Staking has emerged as a cornerstone of many blockchain ecosystems, offering participants the chance to earn rewards while contributing to network security and operations. In this article, we explore staking in the context of Autonity and broader proof-of-stake (PoS) systems, focusing on native liquid staking versus non-liquid staking models, capital efficiency, and considerations for choosing staking service providers.

One of the hottest topics in crypto today seems to be the Ethereum merge, a point where Ethereum transitions fully from Proof of Work to Proof of Stake consensus,but what is staking if you might ask.

Defining consensus Consensus in blockchain is no different from consensus in the physical world,we see consensus in schools,organisations,governments etc. A lawmaker proposes a bill,no matter how integral or beneficial such a bill,it needs consensus(agreement) from majority of other lawmakers for such bill to come to fruition. So what then is consensus?

In blockchain networks,the difference is unlike the corporate world where all consenting parties are known,blockchains are decentralized and permissionless. Imagine the following scenario : Alice wants to send $100 to Bob

Alice have an account with Citibank,Citibank has KYCed Alice,they know everything they need to know about Alice. Bob can simply transfer the $100 to Alice’s bank account electronically or walk into the bank or any payment house to do that. But how does it all work So when Alice initiates a request to send $100 to Bob,her own bank checks if she have the sufficient amount with fees included,it’s true they will allow the transaction,also they will have to check if Bob’s account is worthy of receiving such money(questions like is this account blacklisted? etc) When Alice sends money to Bob,both their banks have done some communication and agreed on it before it went through.

Alice is a random dude just like Bob,she only have an hexadecimal address as an account ID,there are no banks here to check if Alice has $100 and if she can send it to Bob but we have network participants who contribute to keep the state of account in the network. They check if Alice has $100 and fees to be able to send the $100,they update Alice account to reference such transaction and also update Bob’s account,such action is through consensus.

The design of a consensus is referred to as consensus algorithm,there are dozens of such consensus algorithms but for this article we will examine two : the Proof of work algorithm and that of Proof of stake.

This algorithm dates back to the early days of email.Adam Back invented this algorithm to fight against email spammers,he requested that senders attach a hash to an email. A hash is a unique random number generated,it’s the result of computing a hash function. In the case of bitcoin,miners(participating consensus nodes) race against one another to mine blocks by trying the solve a mathematical puzzle behind such a block,the result is that they will produce a hash after the computation which references that the block has been solved and verified by other miners after which the block will be added to the chain,hence the name blockchain(a chain of blocks).

This method is heavily criticised by many and due to reasons like :

1. resource intensiveness :Gone are the days where you could mine bitcoin blocks with your PC,today this endeavour is almost solely the business of big corporations with deep pockets. From securing a safe location with lots of energy available to buying powerful mining rigs,to pay staff etc,this method is not for the average Joe.(more hashpower,more likelihood to mine blocks)

2. Environmental concerns : Bitcoin’s power consumption is more than that of many nations combined and it’s not showing any signs of slowing,there are concerns around the carbon footprints of this method and the need to either transition to a better and less resource intensive algorithm or go the green energy route(like solar or wind energy).

3. Sell offs : The percentage of what is gotten as profit for mining is almost sold immediately,sometimes causing dumping in the market.

Our focus is proof of stake; unlike PoW , PoS ensures that users lock up funds in the network(as a stake) in order to be able to validate blocks. Unlike PoW where anyone with sufficient hashpower can throw themselves into the mining arena,PoS ensures that each participant puts something on the line(staking). There is not much difference between PoW and PoS,rather than competing to solve a block,this time the algorithm randomly chooses who can validate a block per time. The selection process for picking a validator is on any of the following :

1. Weight : How much funds has a user locked up(staked),the higher the better because having a higher stake shows commitment and that the validator believes in the project and is committed long term to the project. Though there is a minimum amount a validator must stake to be eligible to be a validator,the more he stakes the better his chances.

2. Age : The age factor is important,if Alice has 20 times more funds staked than Bob,he can manipulate the validator process but he cannot do such because the network will consider validators based on how long have you been here(How long have you been staking,the loyalty dilemma )

3. Reputation : Your previous reputation may also play a role in determining if you will be selected or not

4. Randomness : The algorithm is designed in a way that no one can game it to their advantage,anyone can be chosen to validate a block regardless of their staked weight,age,reputation etc.

