Staking 101: A Brief Overview

Jumping right into the details, staking is a process that enables a potentially decentralised consensus mechanism to validate transactions by adding them to a blockchain in a verifiably correct manner.

In simpler terms, staking supports blockchain network operations by locking cryptocurrencies in exchange for a return on digital assets.

In general, staking is seen as a less resource intensive alternative to mining, which is the consensus mechanism of Proof-of-Work (PoW) blockchains. The latter mechanism presents a computational problem that needs to be solved via brute force workload, where the first miner that finds the correct answer to the problem receives a reward.

In Proof-of-Stake (PoS) blockchains, a validator node is chosen by the network to propose what goes into the next block. This is done via an algorithm that varies depending on the blockchain, but generally depends on the size of the stake pledged by the node. The larger the stake, the more frequently a node will be chosen by the algorithm to produce a block and receive a reward. To disincentivise improper behaviour, the algorithm can punish the node via a process called slashing. Generally, this is in response to excessive downtime or double-signing events, effectively forfeiting rewards or cutting the collateral put forth by the node as a warranty of good behaviour. In addition to this operational risk, staking also comes with a number of liabilities that need to be taken into consideration and mitigated. This includes the liquidity risk deriving from the possible lock-up periods of certain blockchains. In the lingo of staking, freeze and thaw periods refer to the minimum time horizon an asset can be staked and the time it can be moved again, following the decision to unstake it (i.e. how long it takes to unlock it). In addition to this, staked assets carry a market risk related to the price volatility they are exposed to even while being staked.

Participants that hold Proof-of-Stake tokens can passively participate in the mechanisms described above by delegating their stake to third-party nodes. This effectively turns these staking pools into ones with a higher chance of producing blocks and earning more rewards. Such rewards are then distributed to the delegators pro rata, generating a return. However, institutional clients seeking to increase exposure to staking activities need to be mindful of the validator nodes they rely on.  They need to side with dedicated players that can provide additional protection from certain risks in a manner that is trustworthy, professional, and reliant on a solid IT infrastructure.

Overall, staking is a mechanism that rewards the involvement of network participants with interest on staked assets, but puts it to work to ensure the robustness of the consensus mechanism, aiding in the processing of transactions and overall security. Institutional participants can also leverage staking to dilute the risk they take over time when investing in digital assets. Most of these assets are inflationary with no supply cap, creating an appealing opportunity for entities looking to enter or evolve in their crypto journey.

About Crypto Finance

Crypto Finance provides institutional and professional investors a full suite of crypto asset products and services. This includes non-custodial staking of Cardano (ADA), Tezos (XTZ), and Polkadot (DOT), leveraging the company’s secure storage infrastructure. Soon, we intend to extend our services to include custodial staking, which will seamlessly integrate with the existing custody and trading services. To strengthen the offering, Crypto Finance (Brokerage) AG will also be setting up dedicated and highly professional validator nodes.

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