Mastering Staking: A Comprehensive Guide to Proof of Stake (PoS) and Its Dynamics

Welcome to a journey into the world of staking! Before we dive into the intricacies of this fascinating concept, consider checking out our previous article on the Proof of work consensus model here , the backbone of Bitcoin's financial tracking system. Although it may seem complex initially, grasping proof-of-work will pave the way for a smoother understanding of proof-of-stake, a more efficient and secure blockchain verification method.

At its core, proof of stake (PoS) is a blockchain verification method that surpasses the energy inefficiency and risks associated with proof of work (PoW). Unlike proof of work (PoW), in proof of stake (PoS), only one miner is chosen at a time to validate the blockchain. This selected miner, however, must lock up a portion of their coins as collateral. Frauds incur penalties, whereas successful transactions are rewarded with newly created coins and, potentially, transaction fees. It took me a while to fully understand what proof of stake (PoS) is and I'll try my best to put it into layman's terms for you guys. So Proof of stake (PoS) is a blockchain verification method that is much more energy efficient and less risky than the more common proof of work (PoW) method. Only one miner is chosen at a time to validate the blockchain, but that miner must lock up some of their coins as collateral to be chosen. The miner is punished for creating any fraudulent transactions by losing their collateral and rewarded for good transactions by the creation of new coins and possibly with the transaction fees the senders paid.

To appreciate the need for proof of stake (PoS), first I'm going to tell you why proof of work (PoW) sucks. In fact, proof of stake (PoS) was created mainly to fix the things that proof of work (PoW) sucks at. So for simplicity, let's examine the shortcomings of proof of work (PoW). So, picture a race where all runners aim for the finish line, yet some possess inherent advantages, akin to having stronger legs, less weight, or more extensive training. In proof of work (PoW), only one person wins the reward (e.g., a shiny Bitcoin), leaving others who expended energy with no compensation. Proof of stake (PoS), on the other hand, ensures fairness by selecting a single validator based on specific criteria, minimizing energy waste.

1. Addressing the decentralization Challenges in Proof of Work (PoW)

Proof of work (PoW) introduces challenges with large mining companies competing for block rewards, disadvantaging DIY miners. The risk of centralization and potential fraudulent transactions increases. Proof-of-stake addresses this by selecting one validator (mining facility) to solve puzzles, enhancing fairness, decentralization, and security.

The Problem when it comes to coins that use proof of work like Bitcoin is that many large mining companies compete to solve a block reward the fastest. proof of work also isn't fair to the DIY (do it yourself) miners who don't have access to very powerful machines or supercomputers that can win the puzzle-solving task the quickest with cryptocurrencies. We want there to be lots of miners so that the coin is truly decentralized and so that the blockchain is safe. If those large mining companies join together they could start making fake transactions because the blockchain is a majority vote. If they get 51% of the network, you can kiss your Bitcoins goodbye. So this is a big Proof of Work problem (PoW) and Proof of stake (PoS) attempts to fix this by only selecting one validator which is the word that proof-of-stake cryptocurrencies call miners, the validator or the miner then gets to solve the puzzle and earn the reward while other validators double check them. it's a lot more fair this way. One key thing when it comes to Proof of stake (PoS) is that since only one validator is selected, it's very important that they solve it correctly because otherwise they'll have to select someone else, wait for them to solve it correctly and it just takes a lot of time and in the crypto space, time is money. So to solve this problem we make sure that those participators lock up some of their coins and then other validators can double-check their work, if those validators are wrong we penalize them and take some of the coins that they locked up. This process of locking up their coins as collateral is called staking. In short, to participate in a proof of stake coin you have to own some of that coin then you lock it up so you can't use it and you wait so that the network will pick you to mine. When you get picked, if you mine correctly you get what's called a "Staking reward" which is usually some of the coins, and if you mine incorrectly you get penalized and lose some of the coins that you initially locked up.

2. Validator Selection Process

Let us explore the crucial process of selecting validators, emphasizing the potential bias towards those staking the most coins introduce considerations for stake duration and a random number picker to prevent undue favoritism towards large mining facilities, ensuring a fair selection process. In other words, the way that we select who gets to be the validator is important too because in many cases proof of stake coins will bias those who are staking the most coins because they have the most to lose, but sometimes we also calculate how long they have been locking up those coins, because they have them and they haven't lost them, they're probably making lots of good calculations on the network to keep it safe and secure. If we only select them based on the age of their stake though or who has the most stake we would probably also secretly be biasing the big and rich mining facilities again. So to solve this we also add in a bit of a random number picker. So now, you might understand there's a good incentive for validators to correctly verify the blockchain and a good selection process to reduce energy waste and I hope this clears things up a little bit.

Now that you kind of know how Proof of stake (PoS) works, let's go over the risks and rewards in proof of stake.

So there are a few risks when it comes to staking your cryptocurrency, including locking periods, technical knowledge requirements, validator commissions, rewards duration, and the unlikely event of bad behavior resulting in stake loss. Emphasis are that despite these risks, staking rewards serve as a compelling incentive for participation.

1. locking period:

Risk number one is that there's something called the locking period. When you go to stake your coin it'll be moved into what is called a locked state and during this time you will not be able to move your coins, you can't send them and you can't cash them out. Sometimes you have to lock them up for a certain amount of time like maybe a month minimum all the way up to a year.

2. Technical knowledge:

In almost every case, it's not as easy as just downloading some software and then pushing a button. You usually have to know how to code, how to set up your computer to validate, and how to accept rewards into a wallet, and if there's an issue you are responsible to fix it.

3. Validator Commission:

So if you don't want to have to set up the validation process yourself, you can give your coins to someone else who has the knowledge and equipment to do it. These platforms usually require a validator commission for the use of their computers and this commission could cut into your profit and they could run away with your deposit at any time.

4. Rewards Duration:

Depending on the network that you choose, it could take minutes, days, and sometimes even weeks to see the payout of your staking position. This is why it's crucial to see the network's reward payout time before becoming a miner or validator.

5. Bad Behavior:

last we have risk number five which is bad behavior. So proof of stake is built on validators and if the validation turns out to be bad you'll lose some of that stake. There's a very small chance that you actually have a true good validation but the network says that you're wrong. nobody really mentions this because the likelihood is very low but Staking Rewards is still a risk.

Popular Staking Cryptocurrencies

lets explore four prominent staking cryptocurrencies—Tezos, Cardano, Algorand (Algo), and Ethereum 2.0. Their respective staking rewards and insights into their user-friendly aspects and potential returns.

1. Tezos:

The first one is Tezos which rewards you around six percent (6%) of what you stake per year and coinbase does it for you. You don't have to set up any of that process but they take around one and a half percent (1.5%) of it which lowers your yearly return to 4.6%

2. Cardano:

Cardano is another coin that does staking, they offer around four to five percent (4-5%).

3. Algo coin:

This coin rewards you with around eight to ten percent a year(8-10%).

4. Ethereum:

Ethereum which is actually switching to ethereum 2.0 could be up to fifteen percent but more reliably probably around four to seven percent.

Conclusion

So proof of stake has quite a few benefits over proof of work but it has downsides too like it can invalidate diy(do it yourself) gpu miners who want to participate without owning a whole bunch of the coin but maybe i'll go over more of long-term downsides of proof-of-stake in another article. I hope this article helped you understand what proof-of-stake is.