The staking concept in cryptocurrency has become one of the most talked-about aspects of owning and earning from digital assets, partly owing to the ability to generate yields higher than bank savings interest rates.
The term ‘staking’ stems from an alternative mechanism to verify transactions and secure blockchain networks called Proof-of-Stake (PoS). PoS attempts to improve on the original mechanism used by Bitcoin called Proof-of-Work (PoW). Only crypto using PoS can be staked.
Despite the touted improvements, however, not all cryptocurrencies use staking or have changed their mechanism to staking. Bitcoin, in particular, doesn’t appear to be likely to even consider the switch in the near future.
In this article, we discuss the reason why. You will learn about:
To learn more about staking crypto to earn rewards as a form of investment or passive income, read this Learn Crypto article about how staking rewards work.
Bitcoin was the first blockchain-based asset to achieve mainstream recognition and widespread adoption as a secure digital currency thanks to a simple yet ingenious invention called Proof-of-Work (PoW).
PoW provided a work-around to a coordination problem that was long thought to be unsolvable called the Byzantine Generals problem.
Several generals are besieging the old city of Byzantium. Attack together, and they succeed. Attack at different times and they will fail. How will they communicate to agree when separated from each other, and knowing that some of them are unreliable?
The equivalent problem for a distributed network like Bitcoin was this: how do you ensure that many participants on a distributed network reach the same correct decision despite the presence of dishonest participants?
PoW was a two-pronged economic solution to this problem by introducing a true cost to dishonest behaviour, as well as a reward system to incentivise good behaviour and attract more participants, thereby growing its network and strengthening its security. In this system, the larger the network grows, the greater the cost of dishonest behaviour, and the greater the security.
As the term suggested, PoW network participants must provide proof of work. This work was to solve highly complex mathematical puzzles, using significant computing resources to find the answer to the puzzle provided by the network. Each puzzle solved would create a new “block”, within which validated transactions are recorded. Each block of transactions is then added to an existing chain of blocks thus creating a chronological ledger of transactions.
Anyone could become block creators or crypto miners in this way, as long as they had computational resources able to solve these puzzles.
As more computing resources join a PoW network, these puzzles are solved faster. However, with each puzzle solved, solving the next one becomes harder.
Bitcoin’s growth soon meant that the level of difficulty went out of reach of the computational power of normal computers. At first, anyone with a modest home computer was able to mine Bitcoin. But after a couple of years, solving a block on your own required powerful computers. By 2013, crypto mining participants needed highly-specialised devices built specifically to solve these incredibly complex equations, called ASICs (Application-Specific Integrated Circuits).
There were two major issues created by this situation.
Firstly, as only increasingly expensive and powerful devices were capable of solving the equations needed to produce more blocks, only wealthy individuals and companies could become participants. This became more apparent in the case of Bitcoin, where large and powerful crypto “mining” companies would operate factories of mining rigs, pushing out hobbyists and home computers.
This led to a form of centralisation, where only a handful of entities were responsible for the majority of computing power securing Bitcoin – seen by some as harmful to the decentralisation efforts of cryptocurrency.
Secondly, and perhaps more apparent for observers, this specialised equipment consumed massive amounts of energy and caused concern that PoW-based cryptocurrencies would have an increasingly large carbon footprint.
It was estimated that in 2021, Bitcoin consumed 91 terawatt-hours of electricity annually, more than Finland’s (population 5.5 million) consumption in the same year.
It was only about a couple of years after Bitcoin’s emergence when a new consensus mechanism called Proof-of-Stake (PoS) was introduced. By that time, Bitcoin was thought to already consume electricity worth about $150,000 daily.
In their joint paper, Sunny King and Scott Nadal proposed using a deterministic algorithm called “staking” to add new blocks, choosing successful miners (or nodes or participants) based on the number of crypto tokens they had. There would be far less technical knowledge required as people would only need to stake crypto and not calculate complex mathematical problems in a proof of work chain.
