2009. A cryptocurrency embedded in a digital decentralized ledger based on the so-called Proof-of-Work (PoW) consensus mechanism. Only a blockchain with a stable consensus mechanism provides sufficient security for a decentralized structure to preclude double spending.

The work (Work) takes place during the so-called mining. Miners have to solve complex computational tasks to find blocks in the network in order to validate them afterwards. If successful, the miner is rewarded with a block reward in the form of a certain number of bitcoin. In addition, the miner receives the fees that are fixed for the transactions in the block.

Only those who provide proof of work can participate in the PoW consensus mechanism. This also means that only those, who can prove the work, can also confirm that a block was found by another miner. Mining is thus primarily used to generate consensus. The Bitcoin reward for finding a block is more of a byproduct, but this does provide a financial incentive to participate in mining.

However, the use of miners is very costly. They have to regularly invest in expensive hardware and pay for high electricity costs, which can have a negative impact on the environment.

The proof-of-stake consensus mechanism

These enormous expenditures and energy costs were key factors in working on alternative consensus mechanisms as well. Back in 2012, Sunny King and Scott Nadal first talked about a blockchain with a proof-of-stake consensus mechanism in a whitepaper.

Instead of the miners in PoW, in PoS it is up to the "stakers" to act as validators and confirm new blocks. To do this, a staker must have a certain number of coins in his wallet. The selection of which staker is allowed to create the next block is done by a random algorithm, depending on the number of coins in the wallet and usually also depending on how long the coins have been in the wallet. This means that the probability of creating a block is higher when there are more coins in the wallet.

Unlike PoW, where proof of work must be created, PoS requires proof that one is in possession of a certain number of Coins. To prove ownership, the Wallet with the Coins must be constantly online. In some cases, the coins are also "locked up." So during staking, access to the coins is not possible. On the contrary, by locking away the coins, which must be provable online 24/7, participation in the consensus mechanism is often made possible in the first place.

When participating in the PoS consensus mechanism, the stakers are rewarded with the distribution of coins, similar to the miners in PoW. The amount of payout also depends on the number of staking participants. The more participants, the lower the Stakig rewards, the fewer participants, the higher the payout.

Proof-of-Stake vs. Proof-of-Work - Which is Better?

PoS should enable participation as a validator in the network to become more "democratic", i.e. even more decentralized. Everyone should be given the opportunity to participate, as long as they have enough coins in a wallet. And that without investing in expensive hardware, which is usually reserved for financially strong investors and can thus lead to more centralization.

While with PoW the share of computing power (hashing power) is decisive for finding a block, with PoS the share of coins in the overall network decides how often one is selected for creating a block.

A very detailed explanation and comparison of PoW and PoS can be found here.

Advantages of PoS:

• Lower barrier to entry allows for more staking participants - leading to more decentralization and stability of the network
• Less energy consumption - more environmentally friendly
• Significantly higher scalability - since hardly any work needs to be done as with PoW, transactions can be confirmed much faster
• Higher security against attacks - the general assumption is that more decentralization reduces the likelihood of more than 50% of coins falling into malicious hands
• Better basic governance framework - voting rights (delegated or on-chain) allow stakers to participate directly in the decision-making process for further developments

Many disadvantages of the PoW consensus mechanism are addressed by PoS. However, even PoS is not perfect.

Disadvantages of PoS:

• Depending on the protocol, coins are often locked away - you don't have active access
• Since proof of ownership must take place 24/7 online, the coins are always "visible" in a hot wallet - increased risk of hacking
• Depending on the protocol, misbehavior during staking can be penalized - e.g. if you are not online 24/7 or validate incorrectly, a penalty mechanism (slashing) ensures that a portion of the blocked coins is no longer refunded
• Even with PoS there is still a risk of network attacks - even if less than with PoW.
• The "nothing at stake" problem has not yet been conclusively solved everywhere
• ?The promise of high staking rewards attracts many scams - before participating in staking, one should study the respective blockchain project extensively

Masternode - briefly explained

On the subject of "passive income", in addition to staking, masternodes are mentioned often. A masternode is a node in the network that has more rights than other nodes. However, in order to exercise these rights, duties must be fulfilled, for which there is a reward. These rewards provide the opportunity to generate a regular passive income. In order to operate a masternode, one must have a minimum number and at the same time a maximum number of coins and operate the node 24/7 online, for example with the help of a virtual private server (VPS).

A staking node could therefore also be called a masternode. However, masternodes are not used exclusively for PoS. There are also masternodes in PoW, as the example of Dash shows.

PoW and PoS - is both possible?

There are also hybrid forms in which PoS are used in combination with PoW. One such hybrid solution is offered by Decred (Decentralized Credits). Decred's hybrid solution aims to combine the advantages of PoW and PoS, thereby offering even greater security.

While traditional PoW is used, stakers can participate in a lottery with their DCR coins. In this lottery, PoS tickets for a block are drawn periodically to validate the previous block. If 50% of the lottery drawers validate the miner's work, the miner's reward is accepted and the block is attached to the blockchain.

Different PoS protocols

The first blockchain with PoS was launched in 2013 with Peercoin. Since then, countless other PoS blockchains have been born, their consensus mechanisms always evolving and now recognizably different from each other.

Proof-of-stake is now the umbrella term for a whole group of variations of the PoS consensus mechanism where stakers act as validators.

