Ledger’s Staking Glossary
|— Interest in the concept of staking has increased since Ethereum’s recent transition to a proof-of-stake consensus mechanism.|
— Yet the technical language surrounding staking can make it difficult to access for newcomers looking to get involved.
— In this article, we will provide an invaluable resource for understanding staking by explaining the key concepts and vocab in a clear and concise manner.
The recent transition of Ethereum – the world’s second most significant blockchain – to a proof-of-stake consensus mechanism has driven renewed interest in staking. So here, we make it accessible.
Staking is a tremendously popular option that’s unique to the crypto space. Staking enables cryptocurrency holders to participate in securing a Proof-of-Stake (PoS) or Delegated Proof of Stake (DPoS) network, while potentially making passive income from their inactive coins.
Yet the language and jargon around staking is often very technical, which can make it hard to access for newcomers.
In this glossary, Ledger Academy will demystify staking and enable you to get involved – whatever your level of knowledge – by presenting and unpacking the key terms used in the space.
Your Staking Glossary
Proof-of-Stake (PoS) is an algorithm that defines the rules to add new blocks of transactions to the blockchain. It is defined by the way in which it achieves “consensus”: this is when the network nodes agree that a new block of information is accurate enough to be added to the chain.
Bitcoin, for example, uses proof of work as its consensus mechanism. In POW, a new block can only be added if the hash of the block is below a target value automatically set by the network. It can take trillions of guesses before that value is randomly discovered by a miner. The lucky miner that discovers it first gets to add their block to the blockchain. You can read more detail on that system here.
On the other hand, a proof-of-stake network secures itself via staked crypto. Every validator node must have “locked up” a security deposit consisting of ETH on the network in order to participate in consensus. Doing so enables the network to stay secure because it uses that crypto as collateral to compel those nodes to behave properly as they validate new blocks (more on that in the slashing section below).
You can read full detail about how that works in this article about different types of staking.
Relative to proof-of-work blockchains, proof-of-stake tends to use less energy for processing transactions, since it utilizes staked crypto – instead of power (and expensive hardware) – as its key resource.
However, it must also be acknowledged that this is a newer system, still to reach its full state of development. So the full potential of proof-of-stake, including its security efficiency and vulnerabilities, is still to be properly understood.
A validator is a type of node in a proof-of-stake network that participates in the consensus of the blockchain. Validators play a crucial role in the security of the blockchain, as they are responsible for ensuring that all new blocks of transactions are valid and correct before they are added to the blockchain permanently. Validator nodes each have the same copy of the blockchain’s history – using this shared history, they communicate to confirm whether new blocks of transactions are valid before voting to add them to the main chain.
If a validator node detects an invalid transaction or block, it will reject it and communicate the rejection to the network.
To become a validator node, validators sometimes need to deposit/stake a minimum amount of the native cryptocurrency. In return for validating incoming blocks, validators receive rewards from the network in the form of its native coins.
Delegated proof-of-stake is a variation of the proof-of-stake consensus mechanism. Here, users of the network can delegate voting rights to a validator (known in this system as “delegates” or sometimes “witnesses”) who will validate new blocks on their behalf.
Once each new block is validated, the users who contributed to the pool get a share of the reward proportionate to their delegated coins, while the delegate retains a commission.
The selected delegate can change – the vote is reputation based, and can change to reflect which delegate is performing best, which in theory will produce the best outcome for both the network’s security, and for its users’ rewards.
The entire process takes place while the users’ coins remain in their crypto wallet – although they are committed to the delegate, they remain in the crypto wallet of the user.
Bonding / unbonding period
No matter how well you understand the process, staking has no simple “on and off” switch. The process of staking your coins is book-ended by transition periods, otherwise known as the “bonding” and “unbonding” period.
- Bonding Period
The bonding period is the process of telling the network you want to stake your crypto, and waiting for that intention to be initiated. During this period, you won’t earn any rewards on the coins – it serves purely as an initiation of your intention to stake. The duration of this bonding period will vary between networks.
- Unbonding Period
Similarly, when you wish to unstake your coins, you’ll be subject to an “unbonding period”. Here, you’re telling the network you want to unstake your coins from the protocol and regain full autonomy over them. Again, this is a period set by each individual network, and users will not earn rewards during this time.
It’s important to know a network’s bonding and unbonding periods before you start staking, because these will determine not only the minimum period your coins will be committed for, but also the proportion of time your coins can earn rewards.
Different networks have different bonding and unbending periods, and it will be essential to establish this information whenever you consider staking your coins with a given blockchain.
