Cryptocurrencies incentivize people to take part in validating transactions and maintain the distributed network by relying on two distinct incentive mechanisms: staking and mining.
In cryptocurrencies that run on the Proof of Work consensus protocol, miners must expand computing power in order to generate proof that a certain amount of work has been done to verify the transactions.
Cryptocurrencies that run on the Proof of Stake consensus protocol, on the other hand, require that validators, as they’re called, stake a certain amount of cryptocurrency tokens in order to be authorized to validate transactions and secure the network. The aforementioned process is also known as “staking”.
How does cryptocurrency staking work?
In most cryptocurrencies that support staking, the process involves network participants locking away (or bounding) native cryptocurrency tokens within a specific cryptocurrency wallet for a set time period. As compensation for their efforts in validating transactions and securing the network, validators are rewarded with new cryptocurrency proportional to the amount of their stake. To discourage fraudulent behavior, however, the system is set up so that any validators that try to cheat the system lose all of the crypto tokens they’ve staked.
From the user’s perspective, staking is somewhat similar to a savings account which enables clients to earn interest the longer they keep the money with the bank. As opposed to a bank account, however, staking cannot yield negative interest.
How is staking different from mining?
For one, staking doesn’t require expensive computer equipment or massive amounts of computing power to do its job. This means that it’s not only a cheaper alternative to mining but also a more eco-friendly one.
From an investment perspective, both mining and staking have their own unique advantages and disadvantages. With staking, for example, you’re, almost by default, heavily invested in the said coin, while with mining you can always exchange the coins you mine with something else. Mining also takes a lot more work and capital to find, buy, configure, and maintain the mining equipment, while with staking, you can be up and running within minutes.