What is Proof of Stake? - Earn Passive Income with Staking

Summary

In this informative video, Nate Martin from 99Bitcoins.com dives into the concept of staking, a method for earning passive income with cryptocurrencies. He explains that staking, unlike Bitcoin mining which requires significant computational power, involves locking up a certain amount of cryptocurrency as a 'stake' to participate in the creation of new blocks. Ethereum's transition from proof of work to proof of stake is highlighted, with details on how to become a validator by staking 32 Ether. The video also outlines the risks, including penalties for improper setup or network harm. Alternative staking solutions, such as using exchange services, joining a staking pool, or validator as a service, are presented for those without the technical expertise to run their own node. The summary concludes with an invitation to engage with the content and explore further opportunities in cryptocurrency.

Takeaways

• 💡 **Staking Defined**: Staking is a process where you lock up a certain amount of cryptocurrency to participate in the validation of transactions on a blockchain network.
• 💰 **Passive Income Potential**: Staking can help earn passive income with your cryptocurrency by contributing to the network's security and operation.
• ⚠️ **Risk Involved**: Staking comes with risks, including the potential for penalties or 'slashing' if the validator node is not set up or operated correctly.
• 🔑 **Technical Requirements**: To stake on Ethereum 2.0, you need to set up a validator with 32 Ether as collateral, which requires technical knowledge and a dedicated computer.
• 📈 **Rewards System**: Staking rewards are based on the amount of Ether staked and can vary depending on the total number of validators in the network.
• 🕒 **Long-Term Commitment**: For Ethereum 2.0, you cannot withdraw your staked Ether and rewards until after the 'docking' event, which is expected around 2022.
• 📉 **Dilution of Rewards**: As more Ether is staked, the individual reward rate decreases, as the total reward pool is fixed.
• 🚫 **Limitations on Validators**: Ethereum 2.0 allows only 900 new validators per day, resulting in a waiting list for those wanting to participate.
• 🤝 **Pooling Options**: Staking pools allow users to combine resources to increase the chances of earning rewards, even with less than the minimum staking amount.
• 💻 **Validator Services**: There are services that offer to run a validator node on your behalf, requiring less technical effort but still necessitating a 32 Ether deposit.
• 📊 **Staking Calculators**: Utilize staking calculators to estimate potential earnings from staking a certain amount of Ether in different scenarios.

Q & A

What is the primary problem that staking aims to solve in the context of cryptocurrency?

Staking aims to solve the issue of managing a decentralized blockchain ledger without relying on a central authority. It offers an alternative to the resource-intensive proof of work consensus mechanism by allowing participants to 'stake' their coins to validate transactions and create new blocks.

How does the proof of work consensus mechanism work?

Proof of work is a consensus mechanism where powerful computers compete to solve a mathematical problem. The first to find the solution gets to add the next block of transactions to the blockchain. The process requires significant computational power and electricity, which can be a disadvantage.

What is the alternative to proof of work known as?

The alternative to proof of work is known as proof of stake. In this system, participants lock up a certain amount of cryptocurrency as 'stake' to participate in the validation process, instead of using computational power.

How does the process of staking on Ethereum work?

To stake on Ethereum, you lock up a certain amount of Ether (32 Ether to be precise) on a computer connected to the network, acting as a validator. Based on the amount staked, the duration for which the coins have been staked, and a degree of randomness, a node is chosen to forge the next block and is rewarded with new coins.

What is the Beacon Chain and its significance?

The Beacon Chain is a new blockchain launched in December 2020 that uses proof of stake consensus mechanism. It runs alongside the original Ethereum blockchain (Ethereum 1.0) and is part of Ethereum 2.0, which is expected to fully deploy and merge with Ethereum 1.0, transitioning Ethereum to a proof of stake network.

What are the potential rewards for participating as a validator in Ethereum 2.0?

Validators in Ethereum 2.0 earn staking rewards, which are a percentage of the newly minted Ether. The actual reward rate depends on the total amount of Ether staked by validators in the network, with a higher number of validators leading to smaller individual rewards.

What are the limitations and risks associated with setting up your own validator node for Ethereum 2.0?