Three notable PoS blockchains in the smart?contract platform space are:

Ethereum

Ethereum will soon implement a PoS consensus mechanism with Byzantine fault tolerance. With the help of this game-theoretic approach, the fault tolerance should drop to 33% and the network should become more resistant to attacks. This type of PoS blockchain would then be secure as long as the number of faulty nodes does not equal or exceed one-third of all nodes. That is, it would take at least 66% of fraudulent staking nodes to corrupt the blockchain.

The minimum amount of ETH needed to be a full node operator for staking is said to be 32 ETH.

Solana

Solana?is the fastest blockchain in the world and the fastest growing ecosystem in crypto, with over 400 projects spanning DeFi, NFTs, Web3 and more. It achieves consensus using proof of stake and proof of history. Its internal cryptocurrency is SOL. Bloomberg considers Solana to be "a potential long-term rival for Ethereum". Like Ethereum, Solana can also run smart contracts.

There is no minimum staking amount for SOL.

Polkadot

Polkadot is a multi-chain blockchain system being developed by Web3. Polkadot is developing interchangeable networks which enable side-chains to connect with public blockchains, that enables the blockchains built on top of it, known as "parachains", to execute atomic inter-chain transactions between themselves in a trust-minimized way, thereby creating an interconnected internet of blockchains.

There is a minimum staking amount of approximately 40 DOT required for earning rewards.

Is Staking worthwhile as an investment?

The question now is, should one participate in Staking? Or is it not enough to invest in a solid coin and speculate on an increase in value?

Quite a few stake a coin because they are absolutely convinced of the concept and would like to support the network. Others, however, are more interested in a passive income, similar to money-earning investments.

As with all investments, the same usually applies to staking: the higher the rewards, the higher the risk! There is a reason why government bonds also have different rates of interest. Some states have been stable for decades, others have been bankrupt in history!

Therefore, it is advisable to look very carefully when staking yields of 40% p.a. or more are offered. A yield of 6% p.a. as currently offered by Tezos can also be tempting, and the risk is correspondingly lower.

In general, diversification is the key to a successful investment strategy. Therefore, it also makes sense to focus on different blockchains when staking. In doing so, one should carefully examine each project. What good are high staking rewards if the coin loses value in the long run! In addition, the total number of Staked Coins plays a role, because if they are "locked up" the supply is scarce, which can also affect the price.

Those who cannot raise the minimum amount of coins to stake directly with a full node can participate in staking via so-called staking providers. In these staking services, a basic distinction is made between custodial and non-custodial

Custodial:

Here, one leaves his coins to a central provider such as Kraken or Binance and regularly receives staking rewards on his wallet in the customer account. The provider retains a portion of the Staking Rewards as fees. The risk here, of course, as with any central exchange, is that there is no full control over one's Coins: Not Your Keys, Not Your Coins!

Non-Custodial:

With Non-Custodial, one can participate in Staking without transferring ownership of the Coins to an external party. Delegated Proof-of-Stake as with Solana and Polkadot or Liquid Proof-of-Stake as with stETH on LIDO.fi enable this per se. Here, too, staking providers take over the staking with a full node and involve the client in the staking without transferring ownership.

Even with non-custodial, the staking service providers retain a certain percentage of the staking rewards as fees.

Quite a few service providers offer both types of services, Custodial and Non-Custodial. A very good overview of the different staking returns and staking providers is provided by Stakingrewards.com. So you can compare everything and that in each case at the current daily rate.

Conclusion: Staking offers many opportunities - but will this also be true in the future?

The PoS consensus mechanism offers far-reaching advantages over PoW. First and foremost, reduced energy consumption and mitigated environmental impact.

Simply having proof of ownership of appropriate coins entitles one to verify blocks as well as execute transactions and be rewarded with staking rewards. It also enables participation in decision-making.

This incentive and the low hurdle to qualify as a validator will likely make PoS blockchains more secure and decentralized.

Does staking have a future?

"Proof-of-stake is the future. New blockchains will definitely rely on proof-of-stake. Relevant existing Blockchains will also move to Proof-of-Stake in the medium to long term - see Ethereum. The advantages over Proof-of-Work are simply too great. Only Bitcoin will probably always stay with Proof-of-Work."?

Quote: Mirko Schmiedl (CEO of Stakingrewards.com)

Staking as an investment offers many opportunities and is expected to grow in the future. In times of zero interest rates on cash deposits, Staking Rewards are a tempting alternative to generate passive income. If the increase in the value of the coin is also promising, the total returns can increase tremendously.

Perhaps the famous savings account is no longer familiar to many. You left your hard-earned money to a bank, which cut off access to the money for a limited time. In return, one was rewarded with a fixed interest rate per year on the deposit. Again, there were times when up to 6% p.a. was normal.

At the moment, staking seems to claim this mechanism for itself, but without any banks at all.

But even with staking, there are natural risks that should be kept a close eye on. Staking is relatively new. Meaningful data from the past hardly exist. A proper stress test has yet to be conducted.

When the ICO hype set new records in 2017, few could have imagined that this would not be sustainable. Many were taught otherwise.

Therefore, stay informed. Follow the further development of Staking! And do not put all your eggs in one nest - Diversify!

About P2P Validator

P2P Validator is a world-leading non-custodial staking provider securing more than $4.5 billion in assets by over 10,000 delegators/nominators across 25+ high-class networks.

Web: https://p2p.org

Twitter: @p2pvalidator

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