1. Locking period : one risk with staking is that one must lock up their tokens and must wait for an unlocking period if they so decide to unstake. The advantage of things is that,the network has robust security as more locked tokens equal more security but the demerit are that one cannot access their tokens immediately if they wish to for any reason(sell,lend them etc)

2. Technical know how : it still a technical process,from setting up to ensure your node has enough uptime,maintenance of node etc

3. Bad behaviour : You may lose part or all of your staked funds for going against the norms of the network

4. Rewards distribution : The distribution time and manner varies from network to network

5. Tax consideration : In certain jurisdictions,some govts are planning to tax staking since it’s an economic activity with profit intent.

With Native liquid staking, users to stake their assets and also retain liquidity. This means that staked assets can be used for other purposes or traded, often through derivative tokens or mechanisms provided by the staking protocol itself.

Pros

• Liquidity and Flexibility: Stakers receive derivative tokens representing their staked assets, which can be traded or used in DeFi protocols. Stakers can now engage in other investments without the risk of negating their staking rewards

• Enhanced Capital Efficiency: It extends the capital utility of staked assets by enabling liquidity. Users can earn rewards from both staking and other extral investments.

• Continuous Participation: Native liquid staking encourages more participants as it reduces the opportunity cost associated with staking.

Cons

• Complexity and Risk: The mechanisms involved, such as derivative tokens or staking derivatives, can introduce additional layers of complexity and risk, including potential smart contract vulnerabilities.

• Fees and Slippage: Users may face fees or slippage when trading or using derivative tokens, which can affect overall returns.

• Dependency on Protocol Design: The effectiveness of native liquid staking heavily depends on the design and security of the underlying protocol.

  Example in Autonity: The Autonity’s staking model is made possible with NTN and has native liquid staking.

  Users who stake NTN can continue to interact with the ecosystem while earning rewards.

  This in turn increases liquidity and ensures capital is efficiently utilized within the Autonity network.

Non-liquid staking involves depositing and locking your crypto assets in a staking contract,here you give up your ability to use, trade such assets pending when you unstaked. This approach requires users to commit their assets fully to staking, meaning their capital is tied up and cannot be used elsewhere while it is staked.

Pros

• Simplicity: Non-liquid staking is straightforward, with fewer moving parts and less complexity compared to liquid staking models.

• Security: Fewer mechanisms and intermediaries reduce the risk of smart contract vulnerabilities and other technical issues.

• Stable Rewards: Users can generally expect stable staking rewards without the impact of trading or liquidity fluctuations.

Cons

• Lack of Liquidity: Users cannot access or trade their staked assets until they are unstaked, which can be a significant drawback if liquidity is needed.

• Opportunity Cost: Stakers pass over other opportunities while they are locked in the staking contract.

• Commitment Risk: In case of market downturns or protocol issues, stakers are locked into their positions.

Example in PoS Systems: Traditional PoS blockchains, like Ethereum before its transition to Ethereum 2.0, used non-liquid staking where users committed their ETH to secure the network and earn rewards.

Capital efficiency refers to how effectively staked assets generate returns and how well they can be utilized across different investments.With Liquid staking,users retain liquidity while also getting staking rewards. This dual benefit enables participants to maximize their asset utility.

Advantages

• Diversification: Stakers can allocate their derivative tokens to various DeFi opportunities, enhancing potential returns.

• Reduced Opportunity Cost: By maintaining liquidity, users can capitalize on market movements or new investment opportunities.

Disadvantages

• Complexity and Risk: Managing liquid staking involves understanding derivative tokens and associated risks, which can be complex for some users.

1. Performance and Reliability: Uptime: Ensure the provider has a track record of very good uptime and is reliable. Performance Metrics: As they say, the past can be used to forecast the future, Appraise the validator's historical performance, their staking rewards and slashing incidents.

2. Fees and Costs: Fee Structure: Compare and anayze the fees of different providers. Slippage and Transaction Costs: Assess potential slippage and transaction costs associated with staking and unstaking.

3. Security and Reputation: Security Measures: Verify the provider’s security protocols, including audits and protection against vulnerabilities. Reputation: Research the provider’s reputation within the community and look for reviews and feedback from other stakers.

4. Customer Support: Support Channels: Ensure the provider offers robust customer support and has responsive channels for addressing issues. Documentation: Look for clear and comprehensive documentation on staking processes and policies.

5. Transparency and Governance: Transparency: Check if the provider is transparent about their operations, fees, and performance. Governance Participation: Consider if the provider participates in network governance and contributes to protocol development.

Staking in Autonity and proof-of-stake systems offers diverse options, including native liquid staking, non-liquid staking. Each model has its pros and cons, affecting liquidity, capital efficiency, and overall staking experience.

When choosing staking service providers, conducting thorough due diligence on performance, fees, security, and support is essential to ensure a successful and rewarding staking experience. By understanding these factors, participants can make informed decisions that align with their financial goals and risk tolerance.