Staking 101

What is staking?

Staking is the act of “locking up” your assets with a validator in exchange for rewards. In Proof of Stake (PoS) blockchains, network participants known as validators run the software that powers the chain. Validators participate in the creation of new blocks and vote on whether submitted transactions are valid or not. In exchange for securing the chain, validators receive rewards. The more coins a validator has in their Stake, the more they get to participate in consensus and earn rewards. Coin holders can also participate in the security of the chain by “staking” or locking up a native asset with a validator in exchange for a share of the rewards.

Governance

In addition to helping secure the chain, one of the main features of staking is to allow users to participate in chain governance. In general, one staked coin equals one vote. Stakers vote on different proposals to decide the direction of the chain or protocol, the setting of parameters, and how resources should be allocated.

Where do staking rewards come from?

When assets are staked to a validator, they will earn staking rewards. Different chains produce rewards in different ways, but typically rewards derive from inflation and transaction fees. Inflation refers to the new coins minted by a chain and released as rewards during every block. Transaction fees are fees paid by users to cover the cost of computing power, also known as gas, to settle a transaction on the blockchain. When a block is successfully created, validators are rewarded with the fees and inflation rewards issued from the new block. Although rewards can fluctuate, most chains aim to maintain steady staking rewards to incentivize the stability and security of the chain.

Unstaking

When a user stakes an asset to a validator, the asset can’t be freely traded. While collecting rewards, the staked asset is locked. In order to unstake an asset, a user must wait for a period of time to elapse, known as the unstaking period. At the end of the unstaking period, a user can claim their assets and freely trade them. The unstaking period is meant to align users with the security and durability of the chain: in exchange for locking tokens for a minimum period of time and participating in the security of the chain, stakers receive rewards.

LSTs: unlocking staked assets

Liquid Staking Tokens (LSTs) are an evolution in staking. While conventionally-staked assets cannot be freely traded, LSTs are tokenized representations of staked asset that can be traded or used in different DeFi protocols. But LSTs are more than just staked assets that can be freely transacted: they also represent the compounded yield of the underlying asset. LSTs are made up of the base asset (called the principal) and the yield derived from staking rewards.

Because LSTs represent ongoing yield compounded, they will appreciate in value when compared to their base asset.

For example, an Atom LST is created when a user stakes or “bonds” Atom with an LST provider. The provider stakes the Atom to a validator and issues the user a tokenized version of the staked asset, known as stAtom. The provider claims the rewards from the staked Atom daily, and restakes them, compounding the yield. The stAtom token represents the staked Atom and its rewards compounded daily. When compared to regular Atom, an Atom LST will increase in price at the rate of Atom’s staking reward APY, claimed and compounded daily.

On Pryzm, LSTs and other yield-bearing assets are referred to as cTokens (Collateral Tokens). Assets can be bonded on Pryzm to create cTokens, which can be refracted to separate them into pTokens (Principal Tokens) and yTokens (Yield Tokens).