The growing popularity of Proof-of-Stake (PoS) mechanisms has led to the emergence of over 80 blockchains that offer incentivized network participation. These mechanisms have caught the attention of regulators, who have scrutinized centralized staking programs in particular.
Regulatory bodies, such as the United States Securities and Investments Commission and the UK’s Financial Conduct Authority, have raised concerns about the consumer risks associated with centralized pooled staking. They emphasize the importance of mitigating these risks and ensuring that companies running such programs obtain the necessary licenses.
However, it is crucial to differentiate between centralized staking programs and the technical process of staking directly to a protocol. Clarifying the definitions and distinguishing these two activities is essential for striking the right regulatory balance.
Let’s explore the key differences between these concepts:
1. Staking Is a Network Security Function:
Staking is primarily concerned with network resilience rather than yield generation. PoS blockchains incentivize a decentralized group of validator nodes to produce blocks on the network, thereby enhancing its security. Unlike Proof of Work blockchains dominated by well-capitalized companies, PoS blockchains allow any token holder to contribute to the network’s consensus without the need for expensive infrastructure.
2. You Can Stake Directly to a Blockchain and Control Your Own Private Keys:
In a centralized staking program, the program operators control the private keys and tokens. However, when staking directly to a blockchain, you retain control over your private keys. Instead of transferring tokens to a validator, you stake them while maintaining ownership and control. Compensation for running the server is typically agreed upon in advance, with a small percentage of rewards given to the validator.
3. Rewards Can Be Distributed Automatically via the Blockchain’s Smart Contracts:
Centralized staking programs control reward distribution, whereas direct staking allows for automatic on-chain distribution of rewards via smart contracts. Different blockchains have varying mechanisms for distributing rewards, but they are directly sent to the delegator’s wallet, bypassing any intermediaries.
4. The Risks in Direct Staking Are Different:
In direct staking, validators cannot access tokens in a delegator’s wallet, reducing the risk associated with custodial or pooled services. Instead, the main risk lies in “slashing” events, where a validator’s performance violates network rules. The blockchain automatically imposes penalties by removing a small portion of staked tokens from associated delegators’ wallets. Validators often have insurance to cover slashing events, but it is important to assess their performance records and insurance coverage.
In summary, direct staking models differ significantly from centralized programs and warrant their own considerations. Direct staking promotes network security, allows for individual control over tokens, enables automatic reward distribution, and presents unique risks related to slashing events. Understanding these differences is crucial for regulators, users, and stakeholders in the evolving blockchain ecosystem.
What is staking in blockchain?
Staking is a process in which token holders participate in maintaining the security and consensus of a blockchain network. By staking their tokens, holders contribute to block production and network validation, ensuring the proper functioning of the blockchain.
How does direct staking differ from centralized staking?
Direct staking involves staking tokens directly to a blockchain protocol, where token holders retain control over their private keys and tokens. In contrast, centralized staking involves delegating tokens to a centralized program or service provider, who controls the private keys and manages staking on behalf of token holders.
What are the risks associated with direct staking?
The main risk in direct staking is the occurrence of slashing events. If a validator’s performance violates network rules, a penalty called “slashing” is imposed, resulting in the automatic removal of a small portion of staked tokens from associated delegators’ wallets. Validators typically have insurance to cover slashing events, but it’s important to review their performance records and insurance coverage.
How are rewards distributed in direct staking?
In direct staking, rewards are distributed automatically via the blockchain’s smart contracts. The network uses smart contracts to distribute rewards directly to the delegators’ wallets. The exact mechanism varies across different blockchains, but the rewards are typically sent directly to the delegators without the involvement of intermediaries.