Setting up a validator node requires technical knowledge, a dedicated computer, and 32 Ether. There's a limit to the number of new validators that can join daily, leading to a waiting list. Incorrect setup or network harm can result in penalties, including 'slashing' where a portion of the stake is destroyed, and potential removal from the network.

What are the alternative staking solutions for those who are not technically savvy?

Alternative staking solutions include using staking services provided by exchanges, joining a staking pool where funds are pooled together to increase the chances of forging blocks, and using a validator-as-a-service, where a company runs the validator on your behalf.

How do staking pools work in the context of Ethereum staking?

Staking pools are collectives of individuals who combine their staked Ether to increase the likelihood of being chosen to forge a block. They allow participants to deposit less than the minimum staking requirement and share in the rewards according to their contribution.

What factors should one consider when joining a staking pool?

When considering a staking pool, one should research the reliability of the pool's validators, the fees charged by the pool, the quality of customer support, the size of the pool, user reviews, and whether or not the pool requires access to your private keys.

What is the 'docking' event in the context of Ethereum's transition to Ethereum 2.0?

The 'docking' refers to the future event when Ethereum 2.0, which uses proof of stake via the Beacon Chain, will fully merge with Ethereum 1.0. After the docking, stakers will be able to withdraw their staked Ether and any earned rewards.

How can someone estimate their potential staking rewards on Ethereum 2.0?

There are dedicated staking calculators available online that can estimate potential rewards based on the amount of ETH staked and the current number of validators in the network. These calculators take into account the fixed size of the reward 'pie' and how it is divided among validators.

Outlines

00:00

🔐 Introduction to Staking and Ethereum's Proof of Stake

The video introduces the concept of staking as a means to earn passive income with cryptocurrency. It outlines the risks and essential knowledge required before starting. The host, Nate Martin from 99Bitcoins.com, welcomes viewers to the Crypto Whiteboard Tuesday series, which simplifies complex cryptocurrency topics. The video emphasizes the importance of understanding the problem staking solves, particularly in the context of decentralized cryptocurrencies like Bitcoin. It explains the initial solution to blockchain management through mining, a competition that uses powerful computers to solve mathematical problems and earn the right to add new transactions to the ledger. The video also discusses the limitations of the proof of work consensus mechanism, which is resource-intensive and electricity-consuming. As an alternative, proof of stake is presented, where participants 'stake' their coins instead of using computational power. The process involves locking funds on a connected computer, known as a node, to participate in the selection of the next block producer. The video then focuses on Ethereum's transition to proof of stake with the Beacon Chain, which began in December 2020, and how it differs from the original Ethereum blockchain.

05:00

💰 Staking Rewards and Considerations for Ethereum 2.0 Validators

The video delves into the specifics of Ethereum's proof of stake model, particularly the rewards for validators and the process of becoming one. To participate as a validator in Ethereum 2.0, one must lock up 32 Ether as collateral, which will earn staking rewards. There is a limit to the number of new validators that can join daily, leading to a waiting list. Setting up a validator requires technical knowledge, a dedicated computer, and the Ether required, which can be barriers to entry. Incorrect setup or network harm can result in penalties, including 'slashing', where a portion of the stake is destroyed. The video discusses alternative staking solutions for those without the technical expertise or willingness to run their own node, such as using staking services provided by exchanges, joining a staking pool, or using a validator-as-a-service. These options come with their own considerations, like fees, control over coins, and the reliability of the service provider. The video concludes with a reminder for viewers to ask questions in the comments and to explore additional cryptocurrency opportunities, such as DeFi, in other videos.

Keywords

💡Staking

Staking is the process of participating in the validation of transactions on a blockchain network by locking up a certain amount of cryptocurrency as collateral. In the context of the video, staking is a way to earn passive income with cryptocurrency, particularly on the Ethereum network. It is an alternative to mining and is part of Ethereum's transition to Ethereum 2.0, which uses a proof of stake consensus mechanism.

💡Passive Income

Passive income refers to earnings derived from a rental activity or a business in which the taxpayer does not materially participate. In the video, it is mentioned in relation to staking as a method for cryptocurrency holders to earn income without the need for active work or management. Staking allows individuals to 'lock up' their coins and earn rewards for their contribution to the network.

