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Proof of Stake is a rapidly growing, 99% more energy efficient, next-generation way to validate transactions on a blockchain. Most major blockchains are permissionless and fully decentralized, which means the networks are open, public, and anyone can offer to help record transactions. But there needs to be a way to keep these networks secure and make sure that the nodes on the network agree that the record of transactions is accurate.

That’s where consensus mechanisms come in. Consensus mechanisms are a standardized way for a blockchain’s decentralized nodes to agree on the accurate state of the blockchain.

Every blockchain relies on participants (“validators”) to validate transactions, ensuring that the current state of the blockchain database is accurate and up-to-date. Blockchains are programmed to reward validators with tokens for their efforts to secure the network.

Different types of blockchains use different methodologies to choose who can validate transactions. For example, proof-of-work blockchains like Bitcoin, require validators (“miners”) to solve algorithms of increasing computational intensity to earn the right to validate transactions. This results in mining operations maximizing their computing power and associated power usage.

In Proof of Stake, as an alternative to Proof of Work, validators don’t have to dedicate massive amounts of computing power to validate transactions and secure the network. Instead, while it varies from blockchain to blockchain, validators temporarily commit (or “stake”) their tokens for the right to be chosen to propose transactions and add new blocks to the blockchain that are then validated by the rest of the validators. This process is how the database is maintained as accurate and current across the entire network of computers. In exchange for validating transactions, “stakers” are rewarded with newly created tokens, similar to how miners in proof-of-work blockchains are rewarded.

Because of the increased energy efficiencies and scalability, most newer blockchains use some form of Proof of Stake, including 19 of the 20 largest smart contract platforms. Blockchains like Avalanche, Cardano, Cosmos, Polkadot, Solana, and Tezos are among some of the large blockchains that have utilized Proof of Stake since launch. After the merge in 2022, Ethereum switched to Proof of Stake, which reduced its energy consumption by over 99%. By early 2022, blockchains using Proof of Stake had achieved 30% of the total crypto market (up from 20% the previous year). Millions of Americans already use and rely on proof-of-stake blockchains, and those numbers will continue to grow as novel applications are being developed on top of Proof of Stake blockchains every day.

Staking, or more specifically protocol staking, refers to participation in securing a blockchain. But as our friends at Coin Center have rightfully noted, “use (perhaps overuse) of the term to describe a variety of activities has resulted in confusion over the term’s meaning and makes it difficult for newcomers to cryptocurrency technologies to get up to speed.”. In recent years, the term staking has been co-opted to describe a variety of activities that do not involve securing a proof-of-stake network. These other types of “staking” typically involve users receiving payments for storing or transferring certain types of digital assets to a third-party. These payments to users are typically funded by an exchange’s profits instead of creating new tokens and securing a network, which is akin to lending. That confusion has led to regulatory scrutiny.

Protocol staking differs from crypto-lending in some key ways:

1. Ownership and Control - When protocol staking, token holders retain ownership and possession over their tokens. With crypto-lending, users who lend crypto give up control and possession to a third-party or a smart contract.

2. Risk Profiles - Because they retain ownership and control, protocol stakers do not put their tokens at any material risk. With crypto-lending, the assets are at risk both for financial loss or for being stolen or hacked.

3. Structure of compensation - Protocol stakers generate pre-determined token rewards from a decentralized platform for their efforts in securing the networks. Those that engage in crypto-lending are compensated by either a centralized party or decentralized platform for using assets as collateral, not using their tokens for securing a network.

Every decentralized network, including those using both proof-of-work and proof of stake, face security risks such as 51% attacks where an adversary can manipulate a network by controlling over half the nodes. However, on a blockchain of any meaningful size, this type of attack becomes prohibitively expensive to execute.

There are various ways to participate in securing a proof-of-stake network, each with their own tradeoffs.

The most direct way to participate is to serve as a validator on a network and operate your own node. This allows participants to bypass any other services, but also requires more technical know-how, the possession of the minimum number of digital assets required to participate, and the ability to maintain a node that is constantly connected to the internet.

Other options include using a staking-as-a-service (StaaS) provider to operate their own node, or delegation, which involves trusting tokens to an existing validating node to stake your assets on your behalf. These options eliminate many of the technical and financial barriers to make staking easier for individuals, but also require fees in exchange for the service.

Staking-as-a-service (StaaS) service enterprises offer a suite of services to digital asset holders that enable them to stake their digital assets. Stakers can use StaaS providers to assist in the staking process to earn rewards on the stakers’ behalf in exchange for a small percentage fee of the rewards. In exchange, StaaS providers take the necessary steps required to operate validator nodes and validate transactions. At all times, the staker maintains the sole legal owner of their staked assets.

Liquid staking allows stakers to use their digital assets even while they are temporarily locked up due to them being staked. In exchange for staking their digital assets with a liquid staking protocol or staking-as-as-service provider, stakers receive a receipt token that proves ownership of their staked assets. This means stakers can continue to earn rewards while using their digital assets in other productive ways. In short, liquid staking enhances security for Proof of Stake networks while providing additional functionality for Liquid Stakers.

For a simple example of how this works, think of a coat check. When you deposit your coat, you get a representative ticket that you can redeem for your coat at any time. While coat tickets have no alternative uses, receipt tokens provided by liquid staking protocols can be invested or used in other web3 applications.