Cryptocurrency staking vs mining – how are they different?

Mining is a method of generating new crypto coins by verifying transactions before they are committed to the blockchain network.

The decentralised blockchain network comprises computers located all over the world, all working towards verifying new transactions to keep the network secure. There are different methods of verifying transactions, and most cryptocurrencies today, like Bitcoin, use the proof of work (PoW) mechanism to verify new transactions.

PoW is a mechanism where members in the blockchain network use computational resources (which constitutes the ‘work’) to try and solve an arbitrary computational puzzle and arrive at the right hash to verify a transaction. When a member solves the puzzle, others on the network validate it, and the transaction is then committed to the blockchain.

As the member who solved the puzzle expended computational resources to verify the transaction, they are rewarded in crypto coins. These coins are not from an existing pool but are newly generated or ‘mined’. The generation of new crypto coins by solving computational puzzles to verify new transactions is called ‘mining’.

Mining requires considerable amounts of computational resources or energy to solve the complex equations, which is actually what deters bad actors from spamming false data to the blockchain and keeps it secure. Miners use expensive servers with high-performing GPUs to mine cryptocurrencies like Bitcoin. 

However, the amount of energy needed to mine is also its downside. There is no limit to how many members can compete to verify a transaction, and this results in people and mining farms around the world using excessive amounts of energy to mine coins. 

Concerns have been raised worldwide against PoW systems because of the energy consumption and resulting impact on the environment. The need for an alternate, sustainable method of validating transactions, which does not rely heavily on energy like mining, has made staking popular.

Staking is another method of verifying cryptocurrency transactions before committing them to the blockchain and generating new coins in the process as a reward for the effort put in.

The protocol used to achieve this is where the two differ. While mining uses the proof of work consensus mechanism, staking uses the proof of stake (PoS) consensus mechanism.

In the PoS mechanism, members in the network offer their own crypto coins as collateral for a chance to become validators. A validator is then selected at random to verify a transaction and create a new block. Once other validators on the network attest to this block, it is committed to the blockchain. The validator who verified the transaction and created the block is rewarded newly generated crypto coins for their effort.

Unlike mining, which allows all members to expend energy and compete for a chance to verify a transaction, staking randomly selects one member on the network to verify the transaction. This drastically reduces the amount of energy consumed to generate new coins.

The concept of staking personal coins to become a validator ensures legitimacy within the process and maintains the integrity of the blockchain. If validators create or attest malicious blocks or fail to create or attest blocks, they lose a portion of their staked coins as a penalty.

While staking personal coins ensures good validator behaviour, it also has a downside. Staked coins must be locked-in for a certain period. You cannot trade these coins for a profit if the market price rises or to minimise loss if the market price drops during this time. This increases the risk involved.

The value of the reward received is proportional to the value of the staked coins and the duration of the lock-in period. To earn more, the value and duration of staking must be high, which also means the risk of being affected by fluctuating markets will be high.