A simple example would go like this. If Node A owned and staked 10 coins in a network that had a total supply of 100 coins, then Node A had a 10% probability of finding the next block.
So instead of requiring ever-increasing energy to solve the ever-rising difficulty of puzzles, miners in a crypto staking network only needed to increase the number of crypto assets held to improve their probability of finding new blocks.
In this system, honest participants were still incentivised by getting new coins from block rewards and transaction fees. Dishonest participants would be penalised by being charged fines by the network or even losing part or all of their stakes.
So the matter would appear clear cut then, wouldn’t it not? If PoS is cleaner than PoW, if there were no need to expend millions of dollars worth of electricity simply to secure a currency, wouldn’t it make sense for every crypto to just use PoS?
The arguments for both sides have frequently been brought to debate and improvements to the downsides of the Proof-of-Stake model have led it to become a lot more mature and feasible than in 2012. Some PoW cryptocurrencies have eventually made the switch to PoS or have made the decision to do so, most notably Ethereum (ETH).
Ethereum is a Proof-of-Work model blockchain that very much mirrored Bitcoin’s consensus algorithm in its initial stages. However, for the past four or five years, its developers have been overseeing a steady migration to Proof-of-Stake, chiefly for the key benefit of being a less energy-intensive method of securing the network and validating transactions.
The high costs to verify transactions, witnessed since around 2016, have partially led to this move. As Ethereum continued to grow in popularity as a decentralised application (dApp) platform, its transactional capacity has been maxed out several times since, forcing people to either pay hundreds of dollars simply to get a transaction through or to wait for hours and even days.
The path towards Proof-of-Stake or Ethereum 2.0, however, has not been smooth and Ethereum has delayed its complete switch repeatedly, although December 2020 was a key moment as they began testing the protocol properly.
The main reason for this is that PoS actually has not been proven on a network as robust and as large as Ethereum. A simple mistake could result in losses of billions of dollars worth of assets.
The main issue with PoS as an alternative to PoW is quite simply this: the security of PoS is not as well-known nor as battle-tested as Bitcoin’s. Bitcoin has survived and proven PoW as a viable method to secure a cryptocurrency that today has well over $550 billion in market capitalisation. It also secures Ethereum, which has a market capitalisation of over $210 billion.
In comparison, the current largest PoS coin in terms of market capitalisation is Binance Coin (BNB) with only $50 billion in market capitalisation.
However, this article will not take a direct look at the complex security issues surrounding PoS. Instead, we look at other major concerns or risks of PoS.
Consider that to start a network in PoW, you simply would need to contribute computing power, and then reinvest the earnings. But in PoS, you would need an initial purchase of coins to have a stake. So how does a PoS network distribute coins at first?
For Ethereum, the problem is partially solved since migrating means millions of people already own ETH. On the other hand, if these holders were to desire participation in staking, only the richest owners would have enough ETH to have any chance of getting a reward.
Staking pools, which are explained in this article, solve that entry barrier, but would only enrich the already wealthy or make them even more powerful.
This is slightly related to the point we’ve just left off. If the entire idea of a distributed network is to prevent concentrating power in the hands of the few, than PoS might be even easier to manipulate since the wealthiest will be able to acquire the most stakes, and continue to get even wealthier from staking rewards.
Proof-of-Stake blockchains frequently have governance measures in them, which is a way to determine how a network might develop or make any other kind of decisions. Once more, the voting power is determined by the amount of tokens held. The wealthier the participant, the more powerful their voting weight.
It is, in fact, a significant danger in a PoS network because a malicious actor could easily purchase enough tokens to hold the majority tokens in a network and take over it – something called a 51% attack. In simple terms, own the majority of tokens in a PoS network and you could unilaterally decide which transactions are valid and which are not. This would wreak havoc on all the other millions of participants – simply because they only collectively held 49% of the coins.
If the idea of a decentralised and distributed network is to prevent a single authority from dictating the others, PoS only defers this to large coin holders. In other words, larger stakeholders. Making them almost similar to how other non-crypto networks like SWIFT and banks work,
Nothing at Stake is a theoretical problem that occurs in Proof-of-Stake network when block creators have nothing to lose during a fork of the network.
