Proof of Stake (PoS) Explained
Staking is the modern alternative to Mining. Instead of burning electricity to secure the network, you "stake" (lock up) your coins as collateral. If the network validates transactions correctly, you earn rewards. If you act maliciously, your stake is "slashed" (fined).
APY vs APR
It is crucial to know the difference:
- APR (Annual Percentage Rate): The simple interest rate.
- APY (Annual Percentage Yield): The rate including the effect of compounding.
If you stake 100 ETH at 5% APR and reinvest the rewards daily, your APY will be higher than 5% (approx 5.12%). This calculator lets you select the compounding frequency to verify this.
Validator Staking vs Exchange Staking
- Native/Validator Staking: You run a node (or delegate to one) directly on the blockchain. Example: 32 ETH required for a solo Ethereum node. This is non-custodial and safest.
- Exchange Staking (Earn): You give your coins to Binance/Coinbase. They do the staking. This is easier but carries custodial risk (if the exchange goes bankrupt, you lose your coins).
Lock-up Periods
Many protocols require a lock-up period.
- Cosmos (ATOM): 21 days unbonding period.
- Polkadot (DOT): 28 days unbonding period.
- Ethereum (ETH): Originally locked indefinitely until Shanghai upgrade. Now withdrawals are possible but take days.
During unbonding, you earn usually NO rewards and cannot sell the asset. This is a risk during market crashes.
Liquid Staking (Lido / Rocket Pool)
The problem with traditional staking is illiquidity—your coins are locked. Liquid Staking solves this.
- You deposit ETH into a protocol like Lido.
- You receive a token (stETH) representing your staked deposit.
- You can trade, sell, or use stETH as collateral in DeFi while still earning staking rewards.
This capital efficiency makes liquid staking the dominant form of staking today.
Validator Duties
Being a validator is not passive. You must maintain 100% uptime. If your internet goes down, you leak funds (minor penalty). If you run malicious software, you get slashed (major penalty). This is why most users prefer "Delegated Proof of Stake" (DPoS) or pooled staking.
FAQs
- Is Staking risk-free?
- No. The biggest risk is price volatility. If you earn 10% APY but the coin drops 50% in value, you still lost money in USD terms.
- What is 'Slashing'?
- Slashing is a penalty mechanism in PoS. If the validator you delegated to has downtime or tries to double-sign blocks, a portion of the staked coins is destroyed.
- Are rewards taxable?
- Yes. In most jurisdictions, staking rewards are treated as "Income" at the time of receipt (based on the FMV at that moment).