Ethereum’s exit queue – a work in progress
At the time of writing, Ethereum is an anomaly in the space, as it has not activated a withdrawal functionality for coins staked on its network. Anyone who has staked on the Ethereum protocol since its transition to proof-of-stake will be unable to unstake that sum until the withdrawal functionality is introduced at the completion of the upgrade. This is expected to happen in March 2023 with the Shanghai Upgrade, with the announcement of an unbonding period, and therefore the date when users can unstake their locked Ethereum.
Staking-as-a-service tends to be offered by centralized institutions like crypto exchanges. In a nutshell, it gives absolutely anyone access to the passive income of staking, even where they have no knowledge of the mechanics of the process. This is often done to avoid the hassle of running a full node.
The third-party staking provider operates a validator node on your behalf, usually for a monthly fee. To “stake” coins with that validator, and start earning rewards, users will need to deposit their coins in the associated staking wallet – in other words, the user will no longer be in custody of those coins.
So in short, the benefit is ease of use, since users need no technical knowledge other than sending their coins to a wallet, while the drawback is loss of self-custody over your staked coins.
A staking pool is a group of users who pool their crypto together to obtain the threshold amount required to activate a validator node. A great example of this is RocketPool mini-nodes.
When that node validates a new block of transactions, the reward is shared among those users, according to how much they contributed to the pool. This gives more people access to the options of staking since individuals don’t need to overcome a significant initial threshold to run a node – instead, it’s done collectively and managed via a protocol.
For staking pool users there is another big advantage: coins can be committed to a pool without them ever leaving your wallet. Using a staking pool allows you to enjoy crypto self-custody, even as you stake.
As you know, staking your coins means committing them to a given network or protocol. During that time you can’t use those coins for other things such as trading; they are illiquid.
Liquid staking platforms, like Lido and Frax Finance, pose an alternative to that, by providing staking participants with a composable “receipt” for their staked coins. This receipt is a tokenized representation of the staked coins and can be used elsewhere in the DeFi system, for trading or as collateral.
So in short, liquid staking enables you to benefit from staking rewards – without losing out on the other opportunities your staked coins might have offered you.
Staking rewards are the incentive paid to individuals for either staking their coins directly on a network, or for contributing coins to a staking pool.
If you’re acting directly as a validator, the amount of staking rewards you’ll earn will be set out by the network. Meanwhile, if you’re simply contributing to a staking pool, your expected rewards will be determined by the protocol and made clear in before you start staking.
APY, or annual percentage yield, is a way of expressing the interest rate you’ll earn on your staked crypto.
It is the effective annual rate of return that takes into account the compounding of interest. In other words, the APY means you will earn interest on both the sum you originally staked, and on the subsequent interest you earn on that sum – this is known as compounding.
This is why compound interest is often referred to as “the gift that keeps on giving.”
APR is another unit of measurement you might see used to express staking rewards. The defining feature of this measure is how that interest is calculated over time: the rate applies to the staked sum only, and does not compound interest earned on that sum over time.
Say you stake your crypto (equal in value to 10,000 USD) for three years, and it has a return of 5% APR.
Each year, you will make a return of 5% on the original staked sum of 10, 000 USD – but only on that original sum, and not on the interest has accrued since the start.
Slashing is a process whereby a network deducts some of a validator’s locked-up coins, in response to misconduct by that node. The types of behavior that could lead to slashing include unavailability, frequently going offline and failing to sign blocks when it is their turn to do so, and double signing.
In these instances, the network will penalize the validator node by deducting (slashing) some of the crypto they initially locked up. By doing so, the blockchain incentivizes good behavior from its network of validators, since logically they will want to avoid losing their stake.
Slashing is a vital part of any proof-of-stake protocol. By acting as a security deposit, it helps to keep validators in check and guarantees the smooth running of the network as a whole.
Downtime in the context of staking refers to any period when a validator node is not online and available to validate transactions. This can mean that a node is turned off or disconnected from the network. It can also refer to more serious issues, such as software or hardware failures.
In either case, if a node is unavailable to serve the network for an extended period of time, this is referred to as downtime, and is normally considered an offence by the network.
You Are Now Ready to Stake
With more and more people becoming interested in cryptocurrency and the new options it offers, there is a growing demand for educational material to help people understand the key concepts.
When it comes to the nascent world of crypto, knowledge is power. Now you’ve had a crash course in the technical jargon related to staking, you’re ready to enter the arena yourself. And remember, no matter what you do with your coins and tokens, crypto security should always be your #1 consideration.