Staking has been commonly used to describe several actions in the crypto world, from locking up your tokens on a decentralized finance (DeFi) application or centralized exchange (CEX) to using tokens to run node infrastructure. validation on proof of participation (point of sale network).
PoS is one of the most popular mechanisms that allows blockchains to validate transactions and it has become a credible alternative consensus mechanism to the original proof of work (PoW) used by Bitcoin.
Miners need a lot of computing power to run power-intensive PoW, while PoS requires staking coins as collateral to validate blocks and verify transactions, which is significantly more energy efficient and has less risk of centralization. These are some of the reasons why companies like Mozilla have changed their donation policies to only accept PoS crypto donations in line with its “climate pledges”.
The Ethereum protocol is expected to undergo a transition to a PoS consensus mechanism before the end of the year. On the roadmap to scale the network, the merger seems imminent. Ethereum miners will need to mine a different cryptocurrency or pivot to staking if they want to keep the network secure.
Dogecoin also plans to make this transition in the future.
Staking rewards are incentives provided to blockchain participants to validate new blocks. There are several ways to participate in staking within the crypto ecosystem:
Run your own validation node
Proof of Stake allows anyone with a computer to run a node and validate transactions by participating in the consensus of the selected blockchain. Validators are randomly assigned to verify a block.
Validators must create their own staking infrastructure to run a node. Depending on the network, being a validator can require high entry costs, as a set number of tokens must be staked before going live.
As long as the validator node is active, staked tokens are both locked and yielded. Running your own knot can be complicated and technical for beginners and if done incorrectly can result in financial loss of in-game tokens.
Delegate to a validator
Tokens from PoS networks can be assigned to a third party so that they can run their own node and validate transactions. This is a less complicated method than running your own node, but involves delegates joining a staking pool and trusting the selected validator with their tokens.
Projects like Stake.fish offer “Staking as a Service” to ensure the legitimacy of these validators. The founder of Stake.fish validation services also co-founded f2pool, one of the largest Bitcoin and Ethereum mining pools.
Similar to managing a mining pool, a staking pool requires a strong team of engineers. The main difference is in the target audience. While mining pools focus on miners, staking pools are for anyone who holds PoS tokens. Dasom Song, Marketing Manager of Stake.fish, told Cointelegraph:
“Managing and building our own infrastructure is our way of contributing to the crypto ecosystem. We talk to projects, research ecosystems, and listen to our community to make a decision on which new chains to support.”
Running your own node and delegating to a validator are some of the safest ways to earn an active return on your tokens, but this comes at the cost of making your assets illiquid for a set period of time.
Related: Ethereum 2.0 Staking: A Beginner’s Guide to Staking ETH
In recent years, several projects have emerged that offer token holders an alternative to staking pools and address the illiquidity of staking while helping to validate the network.
Lido (LDO), the highest ranked protocol by Total Value Locked (TVL), supports multiple blockchains with their yield bearing tokens like Ether (ETH), Cosmos (ATOM), Solana (SOL), Polkadot (DOT ), Cardano (ADA) and more. It is a non-custodial protocol, but it is not permissionless as the Lido DAO selects validators through a governance vote. Stake.fish is one of those trusted validators voted by the Lido community to support the protocol.
Other projects like Rocketpool (RPL) have decided to only focus on supporting liquid staking for ETH for the time being. Rocketpool is a permissionless protocol so anyone can become a node operator.
Although similar in principle, LDO tokens are different from RPL tokens.
These tokens staked with Lido are attached to the original token. This means that 1 ETH equals 1 Lido stETH (STETH). This method is similar to yield farming in DeFi and incurs a gas cost to harvest with each transaction.
Rocketpool tokens will remain in the form of a fixed amount of Rocket Pool ETH (RETH), but the value of these tokens increases over time as the decentralized network of nodes earns rewards, making it more profitable because it does not require token harvesting.
Liquid staking was created with DeFi applications as the primary users of these tokens. Staked tokens are valuable and can be used as collateral for many decentralized applications to earn yield in addition to staking rewards.
The first and primary use of DeFi right now is to provide exit liquidity to these liquid staking protocols via liquidity pools. The Curve Finance liquidity pool of ETH + STETH tokens allows trading STETH for ETH until the merger is complete. RETH also has a liquidity pool in Curve Finance.
There is even a liquidity pool that facilitates trading between STETH and RETH with over $100 million in assets locked on Convex Finance.
Locking Tokens in a DeFi Protocol
DeFi protocols can incentivize participants to lock up their tokens in exchange for yield rewards. This can be done for lending and borrowing protocols like Aave (AAVE), to provide liquidity on a decentralized exchange (DEX) like Uniswap (UNI) or SushiSwap (SUSHI), and to support governance-related operations Decentralized Autonomous Organizations (DAO) .
Governance has seen the most innovation in staking, as the Invested Escrow (EV) model has been used by many DeFi applications to align community interests and drive long-term awareness. term of the protocol.
Curve Finance has received particular attention with the use of this mechanism as Curve’s Native Token (CRV) is deposited into the Voting Escrow Agreement for a period of one week to four years; the longer the contract, the greater the voting power of the VE token.
Two things make the DeFi world go round:
Protocols want liquidity, and we want incentives. We say we’re in it for the tech, but we’re also greedy.
The protocols understand that. They fight for our liquidity, incentivizing us with creative rewards.
—Ross Booth (@rossboothr) March 9, 2022
Colloquially referred to as “Curve wars” in DeFi, protocols like Convex Finance have built a structure around this mechanism to influence the allocation of Curve Finance token rewards and position themselves as the primary liquidity providers for CRV governance tokens. which makes it the sixth largest DeFi app with $12.26 billion. TVL, according to data from DeFi Llama at the time of writing.
Related: Crypto Staking: How to Choose the Best Staking Coins for Passive Income
Implementation via a CEX
Centralized exchanges offer many of the staking options mentioned above in a traditional and authorized way. The exchange will stake the tokens on behalf of the users and ask for a commission in exchange for the staking services.
Binance, the largest crypto exchange, allows users to stake their tokens for a locked period or in cash, depending on their preferences and appetite for returns. For users who invest in ETH, the platform provides exit liquidity in the form of a Binance ETH token (BETH) until the merger takes place. Binance recently launched a new TerraUSD (UST) staking program for over 30 million users.
Kraken, another top exchange, provides staking services but does not offer an exit liquidity option. Users who invest in ETH will have to wait after the merger to obtain a liquid asset. It also recently announced the acquisition of noncustodial staking platform, Staked for an undisclosed amount, which has been described as “one of the biggest acquisitions in the crypto industry to date.”
Locked tokens that earn yield
Staking comes from PoS but has taken on a meaning of its own in DeFi and crypto as a whole. At the time of writing, any token locked to support a network through a validator or used in a decentralized application is considered staked.
The examples mentioned above show the different ways of betting chips and they all have different implications and characteristics. Token staking provides a solid foundation for earning returns while contributing to a network’s overall ecosystem.