💡Risk

Risk, in the context of the video, refers to the potential for loss or negative outcomes when engaging in staking. It is associated with the possibility of penalties, including 'slashing' where a portion of the staked funds can be destroyed if the validator node behaves improperly. The video emphasizes the importance of understanding these risks before getting started with staking.

💡Proof of Work

Proof of work (PoW) is a consensus mechanism used in blockchain networks, such as Bitcoin's, where miners compete to solve complex mathematical problems to validate transactions and add new blocks to the blockchain. The video explains that PoW requires significant computational power and energy, making it resource-intensive. It contrasts with proof of stake, which is less energy-consuming.

💡Proof of Stake

Proof of stake (PoS) is an alternative consensus mechanism to PoW where validators are chosen to create new blocks and confirm transactions based on the amount of cryptocurrency they can 'stake' as collateral, rather than their computational power. The video discusses how PoS operates on Ethereum 2.0 and how it is designed to be more energy-efficient and less susceptible to centralization.

💡Validator

In the context of staking, a validator is a node operator that has locked up a certain amount of cryptocurrency to participate in the consensus process. Validators are responsible for proposing and attesting to blocks in the blockchain. The video outlines the process of becoming a validator on Ethereum 2.0 and the rewards that come with it.

💡Beacon Chain

The Beacon Chain is a new blockchain launched in December 2020 that runs alongside the original Ethereum blockchain (Ethereum 1.0) and uses a proof of stake consensus mechanism. It is part of Ethereum's transition to Ethereum 2.0. The video mentions the Beacon Chain as a key component in Ethereum's shift to a more sustainable and scalable network.

💡Ethereum 2.0

Ethereum 2.0 refers to the next major iteration of the Ethereum blockchain, which aims to improve scalability, security, and sustainability. It incorporates the Beacon Chain and the shift from proof of work to proof of stake. The video focuses on Ethereum's staking model within the context of Ethereum 2.0.

💡Slashing

Slashing is a penalty mechanism in proof of stake blockchains where validators can lose a portion of their staked funds for acting against the network's rules, such as being offline or behaving maliciously. The video warns about the risk of slashing as a reason to be cautious and knowledgeable when setting up a validator node.

💡Staking Services

Staking services are platforms or exchanges that allow users to stake their cryptocurrency without the need to set up and maintain their own validator node. These services are designed for users who may not have the technical expertise or the required amount of cryptocurrency to stake independently. The video discusses staking services as an accessible way for everyday users to earn staking rewards.

💡Staking Pools

Staking pools are collectives where multiple participants pool their staked funds to increase the chances of earning rewards. They are similar to mining pools and allow users to join with less than the minimum staking amount. The video highlights staking pools as an alternative for users who wish to participate in staking without the full commitment required for individual validator nodes.

💡Validator as a Service

Validator as a Service is a business model where companies provide the infrastructure and maintenance for running a validator node on behalf of the user. Users still need to provide the required stake but benefit from the ease of setup and reduced technical overhead. The video presents this option as a middle ground between running a personal validator and using a staking service.

Highlights

Staking is a way to earn passive income with cryptocurrency by participating in the process of updating a ledger of transactions.

Staking uses a proof of stake consensus mechanism, where people lock up actual coins instead of using computational power.

In proof of stake, the more funds you stake and the longer you've staked them, the higher your chances of being chosen to forge the next block.

Forging a block as a staker involves receiving rewards in coins for contributing to the network.

Different coins like Tezos, Cosmos and Cardano use proof of stake with varying rules for calculating and distributing rewards.

Ethereum 2.0, also known as the Beacon Chain, was launched in December 2020 and uses proof of stake.

To become a validator for Ethereum 2.0, you need to lock up 32 Ether as collateral to earn staking rewards.

After the 'docking' event around 2022, Ethereum will become a pure proof of stake network.

Your staking rewards in Ethereum 2.0 depend on the total amount of Ether staked - the more validators, the smaller your share.

There are staking calculators available to estimate your potential rewards from staking a certain amount of ETH.

Becoming a validator requires technical knowledge, a dedicated computer, and 32 Ether, with penalties for improper setup.

