LiteBit, 2 months ago

On-chain versus off-chain staking: how does it work?

Staking crypto is a way to earn crypto rewards. This article explains how staking works, the difference between on- and off-chain staking, and the risks involved.

What is staking?

When you hold crypto, you can use it to stake if the crypto works with a Proof-of-Stake (POS) mechanism. Parties who stake their crypto (also known as stakers) thereby support the blockchain and receive rewards for doing so. Stakers usually verify transactions in the network by guaranteeing the validity of the next block with their own stake. If you incorrectly confirm the next block, you do not get a reward or may even be penalized. Therefore, someone who stakes does not benefit from manipulating the blockchain. By doing so, they are harming themselves. As a result, stakers are not only important to the network but also generally trusted. Some blockchains require stakers to hold a specific minimum amount of crypto, while others do not.

How does staking work?

To validate new transactions, a POS blockchain needs to produce new blocks. Block production and validation are done by stakers, also called validators. To avoid manipulating the blockchain, the network chooses a random validator. Once chosen, the validator checks the block. If it is correct, it is validated, reviewed, and then confirmed. In return, the chosen validator receives a block reward in the form of crypto (similar to what a miner receives).

What is on- and off-chain staking?

On-chain staking happens on Proof-of-Stake blockchains, such as Ethereum and Cardano. So your crypto is staked on this blockchain, hence the name on-chain staking. Its counterpart is off-chain staking, which is also sometimes called lending. In this, you do not stake your crypto directly on the blockchain. In crypto, lending refers to lending your crypto to other external parties with the aim of making money from it. You can compare this to a bank lending your money to other external parties. So the main difference you need to know about on- and off-chain staking is that on-chain staking is useful to support the network and keep it running (and you are rewarded for it). Off-chain staking has purely a financial motive and has no other technical use for the blockchain. Both on- and off-chain staking have their own risks, with off-chain being the riskiest as everything happens outside the blockchain.

How does this work at LiteBit?

LiteBit only offers on-chain staking of crypto that works with Proof-of-Stake. Bitcoin is a Proof-of-Work blockchain, making on-chain staking technically not possible at all. Therefore, you cannot receive rewards over Bitcoin at LiteBit. LiteBit customers' crypto is securely stored in wallets managed by LiteBit. In addition, LiteBit's capital is not lent to other parties or invested in cryptocurrencies. 

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What is mining?

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Cryptocurrency mining is the process of verifying transactions on a blockchain network and adding them to the public ledger. The process involves solving complex mathematical algorithms using high-powered computers to generate new blocks of transactions. The reward for successfully mining a block is a predetermined amount of cryptocurrency.

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