Let's dive into Cardano staking and explain how it works.
What is staking
Decentralization is about distributing power between entities to avoid single points of failure. Staking is a way how to distribute consensus power proportionally based on ADA holdings. You can consider it as an improvement of PoW where only pools and miners are responsible for making consensus. While in PoW, distribution of consensus power is based on external resources like electricity, in PoS, the distribution of ADA coin is used. Thus the Cardano network consumes less energy than PoW networks achieving a similar result.
Every consensus must economically motivate users to participate in making the network consensus and discourage them from dishonest behavior. Users must be rewarded only for honest behavior to ensure the honesty of the whole network. In the open distributed network everybody can take a part of the consensus power by buying ADA. It can be a dishonest person preparing some fraud. The goal is to economically encourage the majority of entities to behave honestly and distribute the power to as many entities as possible. If more than 50% of participants behave honestly then the network will be secure.
ADA coins are the stake — kind of skin in the game. There is no slashing in Cardano so the protocol does not take any ADA from owners in case of dishonest behavior. Only the chance to earn new ADA coins is sufficient to ensure honesty.
Cardano Ouroboros PoS provides the right to create a block to a node that must be running and connected to the network 24/7. The node operated by a pool operator has to inform a network that it wants to participate in the consensus. It is technically done by the creation of a pool certificate that is sent to the network. Thus pool ID is assigned to the pool and users can find the pool in wallets supporting staking.
The right to produce a block is provided based on a lottery. Every single ADA can be a ticket in the lottery. The lottery mechanism takes into account all staked ADA coins and gives the right to produce a block to a selected ADA in every slot (round). The owner of ADA can be either the pool operator and his node produces the block or it can be a user that has delegated ADA to the pool. In this case, the block is created by the same node on behalf of the ADA owner. Pool poses own coins and coins that are delegated by users to the pool.
Not all users are willing to operate a node or they might not have enough ADA to do so. No minimum is not set to create a pool. However, middle-size or bigger pools will be probably preferred by users. The delegation is a way how to involve every user in the consensus process.
Users will be able to delegate ADA to a selected pool via a Daedalus and YOROI wallets. Wallets create a delegation certificate and send it to the network.
In Cardano, time is divided into discrete increments, called slots and slots are grouped into longer periods, called an epoch. There are 21 600 slots in each epoch. At the start of each epoch, a lottery determines who gets the right to create a block in every slot. The winner is called a slot leader. The lottery is based on the generation of a random number which determines who will get the right to become a slot leader. Chances of winning for any given slot is proportional to the stake one control.
The reward is a collection of transaction fees and ADA coins prepared as a subsidy in the first 10 years (see the table below). The reward is distributed by the protocol at the end of each epoch. It is every 5 days. The reward is not distributed after each valid block creation as it works in Bitcoin PoW. Pool operators do not touch and have no chance to influence or restrict sending of the reward to users.
Cardano strives to have many pools to be more decentralized than the PoW networks. Thus, incentives are set in a way that it is more profitable to delegate coins to an average-size pool than to the biggest one. Users must keep it in mind and delegate coins smartly.
The biggest pools come to point of saturation. From this point, the reward will be the same or similar to a bigger or middle-sized pool. It should ensure that there will be a higher amount of middle-sized pools rather than only a few big pools.
How delegation works
It will be very simple for users to delegate coins to a pool. Everything will be available in official wallets.
- Desktop wallet Daedalus.
- Lightweight wallet Yoroi.
There will be a list of registered pools with all the needed statistics about them. A user just picks one and the wallet creates a certificate and delegates coins to the pool. It should be possible to pick more pools.
Important information is that the user does not lock coins by the delegation. The user still has all coins in the wallet that can spend them. Pool operators cannot touch and misuse the user’s coins. Even if the pool does not behave honestly users do not risk their coins and cannot lose them.
It is recommended to keep ADA in own wallet. It is not smart to keep ADA on exchanges. You know the rule. Not your keys, not your ADA. Cardano will have kind od enterprise address that exchanges should use. Staking will not be supported on enterprise addresses. Cardano cannot enforce enterprise addresses to exchanges so basically an exchange could offer to stake coins. But it is not a supported scenario.
ADA is supported by hardware wallets Ledger Nano X, Ledger Nano S and Trezor Model T. Staking should be possible even if you keep ADA on any hardware wallet.
Nobody loves taxes. The Yoroi wallet will be able to prepare a document for taxation. Every tax event, so every reward paid you by the protocol, will be listed in the document including the current value in fiat. You can choose from some major fiat currency. So at the end of the year, you will exactly know how much you should pay.