It took me some time to get convinced about the power of crypto lending. Crypto lending has existed for a few years but is only becoming mainstream now.
Lending & Staking 101
There is some confusion between lending and staking so it is a good idea to start by explaining the similarities and differences between the two. It looks staking term was used for lending for some time as initially this term was not being used in the crypto space. The confusion only arose when proof-of-stake became mainstream.
Proof of Work vs Proof of Stake
There were attempts to solve the double-spend problem even before bitcoin but BTC solved it in the most elegant way using proof of work.
Proof of Work
Let me explain how proof of work works with a simple example of a hypothetical PrimeCoin. Let’s say that there is a Coin called PrimeCoin which is rewarded to the first person who is able to find the next prime number. There is also a need to validate if the previous prime number was awarded to the right person.
Since it is fairly easy to create the first few hundred coins, Patosi the creator of PrimeCoin mines them himself. In fact, he goes to the extent of mining the first one million coins himself. Increasingly it becomes difficult to find the next prime and as the difficulty level increases so is the price of PrimeCoin. In fact, after a few years, the daily electricity consumed in the compute jobs which compete to find the next PrimeCoin is more than what small nation-states consume in the whole year.
Proof of Stake
To solve the PoW problem, a new coin uses an innovative approach. To avoid both electricity consumption and Sybil attack, the validator nodes need to have proof of stake ie. prove that they own a substantial number of coins already. Let’s use a simple example to understand it.
It’s the gold rush era and you arrive as a prospector in San Francisco along with 100 miners who would help you with finding gold. You need tools, equipment, a panning kit, denim, etc. You go to Levi Strauss (yup, he was a real person) and tell him you want to rent these things. He says you need to provide some gold as collateral.
Now you have two choices, either you buy the gold from then open-market or you go to James Lick and borrow gold from him. You offer James 10% of the gold you mine as interest. This way you can leverage the amount of money you have to borrow 10 times more gold and James makes money on his idle gold.
On-line Staking vs Off-line Staking
Whenever staking is the term used for lending, it is qualified as offline staking. The PoS staking is called online staking.
Staking and ETH2
Coming back to IRL, Ethereum is being upgraded to adopt Proof of Stake. During the process, Ethereum is being mined using existing ETH as stake. In fact, every validator node needs 32 ETH to run. This gives an opportunity to existing ETH holders to get staking rewards.