After a long time and repeated delays, Ethereum has finally moved away from its proof-of-work model to validate transactions into the cutting-edge, less resource intensive proof-of-stake model that most new blockchain projects over the last couple years have adopted.
Along with this change has, as one would expect, come many questions from Ethereum’s own users, particularly those who mined Ethereum either as a hobby or to make ends meet, about how the system works, or why it is any better. In some cases, when people only mined and invested in Ethereum and no other tokens, they genuinely don’t know anything about the proof-of-stake mechanism that has become commonplace.
So what’s this proof-of-stake?
Proof-of-stake is the now preferred method of assigning transaction blocks for validating transactions in blockchain environments.
The older system, called proof-of-work (and more commonly known as “mining,”) tasked participants (that is, miners) with solving an extremely complex mathematical problem via brute force. Whoever solved the problem first was assigned the block for validation along with the reward, which was the cryptocurrency that was “mined.”
This system is extremely wasteful, because said mathematical problems have no actual use other than help the system decide who gets what. In the end, they proof-of-work model leads to huge losses in energy and processing power. To deal with this, the proof-of-stake method was created.
In a proof-of-stake environment, you don’t need to dedicate your computer’s processing power to solving repetitive problems. Instead, in order to establish your credibility with the network and ensure you’ll authenticate transactions properly, you put some of your cryptocurrency at stake, hence the term “staking”.
If your authentication is considered correct (that is, if you’re not trying to meddle with the blockchain,) at the end of the process you’re given back the crypto you staked plus extra crypto rewards. If it isn’t, the system takes the crypto you staked, or a part of it, as a fine of sorts.
What do I need to stake?
Staking is a much easier process than mining, because all you need is to have some cryptocurrency at hand. For the ETH network, said currency is naturally ETH tokens. If you want to operate your own node, which will net you full rewards from staking, you’ll have to stake a minimum of 32 ETH. That’s about $20,000, which is pretty much pocket change and an amount so small people have asked Ethereum to raise it, lest the have-nots start staking too.
Alright, joke’s over. It’s a huge amount. More money than most people have ever held in their lives, or will ever hold. Luckily, you only need such a monstrous amount of Ethereum if you want to run a full node yourself. For people who don’t have massive amounts of money invested in crypto, staking pools exist.
Staking pools work in the same way mining pools did: They allow many people to chip in with whatever they can, in this case to reach the minimum 32ETH or surpass it so the node can be run. The rewards for staking are then divided among all people staking, proportional to how much they staked and for how long.
How do I set up a stake? Can I just jump in and out?
While some systems using proof-of-stake allow individuals to jump in and out, it’s a bit more complicated with the Ethereum network. Every time you choose to run a staking node or join a staking pool, you should think of it as a timed deposit – meaning you shouldn’t expect to be able to take back your staked Ethereum before the time is up.
Certain staking pools can allow you to retrieve your ETH, although usually this will imply forfeiting any earnings, and some will not allow you to retrieve it at all until your agreed upon time is over. As such, you shouldn’t stake any crypto you might soon need. The feelers from Binance-supporetd pools is that you must leave your stake untouched for at least one year.
What are the risks in staking?
From a general point of view, staking is risk free as long as you’re not trying to cheat the system. You deposit your crypto, wait a set time, take earnings based on how many blocks you were assigned. The higher your staked amount is, the more likely you’ll be to be assigned blocks. It’s simple and relatively direct.
However, we did mention that staking should be treated as a timed deposit – meaning in many cases you won’t be able to withdraw your staked crypto at a moment’s notice. In a stable or bullish market that’s not a problem, since you won’t need to cash out unexpectedly. But in a bear market, or an outright market crash, staking can mean you won’t be able to react to market movements, and thus will have to soldier through it all.
Now, Ethereum is usually stable, so it’s not a particularly risky move since even when prices crash it recovers relatively quickly. However, the risk still exists – so it’s not an entirely risk-free process.
Is staking good?
The proof-of-stake consensus algorithm has existed for years, and it is generally considered superior to proof-of-work algorithms. On that degree, considering anyone can stake and the carbon footprint of staking is minimal when compared to that of mining, staking is the best model we currently have to assign blocks for authentication.
However, since it has inherent risks not existing in mining, some people stay away from it. This in the end creates a system that’s much greener, much more open than the older one, but that some people who are extremely protective of their investments might wish to stay away from.
The traditional finance options in deposits and financial papers allows for long periods in tenor before rewards are accessed. Same works here for staking except that this platform is a decentralized one. With traditional finance undergoing rejuvenation, staking and its ilks seem to lead the way to a newer frontier.