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Chapter 7

What is staking?

Staking is a process of validating transactions on a proof-of-stake networkmodel via a consensus mechanism. Stakers are rewarded for this action in the form of the network’s native token.

Note that while staking has a technical meaning from a DeFi perspective as described above, it is also often used colloquially for any DeFi activity that helps users earn yield.

What are Proof-of-Stake Networks?

Proof-of-stake or POS is a consensus mechanism. Block creators are required to put forward a set amount of native blockchain tokens on stake to become a validator in the network. The network selects a node at random to become a block creator. If the validator is inactive or attempts something malicious, they are penalized. This is called slashing penalties. In contrast, for successful and honest validations, block creators are awarded from the block rewards and the transaction fees.
Both Bitcoin and Ethereum run on Proof-of-work consensus. Ethereum is expected to migrate to the Proof-of-stake model sometime this year. Solana, Polygon, and Avalanche are a few other popular blockchain networks that work on Proof-of-stake consensus model.

Different ways to stake cryptocurrencies: 

1. Staking as Validators: This process involves staking native tokens and running your own hardware to validate transactions.
To become a validator on Ethereum2 which is PoS network, you need to stake 32 ETH.
2. Staking as a service: If you are uncomfortable with running your own hardware and software stack, you can deposit 32ETH in Ethereum or the equivalent amount for a different network with a service provider who can run the stack for you in exchange for a portion of staking earnings.
3. Pooled Staking or Liquid Staking: There are DeFi protocols that act as a matchmaker between liquidity providers and entities that can run validation nodes. Your tokens get added to a pool that are then used for running validation nodes. In exchange for providing liquidity, you receive Liquidity Provider Tokens.
4. Centralized Exchanges: Users can stake their crypto via centralized poolscreated by centralized exchanges. However, it involves giving up custody of funds.
Staking requires locking up crypto tokens on the network for a fixed period of time.

Liquid Staking

Liquid staking is a process to earn staking awards without locking up crypto tokens on a blockchain network. This is made possible by issuing tokenized versions (derivative contracts) of already staked crypto tokens, for example, stETH for ETH.
Once the user deposits a token, for example, ETH on a DeFi protocol that enables liquid staking, the platform instantly deposits ETH in its own validator pools.
The user then receives equivalent stETH tokens that let them maintain the liquidity of ETH while also earning staking rewards. These staked tokens can be swapped on Decentralized Exchanges such as Curve.
Lido, Stader Labs, and Rocket Pool are a few Liquid Staking DeFi protocols.

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