Solana Staking Guide Part 1: How Staking works and How to Make Risk Free Gains

What is Staking?

Put simply, staking is using your crypto holdings to earn rewards. More specifically in Proof of Stake networks like Solana, Avalanche, Polygon, Cardano, etc…, delegated stake is used to represent voting power in their respective consensus algorithms. Proof of Stake networks depend on the difficulty of acquiring a dominant amount of stake to prevent bad actors from stopping the network or, even worse, from corrupting the ledger. When you stake with a network operator/validator you are assigning them the voting power represented by your native tokens and helping decentralize the network. To encourage users to participate in the decentralization of their network, most protocols give out rewards for delegating that stake.

Native Staking on Solana

Consensus

As mentioned above, Solana is a proof of stake network which means its consensus algorithm uses weighted voting from its pool of validators to maintain ledger integrity. All blocks (group of transactions) have to have 66% of the weighted votes agree that the transactions are valid for them to be added to the chain of blocks. If more than 33% of the voting power is controlled by bad actors then consensus will fail and the network will come to a halt. This is where the term “halting line” comes from. (It is worth noting however, that in the event of a 33% attack, the other validators could exclude that 33% and restart, rendering such an attack as not enough to be able to take over the Solana network or make changes to the ledger.) If you take the list of all validators sorted by their delegated stake, the halting line separates the group of entities that, if combined, could conceivably halt the network. The smallest number of entities required to interrupt a block chain is referred to as the Nakamoto Coefficient. At this current time, April 2023, Solana’s coefficient is 33.

Rewards

Solana staking rewards are paid out from its inflation. Solana has a predefined inflation schedule that started with 8% per year and gradually decreases to 1.5% over the next 10 years. As of April 2023, the Solana inflation rate is 6.325%. That means at the beginning of each epoch, a pool of tokens that match the per epoch interest rate is created. This pool of tokens is then distributed amongst the staked SOL across all validators accordingly, in respect to their performance and commission rate.

Delegating SOL

To take advantage of the staking rewards you must delegate your SOL to a validator. When you do so you are increasing their voting power and you are “vouching” for that validator. It is important to pick a good validator, not only from a network strength perspective but also to maximize the amount of rewards you get. We go further into how to choose a validator below.

Decentralization

The other most important thing to consider when choosing a Validator is how delegating SOL to a specific validator will help or harm Solana’s overall decentralization.

Data Center Concentration: Another important consideration is the data center that the validator operates in. If something catastrophic happened in a highly concentrated data center then the network could become vulnerable by making the total active stake considerably reduced and, in return, making the resources needed to halt the network considerably reduced as well. This is mitigated by the warm up and cool down period when changing stake but, in general, the more spread out the stake is among data centers the better. 

Liquid Staking: Tokenized Stake Accounts

A tokenized stake account is simply a representation of a stake account that is delegated to a validator. Think of it as a receipt token for staking with a validator. It provides holders with the same cumulative staking rewards as native staking but with the additional benefit of automatic accumulation of MEV rewards, freedom to access instant liquidity and a way to explore and enjoy DeFi.