A fork happens when two nodes meet the right conditions for adding a new block. Let’s call them Node A and Node B. Because both nodes legitimately find a block, two blockchains now exist, each of them completely identical except for the newest block. One chain has Node A’s block and the other has Node B’s block.
Usually, other nodes will decide which block to follow, and when everyone agrees, they discard the other block and continue adding new blocks to the chosen chain.
In a PoW network, should the discarded block’s node continue to mine on that chain, they would lose a lot of money from expending electricity there. Since that chain wouldn’t be recognised by anyone else, and the coins generated on that fork would be of no value. Thus, there is a preventive economic penalty to discourage them from continuing to build on that node.
However, in a PoS network, there is literally nothing to lose by continuing to work on the other chain. Miners can continue to stake on both chains and reap the possible rewards at no additional cost to their original deposit.
The more serious side to this problem is, what’s to stop miners from simply continuing on with another fork and trying to use that to defraud others, perhaps by signing a transaction on that and passing it off to unsuspecting people as valid transactions?
It’s very difficult to predict how Bitcoin might evolve in the next decades but if there is anything we can tell from its 12-year history, it is that its developers and technical community are highly conservative when it comes to change.
While other blockchains have quickly migrated, merged, and even re-emerged as completely new algorithms – Ethereum itself may complete its switch to PoS by the end of 2022 (but we wouldn’t hold our breath) – Bitcoin has been slower to adopt new foundational technologies, opting instead to improve upon its current technology with “soft” upgrades that don’t change the core mechanism.
As we discussed above, there are a great many reasons for sticking to a system that is proven and that has kept Bitcoin secure all these years.
Financially speaking, the cost to attack Bitcoin (over $13 billion in 2021) is cripplingly unfeasible to the point that there isn’t any incentive at all to do so, especially when the network could theoretically correct itself in a matter of minutes.
This is why more and more people are accepting Bitcoin as a reliable, secure, and immutable currency. The fact that so many big corporations like Micro Strategy and even governments like El Salvador and Norway are now storing away their wealth in Bitcoin. The belief that the network is secure is largely because of its PoW mechanism that makes it so expensive to attack.
Almost everyone using Bitcoin and the computers securing Bitcoin are so entrenched in an economic incentive (and penalty) system that works, convincing them that there is another way would require a lot of additional incentive.
There is no denying that Bitcoin’s PoW consumes a lot of energy, but the benefit to that is the security that makes Bitcoin virtually impregnable to hackers and malicious actors.
Then there are the counter-arguments that also show that Bitcoin isn’t as harmful to the climate as some quarters claim. The topic was most recently discussed in the latest World Economic Forum meeting in May 2022, where world leaders called for a check on Bitcoin’s energy consumption, following earlier calls from the likes of Greenpeace to move Bitcoin to Proof-of-Stake.
While the climate crisis is certainly a critical issue to tackle, a Learn Crypto article shows that some 39% of the energy used in Bitcoin mining is drawn from renewables, while the remainder comes from surplus production – far higher than in many other industries.
In fact, more recent findings from the Bitcoin Policy Institute (BPI) show that many of the criticisms against PoW don’t stand up to scrutiny. For example:
Essentially, the cost-benefit argument can be distilled to this: Proof of Work secures a collective value of $550 billion from more than 100 million people accessible to anyone over the Internet, providing other unique advantages over alternatives.
Of course, the future can be hard to predict and if anything, Bitcoin has proven that it can adapt and evolve to changing demands and requirements.
As Ethereum’s travails over the past few years have shown, a shift to PoS will get messy and disrupt the network. That is not something Bitcoin users and stakeholders are prepared to face.
Perhaps, however, a successful move to Ethereum 2.0 might give more insight into how Bitcoin could also do that one day with fewer disruptions.
Or perhaps another alternative to the Proof-of-Stake model could be invented?