Only 900 new validators can join Ethereum 2.0 daily, leading to a long waiting list.

Staking services provided by exchanges allow non-technical users to stake their coins and earn rewards with less effort and risk.

Staking pools combine funds to increase the chances of forging blocks and allow staking with less than the minimum amount.

When joining a staking pool, it's important to research the pool's reliability, fees, support, size, reviews and whether private keys are required.

Validator as a service companies allow you to run your own validator on their infrastructure, with less setup and maintenance required.

Staking is beneficial mainly for long term Ethereum holders, as rewards can only be withdrawn after the docking event.

Transcripts

What is Staking?

Can it help me earn passive income with my cryptocurrency?

It is risky?

And what do I need to know before I get started?

Well stick around:

here on Crypto Whiteboard Tuesday, we’ll answer these questions and more.

Hi, I’m Nate Martin from 99Bitcoins.com

and welcome to Crypto Whiteboard Tuesday

where we take complex cryptocurrency topics, break them down

and translate them into plain English.

Before we begin,

don't forget to subscribe to the channel and click the bell

so you’ll immediately get notified when a new video comes out.

Today’s topic is staking and how it’s done on Ethereum.

But before we dive into staking

let’s take a moment to understand the problem that staking tries to solve.

Also, if you’re new to cryptocurrencies

let me suggest that you start with our

“what is Bitcoin” and “what is Bitcoin mining” videos

before watching this one

to gain a solid foundation for what we’ll be covering here.

Bitcoin and other decentralized cryptocurrencies

hold the promise of sending money digitally without any central authority.

Initially, the solution to managing a blockchain,

which is a fancy term for a ledger of balances that isn’t controlled by any one entity,

was done through mining.

Mining is sort of a competition

where powerful computers try to guess the solution to a mathematical question.

Whoever finds the solution first,

earns the right to write the next page of transactions,

also known as a block, into the ledger.

With mining, the more powerful computer you use,

the more guesses it can make in a second,

increasing your chances of winning this contest.

Thanks to the laws of math and probability,

it is highly unlikely that any single person or group

will gain a monopoly over updating the ledger,

and that’s how decentralization is maintained.

Mining’s technical term is “proof of work” -

because by displaying the right solution,

miners prove that they’ve put in a lot of work,

as there is no other way to get to the solution

aside from using computing power

to constantly work at trying to guess it.

Proof of work is what is known as a consensus mechanism

since its design is to create an agreement

as to who gets to update the ledger amongst a group of people

who don’t really know each other

or have any other basis for working together.

While the proof of work consensus mechanism

may be a reliable and secure solution for managing a decentralized ledger,

it's also very resource intensive.

Running all of these supercomputers just for the sake of guessing a number

takes up a lot of electricity, among other disadvantages.

Because of these disadvantages,

other alternative consensus mechanisms have been suggested throughout the years.

One very popular alternative is proof of stake.

This means that instead of committing electricity to run computers

and try to win a contest, people will stake actual coins.

But how does this all work?

Well, you basically lock a certain amount of funds

on an everyday computer that is connected to the network.

Your computer is called a node in technical terms

and your locked funds are your stake.

Once your stake is in place

you take part in the contest of which node will get to forge the next block.

You see stakers forge blocks, they don’t mine them.

The winner of this contest is chosen by taking into consideration several factors

such as how much money is being staked, how long the coins have been staked for

and randomization

so that no single entity will gain a monopoly over forging.

Generally speaking,

whoever wins the contest gets to forge the next block of transactions

and is rewarded in coins for his contribution to the network.

It is important to note

that there are many coins that use proof of stake

such as Tezos, Cosmos and Cardano,

and each coin has different rules as to how it calculates and distributes rewards.

In this video we will focus mainly on how Ethereum’s proof of stake model works.

Up until 2020,

Ethereum’s blockchain was based purely on proof of work;

but in December of 2020 a new blockchain named “Beacon chain” was set up

that uses proof of stake:

this is also known as Ethereum 2.0

and it runs alongside the original Ethereum blockchain, Ethereum 1.0.

