In this paper, I will go through the most important aspects of staking. What is it? How does it work? What do you, as an investor, need to know in order to get started with staking. Once you have read this paper, I hope that you will feel comfortable enough to start your staking journey with us.
Before we start, get familiar with a couple of words:
Validator = Someone who is responsible for verifying transactions on a blockchain
Network = Any blockchain like Concordium, Ethereum
Consensus mechanism = A computational method to reach agreement across a blockchain
1) What is staking?
Staking can be simple or complicated depending on the level of knowledge you are looking to unlock. However, the key takeaway of Staking is; A way of earning passive income on any given cryptocurrency that functions on a blockchain that uses a proof of stake consensus mechanism, for example Concordium or Ethereum. Staking is different to mining, which is how Bitcoin operates. Mining is very energy intensive while staking is 99.95% less energy intensive. However, they both serves the same thing in the end; To validate and ensure transactions are verified on a blockchain. In this section we will cover all the important aspects of staking you need to know.
2) What is a “proof of stake” consensus mechanism?
This is where it gets a little technical but it is important to understand the difference between Proof of Work and Proof of stake. Cryptocurrencies are designed to be decentralized, meaning no central authority is needed to govern the show. So how does this work without having a bank or a credit-card company settling the information between all various parties? They use a Consensus mechanism. Consensus mechanism refers to a computational “method” used to achieve agreement, trust and security across a blockchain. The two most common “methods” are Proof of Work (Fx. Bitcoin) and Proof of stake (Fx. Concordium).
Many networks use a method or consensus mechanism called Proof of work. In a proof of work blockchain, you have a huge number of computers running some software that can solve complex mathematical algorithms, fx. validating a transaction between two strangers and making sure nobody is trying to spend the same money twice. These are called “miners”. Miners compete with each-other to solve this puzzle and add the latest transactions to the blockchain, and in return, they receive some crypto as a “reward”. Of course, the more activity on the network, the harder it becomes to solve these mathematical algorithms, thus, more energy is needed from every miner and ultimately making it very energy intensive and expensive to run, because the competition gets harder.
Therefore, a newer consensus mechanism to overcome this issue has emerged, namely Proof of stake. The key difference is, by not having all those miners competing with energy as the source of their “proof” for participating, you have people who are invested in the blockchain using their money as their source of “proof” for participating. But how is that done? Let’s take a look at the next section.
3) How does staking work?
In order to perform a staking operation, two things are needed:
1) A sum of money in the form of a cryptocurrency that uses proof of stake
2) Proper software/hardware to perform the staking operation.
Number 1 is you, as an investor, that invest $1000 in fx. Concordium and in exchange receive their token, CCD. Number 2 is Myrmidon Staking that runs proper software and hardware that interacts with the Concordium Blockchain. A typical scenario when staking your cryptocurrency goes like this; You, as an investor, have the money and we, as a staking service, have the expertise and software to operate on a blockchain. We then make a mutual agreement, that we, as the staking service, can use your money as the “proof” to perform the staking operations on the blockchain, and take part in validating transactions, and in return give you, the investor, staking rewards for your participation. In this scenario, we are business partners, performing a job on a blockchain and in return, we own rewards as our payment for doing our part. We then share this reward as agreed to in our agreement. That’s it!
Staking serves a similar function to mining, in that way it is a process, by which a blockchain participant (us a business partners and “validators”) gets selected, to add the latest transactions to the blockchain and in return earn some crypto as a reward i.e., staking rewards. A proof of stake blockchain selects participants (People who stake) based on the size of their stake (How much money is “at stake”) and the length of time they have participated.
4) What are the advantages of staking?
Think about having money in your savings account. What would prefer? Having the money sit at the account and collect dust or would you rather put the money into work and have them generate a yield? Staking is the last part. Many crypto investors use staking as a way of making their asset work for them by generating a yield i.e., staking rewards, instead of having the crypto assets collect dust in a wallet. You have already chosen to invest in a given blockchain project, so why not earn an interest while being invested?
Staking also has the added benefit of contributing to security and efficiency of a blockchain. By staking your funds, you actually make the blockchain more resistant to attacks, because the larger the stake in a blockchain, the harder it becomes to exploit the blockchain, i.e., by staking your funds, you take part in protecting your own investment.
5) What are the risks?
It is very important, always, to know your risk and do proper research when investing your money into something. Staking is no different to this rule of thumb. Here I have listed some of the most important things to be aware of when engaging in staking:
1) Staking often requires a lockup of your funds for a set period of time. This means, that your funds are locked for the purpose of staking and you cannot transfer the funds until the lockup has finished. Lockup periods vary from blockchain to blockchain and can be anywhere from 7–30 days. The drawback can be, that you will not be able to sell your funds even if the market shifts dramatically and hereby miss a chance to sell while your funds are locked.
2) Staking rewards are determined by an annual %-percentage yield (APY) and vary from blockchain to blockchain and also tends to change over time. This means, that you are not guaranteed a fixed APY on your staking allocation. Staking rewards are always paid in the native token of the blockchain you invested in. For example, when investing in Concordium, your staking rewards and hereby the %APY on your investment, will always be paid in the form of CCD tokens, the native token for Concordium, that you used in the first place to gain access to staking. Cryptocurrencies are volatile and therefore, drops in prices can outweigh the rewards you earn. Staking is usually chosen if the investor plans to hold the asset for a longer period of time regardless of the volatility.
3) Can I lose my money? In theory, there is a risk of losing some of your money. However, the risk is very low. How is that to be understood?
When staking with Myrmidon, your money never leaves your wallet. This means, we never hold custody over your money, thus we cannot control, steal or lose your money. They stay safe with you. However, when engaging in staking, you give the staking service the right to use your money for staking on your behalf. In crypto language, you perform a delegation. By doing so, you face a counter-party risk, meaning that you rely on the staking service to facilitate the staking operation. If the staking service or validator, as it is called, does not do its job properly, they risk getting penalized and lose some of the stake. This could be in the event of power failure, in which the staking services goes offline for a period of time. Such event could cause a penalty and the risk of losing some of the staked funds. Therefore, always do the research behind the staking service to find out if they can be trusted and how they operate.
From reading this paper, you have learned that staking is a way of putting your crypto assets to work, and earn a passive income called staking rewards. Staking is only possible on a proof of stake blockchain since your money, in a form of a cryptocurrency, is your proof for participating, not energy which is the proof for participating in proof of work. You have also learned, that staking is a process that helps verify transactions and make a proof of stake blockchain more secure. You know that proof of stake is a consensus mechanism, and this refers to a computational method to reach agreement across a blockchain network, and is used because cryptocurrencies are designed to be decentralized, thus no central authority runs the show. You should also have learned some of the advantages and some of the risk of participating in staking. Therefore, I would argue that you know just enough and are well prepared to start your staking journey.
Visit Myrmidon Staking and get started right away
Sincerely, Nikolaj Rosenthal — CEO, Myrmidon Staking