In this article you’re gonna learn about something called staking and Proof of Stake
So what is proof of stake (POS)? Well, here’s a text book answer first, and then it’ll explain it so easy that a five year old could understand.
Proof of stake is a blockchain verification method that is much more energy efficient and less risky than the more common proof of work method. Only one minor is chosen at a time to validate the blockchain, but that minor must lock up some of their coins as collateral to be chosen. The minor 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 that the cinders paid.
First, I’m gonna tell you why proof of work sucks. In fact, we have proof of stake to fix the things that proof of work sucks at. So think of it like this in proof of work, let’s say you have runners lining up for a race. All eight racers are racing to the finish line, but you have some racers that have an advantage. Given the amount of resources they have kinda like they have stronger legs or they way less. They’ve trained longer, even though all racers get to the finish line.
Eventually only one person wins and they get the reward, which might be a shiny Bitcoin. While the other runners still had to run down the track. And those who didn’t win essentially wasted their energy for no reward. And with proof of stake, all the runners would line up at the starting line. And then only a single racer would selected based on a few factors, which we’ll talk about here soon. This way we don’t waste electricity or energy, and nobody runs without getting a reward. When it comes to coins that use proof of work like Bitcoin, many large mining companies compete to solve a blocks reward. The fastest proof of work. Also isn’t fair to the DIY miners who don’t have access to very machines are super computers that can win the puzzle, solving task. The quickest with cryptocurrencies. We want there to be lots of minors so that the coin is truly decentralized.
And so that the blockchain is safe. If those large mining companies join together, they could actually start making fake transactions because the blockchain is a majority vote. If they get even 51%, you can your Bitcoins goodbye. So this is a big problem and proof of steak attempts to fix this by only selecting one validator, which is the word that proof of steak cryptocurrencies call miners, the validator or the minor 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 steak is that since only one and 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 particip lock up some of their coins and then other validators can actually double check their work. And if those validators were 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. So in short to participate in a proof of work 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 network will pick you to mine. When you get picked, if you mind correctly, you get what’s called a staking reward, usually some of the coin. And if you mind incorrectly, you actually get penalized and lose some of the coin that you initially locked up. Moving on. The way that we select who gets to be the validator is important too, because in many cases, proof of steak coins will bias those who are staking most coins because they have the most to lose.
But sometimes we also calculate in 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 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, and to solve this also add in a bit of a random number picker. And I’m not gonna go much into that in this video because honestly I’m not completely sure about it either, but it is a factor in the validator selection process. 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. If it did, please leave a like below because a, it helps our channel grow.
It takes a lot of time to research, narrate, animate and promote videos like this. And if it doesn’t clear things up, leave a comment below and let us know what’s confusing. So maybe we can break it down even further in a future video. But now that you kind of know how it works, let’s go over the risks and rewards. So there’s a few risks when it comes to staking your cryptocurrency risk. Number one is that there’s some thing 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.
This is a risk risk. Number two is 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. Risk number three is validator commission. So if you don’t want to, you don’t 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, you 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. Risk four is the rewards duration. So 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. 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. And there’s a very, very small chance that you actually have a true, a good validation, but the network says that you’re wrong. Nobody really mentions this because the likelihood is very low, but it is still a risk. And lastly, I wanna go over the reason that we would stake because you do get staking rewards. Currently, I’m gonna go over four of the most popular staking cryptocurrencies. The first one is Tezos, which rewards you around 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 of it, which lowers your yearly return to 4.6.
Second Carano is another coin that does staking. They will give out around four to 5%. The algo coin rewards you with around eight to 10% a year. And lastly, Ethereum, which is actually switching to Ethereum 0.0, could be up to 15%, but more reliably, probably around four to seven, but this won’t happen for at least another year. So proof of steak has quite a few benefits over proof of work, but it has downsides too. Like it can invalidate DIY GPU miners who wanna participate without owning a whole bunch of the coin, but maybe I’ll go over more of long term downsides of proof of steak and another video. I hope this video helped you understand what proof of steak is and if you liked it, be sure subscribe, because we were planning to release many similar, helpful videos soon. We’ll see you in the next video.
