Okay, so last post (linked here) I talked about the basic concepts that I grappled with in my first few weeks of crypto investing. Specifically, I discussed the value propositions of blockchain, smart contracts, ETH, and BTC. If you don’t feel entirely comfortable with these concepts, I would encourage you to go back and read my last post before continuing through this one. Okay, so the next stage of my journey was understanding staking. Quick side note: I don’t have a list of concepts that I am going down and checking off. The way I determine what I want to focus on next is by reading and listening to other people. If I hear a certain term enough, I start to think it may be relevant, and I begin to dive deeper. Okay, back to staking. One way to earn money in crypto is simply by investing in the currency. If you buy ETH and the value of it goes up vs the dollar, then you make money. However, given the infancy of the crypto-market on the whole, there are other ways to earn and that is what I want to talk about today. I will cover what staking is and how you can start doing it yourself.
Staking:
First and foremost, it is important to broadly understand the process of adding blocks to the blockchain. As we discussed last time, the blockchain is a long chain that consists of blocks that contain transaction data. To add a new block to the chain, the data that the new block will contain must first be agreed upon. In order to do this, the network selects a node (computer) to bundle the data, and then asks the other participating nodes to validate it. In other words, the network says, “computer A, you have been selected to propose the next block.” Then, computer A says, “okay, I think that this is what the next block should look like, does everyone agree?” and then the other nodes either confirm or reject the block. This process is how blockchains in general function. They rely on consensus among participating members of the network to propose and affirm each new block. Where staking comes into play is when we start discussing how the node proposing the block is selected.
As it currently stands, the way a node is chosen to propose the next block is through a process called proof-of-work (PoW). In PoW, nodes compete with one another to solve complex math problems. Whichever node solves the problem first, earns the right to create the next block. That block is then validated by the other nodes on the chain, and the participants are rewarded in the form of cryptocurrency. One of the primary downsides to proof-of-work is that it requires a large amount of energy… like a lot of energy…more than all of Finland uses in a given year. Staking is part of an alternate validation process known as proof-of-stake (PoS). Most of the newer chains (Solana, Avalanche etc.) use PoS, and Ethereum is currently trying to migrate from PoW to PoS.
In a proof-of-stake world, instead of choosing a node to propose a new block by pinning computers against one another, the network pseudo-randomly* selects a node from a pool of eligible nodes. Nodes make themselves eligible to be selected by staking (i.e pledging not to sell or move) their crypto with the network. So, where nodes once competed with one another to propose/validate blocks, with PoS they are now simply making the network aware that they are willing to help validate and/or propose the next block by staking currency. Thus, under PoS the process of adding a new block looks something like this: a new block needs to be added, so the network looks to the pool of nodes that have staked currency and selects one to propose the next block (no energy intensive competition required). The selected node then bundles the transaction data together into a block, and the other nodes vote on the proposed block. If a supermajority of voting power (i.e., % of staked ETH) votes yes (usually 2/3 is required) then the block is added. If the block is confirmed it is added and all participants are rewarded with cryptocurrency. It is also worth noting that each chain has its own rules around minimum quantities required for staking. For instance, the Ethereum blockchain requires that a node stakes 32 ETH in order to be considered for the next block. Ethereum also does not allow a potential validator to lock up more than 32 ETH, so in order to increase the chances of being chosen a validator would want to setup multiple nodes with 32 ETH. Here is a great video on the topic of staking if you want to explore it further.
How to Earn Staking:
Okay, so what does this mean for you and how can you make money staking? I have only dabbled in staking on Ethereum, and, honestly, I haven’t found it to be that fruitful. First off, it’s worth knowing that you can stake ETH even if you don’t have ~$130k of the currency lying around. The way you do this is through exchanges like Kraken or Coinbase, which let you pool your ETH together with other holders. The reason I’m not that excited about vanilla ETH staking is because it offers very little return (~4%-7%). I staked about $1,700 in mid November (i.e 1.5 months ago and have made $6.00 (0.3%). Where I think staking gets interesting is via DAOs that are trying to build out reserve currency systems (Olympus DAO for example). For vanilla chains, I think the real compelling value prop of staking is not in the money making opportunity that it offers, but rather the potential that it has to make slow, expensive networks like Ethereum much more scalable. That’s all for now. Next time we will get into my experience staking on Olympus DAO.
*I say “pseudo-randomly” because different PoS algorithms apply weight to different factors, such as the amount of currency staked, when determining which node is chosen.