Proof of Stake Explained

August 31, 2021 | 

Proof of Stake Explained

Proof of stake has become a popular choice as an alternative to traditional cryptocurrency mining. These processes occur in order to maintain a blockchain by securing the network and validating transactions. They also create a structure of incentives that keeps miners and validators from attacking a blockchain.

Looking at Proof of Stake vs. Proof of Work, instead of expending computer power and incurring potentially high electricity costs, staking only requires that you leave some cryptocurrency in a staking-enabled wallet.

The network fees that are collected on a Proof of Stake blockchain are distributed back to the wallets that are staking on the network. Similar to traditional mining, rewards are earned in exchange for locking some cryptocurrency and staking it on the network.

Depending on the blockchain that you wish to stake on, there may be a minimum requirement in terms of the amount of cryptocurrency that you need to leave in your wallet or the length of time that it must be left there to earn rewards. Typically, proof of stake earnings scale up as you stake more tokens or lock them for longer periods of time.

What is Proof of Stake (PoS)?

The Bitcoin blockchain uses Proof of Work as a consensus mechanism. Meaning that miners deploy a proof of work algorithm to validate blocks of Bitcoin transactions. In Bitcoin’s Proof of Work, the miners are generating hashes in order to solve a mathematical problem. The first miner to solve the problem gets to validate a block.

Proof of Stake is a consensus mechanism that works as an alternative to Proof of Work. Instead of using computer power to generate hashes, a blockchain will select a staking wallet at random so that they can validate the next block of transactions. In Proof of Work, the odds that a miner will mine a block is proportional to the computer power that they are deploying. In Proof of Stake, the probability of being rewarded for validating a block is typically proportional to the number of tokens that are staked on the blockchain.

How to Maximize Staking Rewards?

Proof of Stake Explained

The methods used to calculate staking payments vary for each blockchain that uses Proof of Stake as a consensus mechanism. Some may even adjust their payout calculations on a consistent basis.

The most common methods for increasing your staking rewards include:

  • Staking tokens for a longer-term results in higher payouts
  • Staking more tokens nets a higher percentage payout
  • Staking on networks with lower inflation rates
  • Having a larger share of the total staked tokens earns a higher payout

These methods may provide higher payouts as a percentage of your staked tokens. To increase the odds of receiving a payout, tokens are often aggregated from multiple participants in a staking pool.

As previously mentioned, staking more tokens in a wallet typically results in a higher probability of being selected to validate a block and receive a reward. That doesn’t provide many opportunities for smaller wallets to participate. Due to this, staking pools allow smaller holders to combined their tokens into one staking wallet to increase the odds that each individual staker receives a payout.

Summary

Proof of Stake lowers the barrier to earning passive income with digital currency. Traditional mining has high overhead costs and has additional risks like hardware failure or surging electricity costs.

The primary risks for those staking digital assets are price risk and security risks, or the possibility that the value of the asset you are staking may decrease and the possibility that the smart contract you are stacking on has critical bugs.

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