What is staking ? Proof-of-stake vs. proof-of-work

Staking has been widely seen as a catalyst for the mainstream adoption of crypto and a huge revenue opportunity for exchanges like Coinbase. Staking and staking services can have detrimental consequences not only for those exchanges, but also for Ethereum and other proof-of-stake blockchain networks. To understand why, it helps to have a basic understanding of the activity in question.

What is staking?

Staking is sometimes referred to as the crypto version of a high-interest savings account, but that comparison has a major flaw: crypto networks are decentralized, and banking institutions are not.

How does staking work?

Earning interest through staking is not the same as earning interest from the high annual percentage yield offered by a centralized platform, such as BlockFi and Celsius last year, or Gemini, which ran into trouble last month. Those offerings were really more akin to a savings account: people would deposit their crypto with centralized entities that would lend those funds and promise to reward depositors in interest (up to 20% in some cases). Rewards vary by network, but generally, the more you bet, the more you earn.

Conversely, when you stake your crypto, you are contributing to the proof-of-stake system that keeps decentralized networks such as Ethereum running and secure; You become a "validator" on the blockchain, meaning you verify and process transactions as they are algorithmically selected. The selection is semi-random - the more crypto you stake, the more likely you are to be selected as a validator.

This is true only for proof-of-stake networks like Ethereum, Solana, Polkadot and Cardano. A proof-of-work network like Bitcoin uses a different process to confirm transactions.

Proof-of-stake vs. proof-of-work

Staking only works for Proof-of-Stake networks like Ethereum, Solana, Polkadot, and Cardano. A proof-of-work network, such as bitcoin, uses a different process to verify transactions.

The two are simply the protocols used to secure cryptocurrency networks.

Proof-of-work requires specialized computing equipment, such as high-end graphics cards, to validate transactions by solving highly complex math problems. Validators get rewarded for each transaction they confirm. It takes a ton of energy to complete this process.

Ethereum's massive migration from proof-of-stake to proof-of-work improved its energy efficiency by nearly 100%.

Risks involved

The source of return in staking is different from traditional markets. There aren't humans on the other side promising returns, but rather the protocol itself paying investors to run the computational network.

Despite how far crypto has come, it's still a young industry filled with technological risks, and potential bugs in the code is a big one. If the system doesn't work as expected, it's possible investors could lose some of their staked coins.