Staking, or committing crypto assets, is not a new concept, though last year’s rise of decentralized finance (DeFi) has really pushed this to the maximum. Before we dive into how it is helping millions of people make profits, let’s look at its history a bit.
The Consensus Model
Bitcoin, the parent modern cryptocurrency, uses a method of ensuring that no entity is able to recreate the infamous “double spend” problem. Before Satoshi Nakamoto created blockchain and Bitcoin, all previous attempts failed because people would be able to spend their held digital assets more than once since the record was too slow to be updated or not updated at all.
To counter this, Nakamoto created what is called the Proof of Work (PoW), a consensus model in which miners validate transactions and they are permanently recorded in the distributed ledger, unable to be edited or altered. Thereby, coins sent on a transaction would not be able to be resend to other receivers and no double spending would be possible. This consensus method required the miners to prove that they had actually validated the transaction in a correct manner. The proof is done through solving complex mathematical calculations, with the right answer showing that there has been an effort made, a proof of work (hence the PoW name).
PoW, good as it is, soon started to face problems. As difficulty in the network increased, so did effort required to solve a problem and consequently the computing power. In attempt to still have operations feasible, miners started to use very heavy dedicated computers, which require an enormous energy to run. Today, the Bitcoin network consumes more power than small nations.
Staking, or PoS, was introduced as an alternative method.
Proof of Stake
PoS basically gamified the whole consensus model by letting people have a stake in the network through locking up their tokens in smart contracts. The more tokens are locked, the more stake they have. Their staked tokens give them the right to validate transactions.
With their own assets at stake, it will be in the best interest of the validators to only pass on the correct transactions. In case they double cross the network, the token value will fall and so will their locked up wealth dwindle. In this way, PoS offers a much better choice of using a consensus model that is energy efficient and faster.
Just like PoW, where miners are incentivised with newly minted coins, the PoS transaction validators are also given block rewards.
DeFi offered a whole new avenue of staking. The same staking concept is now used in different crypto financial services. Yield farming, as it has come to be known, is all about providing liquidity to the products, be it lending, swaps, margin or others.
Yield farming typically involves two things, the liquidity pools and the liquidity providers. Different DeFi services and platforms require people to deposit their tokens and assets in the pools so other users can use the lending, borrowing and swap features. The bigger the pool is, the more liquidity it has.
The network fee incurred in the services is passed on to the liquidity providers as their incentive. In this way, DeFi staking has many parallels with simple staking and at the same time, it differs as the financial products get more complex.
What Can I Stake?
There are hundreds of DeFi staking platforms out there, each one offering different rates of rewards. The complexity rises with the fact that you will need to cater not only the rewards offered, but their value in terms of fiat and compensate for the volatility that cryptos are famous for.
If you are really interested in DeFi staking, check out the following famous platforms:
- Compound: The DeFi king, Compound allows people to borrow a range of crypto assets through crypto collaterals. The platform charges interest which is distributed to the liquidity providers.
- Maker: The largest DeFi platform, it allows people to borrow its stablecoin DAI against their volatile assets, with the interest used to pay out to the lenders.
- Yearn Finance: A DeFi aggregator, Yearn distributes its users deposited funds in different DeFi platforms to reduce risk and at the same time maximize profits.
With the DeFi world exploding and billions locked in hundreds of platforms, the question of which platform to use does arise. There’s no clear answer to it. The game is to make sure that the staking platform you use is legitimate and they don’t have any fraud intentions.
Try to stick to reputable platforms and avoid high risk endeavours. Do your homework and read up on different social media and community pages on your preferred platform before deciding to commit any amount of crypto. Read the fine print too, such as the locked period, service charges and any other snag that you might hit.