By description, Ethereum staking is holding a certain amount of Ether to participate in the network and get a reward in return. The staking process involves locking up an amount of crypto in a wallet to participate in the operation of a blockchain for the rewards.
In general, anyone is allowed to participate in staking on any blockchain that operates proof-of-stake (PoS) consensus. PoS has multiple variations that also enable people to participate in this process.
Notably, the Ethereum core development team is today working on a major upgrade known as Ethereum 2.0. it comprises of re-engineering the whole ETH platform, effectively launching a new and more scalable version. The new implementation is expected to start in the summer of 2020 and may run for an entire year or two until the three phases are completed.
A segment of the Ethereum 2.0 implementation comprises of moving Ethereum from a proof-of-work to a proof-of-stake consensus.
PoS is a consensus mechanism that is used by some blockchains. It offers those with a stake of network tokens the right and permission to earn various rewards for validating blocks. It comes in contrast to the proof-of-work, or PoW. The PoW is a consensus model that is used by Bitcoin (BTC).
PoW assigns the block confirmation rights to those that demonstrate the most significant amount of computing power. After a validator agrees to stake its tokens, the stock is fully locked up. In most cases, it is forfeited partially or entirely of the validator does not act in the interests of the network, intentionally or otherwise.
In general, any person can stake, but in reality, a protocol is used to determine which participants get chosen to validate blocks and get the staking rewards. The right to approve a block and earn rewards is normally assigned according to the stake’s proportionate value.
Therefore, someone staking 1% of the overall value gets to validate 1% of all the blocks. Nonetheless, the length of time that the stake has been locked up may also factor into the validator selection protocol.
Why has Ethereum 2.0 chosen PoS?
ETH has chosen this strategy to decentralize and speed up the network. Since its inception, Ethereum has operated on a proof-of-work consensus. Nevertheless, one primary reason for shifting to proof-of-stake is that it is generally perceived as a far more energy-efficient method than proof-of-work.
The core developers are heavily in support of decentralization, which accounts for the shift to PoS. In recent years, the mining of the biggest cryptos like ETH and BTC has heavily become dependent on a few mining pools. The pools dominate due to the race for creating faster and more sophisticated mining hardware.
Anybody can operate as a PoS validator without having to use any specialist hardware. Hence, the allegation is that PoS blockchains have a better chance of becoming more decentralized due to lower barriers to entry.
In that context, Ethereum 2.0 will also incorporate the implementation of sharding. Sharding is a partitioning technique that enables faster throughput.
How does Ethereum 2.0 staking work?
Just like it is the case with most of the other platforms, lock, load, and wait. Staking on Ethereum 2.0 is expected to be quite straightforward. There will be a minimum set threshold of 32 ETH needed to participate in staking. Validators need to be running a validator node.
As mentioned earlier, it does not need to be specialized machinery and can be performed on a consumer-grade computer or laptop. Nonetheless, validators need to be online always, or they might face minor penalties.
The rate of return for staking ETH ranges between 4% and 10%. A program is known as ‘slashing’ applies to any validator acting maliciously toward the network by taking a portion of the validator’s stake.
Ethereum 2.0 staking vs other PoS platforms
Many other large blockchains are already functional on a proof-of-stake consensus, which includes Algorand, Tezos, and Qtum. Tezos is designed to run a staking program under its “Liquid Proof-of-Stake” algorithm. The algorithm is a hybrid between delegated proof-of-stake, or DpoS and pure PoS. Validating the blocks in the Tezos network is referred to as ‘baking.’
Anyone holding the Tezos (XTZ) token can delegate their tokens to a validator to ‘bake’ on their behalf. Nonetheless, the original owner retains their tokens in their wallet. Anybody can participate as a baker if they own at least 8,000 XTZ tokens known as a ‘roll.’ They can operate a validator node. The rate of return for staking on Tezos is currently almost 7%.
In the case of Algorand, it operates a consensus protocol known as “pure proof-of-stake,” which uses a system known as “secret self-selection.” The system randomly selects committees of stakeholders that will validate every block. What is unique about Algorand is that all the Algo holders get rewards by merely holding their tokens.
The Algo holders get rewards whether they decide to participate in the PoS program to validate the blocks or not. Hence, there is no minimum stake for earning these rewards with Algorand. The current rate of return for holding these Algorand tokens is almost 5%.
Qtum also operates on a pure PoS consensus. Anyone who has a small portion of a Qtum token can successfully become a validator and compete for the block rewards. The project has implemented a native application, which makes it easier for daily users to participate in its staking program. There is also a command-line option for more technical users.
Qtum staking offers a return of about 7% annually. There is no minimum stake. Nonetheless, holding more tokens increases the chances of being selected to validate and process transactions in the entire network. Many other blockchains operate staking programs, which include Cosmos, EOS, and more. Most of these are running variants of the regular PoS consensus, like DpoS.
What are staking pools?
The pools involve multiple parties coming together to participate in staking as a single validator. A pool operator runs them. For instance, exchanges like Crypto.com, Binance, and Kraken run a staking pool program where the exchange involved deposits users’ funds into a wallet that is then used for staking purposes.
But, there is also an excellent opportunity to participate in staking pools that operate according to the users keeping tokens in their wallets even in the cold wallets. The benefits of staking pools are that they allow users to pool their crypto; to stand a better opportunity of being chosen as a validator and earning the staking rewards.
On the flip side, the rewards are spread across all of the pool participants; which means that they yield proportionately less. The staking pools are also a great option to earn passive income via staking without having to use any technical know-how to set up a validating node in the network.
Another benefit is that no tokens have to be locked up for a defined amount of time necessary for a validator in most of the other staking programs.
Risks and benefits of ETH staking
The most notable benefit of staking is the opportunity it offers to generate income by just holding crypto. Staking also provides a chance to be an active participant in an investor’s favourite blockchain projects.
But, by staking, users must lock up their crypto holdings for a stipulated period. Hence, in the case of a sudden market crash, the investors cannot pull their crypto out of the staking program to sell and mitigate their losses.
Even when a small market downturn arises, the value of the rewards may not be adequate to neutralize the impact of the reduction in crypto value. Whenever taking part in a staking pool, people must realize that someone else may be taking custody of their crypto; that comes with a risk. Thus, all private keys must be kept secure and never shared with other entities or people.