In order to join as a validator for Ethereum 2.0

you will need to lock up 32 Ether as collateral,

which in turn will earn you staking rewards.

There’s no way to lock up more than 32 Ether on a single node,

so if you want to increase your reward

you can just set up multiple nodes with 32 Ether each.

In a few years,

Ethereum 2.0 will deploy in full and will merge with Ethereum 1.0.

This event, known as “the docking”, will happen somewhere around 2022,

after which Ethereum will become purely a proof of stake network.

Only after the docking occurs

will you be able to withdraw your staked Ether and rewards,

which means that staking is mainly beneficial for long term Ethereum holders.

Now you’re probably asking how much Ether is rewarded?

In Ethereum 2.0 each validator that participates

in the forging of a block

gets a percentage of the newly minted Ether when it’s created.

The more validators the network has,

the smaller the proportion of the reward will be.

For example if 1 million ETH is staked,

the max annual reward for each staker could reach 18.10%,

however if 3 million Ether are staked,

that annual reward rate would drop to 10.45%.

You can think of the total amount of new Ether awarded

as a pie with a fixed size,

and the more validators you have that want a piece of that pie -

well, the smaller each slice will be.

To simplify things

there are dedicated staking calculators you can use

that will try and estimate how much Ether you’ll make

when staking a certain amount of ETH in any certain way.

So where do I sign up?

Well, signing up is not that easy,

as there are certain limitations you should be aware of.

Each day, only 900 new validators are allowed on board,

so as you can imagine there’s a pretty long waiting list.

At the time of posting this video

there are almost 20,000 pending validators waiting to join.

Additionally,

setting up your own validator requires technical knowledge,

a dedicated computer and 32 Ether -

all of which provide barriers

that may keep a lot of people from being able to take part.

To make matters even more complicated,

if you don’t set up your validator correctly,

or if it goes offline or it is harmful to the network in any way,

you may be subject to penalties.

These penalties may even include ‘slashing’ -

a term referring to the destruction of portions of your stake

and even removal from the network.

All of the risks I’ve just mentioned

are why some additional staking solutions were created.

These alternatives allow for the everyday person to stake ETH

and earn staking rewards -

without the considerable effort or risk of running your own node.

The easiest way to stake for a non tech savvy person

would be to use staking services supplied by exchanges.

Certain exchanges allow you to stake your coins

through their validators

even if you only have a small amount for a fee.

This completely eliminates the hassle of running your own validator

but requires you to forfeit control over your coins to the exchange.

Some exchanges will also allow you to claim your staking rewards immediately

and not wait until Ethereum 2.0 reaches the docking phase.

Another option is to join a staking pool.

Just like mining pools,

staking pools are groups of people joined together

in order to get a better chance at forging the next block.

Staking pools also allow you to deposit less than the minimum staking amount

since all of the funds are pooled together.

If you decide to go with a staking pool

it’s important to research certain aspects of the pool;

such as reliability of its validators, pool fees, customer support,

the size of the pool, user reviews

and whether or not you are required to give up your private keys to the pool.

Finally, there is the validator as a service option.

These are companies that will allow you to run your own validator on their computers

without the need to set it up or maintain it.

Since this is your own personal validator,

you’ll still be required to deposit 32 ETH and pay a certain fee for this service.

The great thing about this option is that it’s relatively easy to set up

and you don’t need to give control over your coins to another company.

That’s it for today’s episode of Crypto Whiteboard Tuesday.

Hopefully by now you understand what staking is -

a way of participating in the process of updating a ledger of transactions

by putting your funds at stake and earning rewards for your contribution.

You may still have some questions.

If so, just leave them in the comment section.

And if you want to learn about the different staking options

just take a look at the links we’ve listed below.

Also, if you want to discover more opportunities

for generating interest on your cryptocurrency

take a look at our “What is Defi?” video.

Finally, if you’re watching this video on YouTube, and enjoy what you’ve seen,

don’t forget to hit the like button, subscribe to the channel

and click that bell

so that you’ll be notified as soon as we post new episodes.

It really helps us out a lot.

Thanks for joining me here at the Whiteboard.

For 99bitcoins.com,

I’m Nate Martin, and I’ll see you…in a bit.