What the heck is Stacking?
Photo: Sergio Kotrikadze/Shutterstock
There has been a lack of knowledge amongst people, which has been reflected through wrong interchanging of the terms stacking and staking. In this article, I will explain the difference between stacking and staking, and dig a little bit deeper into stacking.
Staking; a mechanism derived from the Proof- of- Stake(PoS) consensus model as an alternative to Proof- of- Work(PoW). Rather than securing the blockchain with computing power, this is done by locking up financial assets to confirm blocks. The rewards in this mechanism are usually the native token in that blockchain.
Stacking; a mechanism derived from the Proof- of- Transfer(PoX) consensus model which is also an alternative to Proof of Work(PoW) and a generalization of Proof of Burn(PoB). Rather than securing the blockchain with computing power or a burn address, a miner sends the base currency to specified addresses in order to win a block. Upon winning a block and validating it, the miner is rewarded with the secondary currency.
Which one is more profitable?
In staking the annual percentage yield (APY) is usually fixed since the staker is rewarded with the native coin/token.
In stacking it’s a bit more complicated since the APY depends on several factors including the relationship between the base and secondary currency in the PoX. Currently, Stacks(STX) is the only cryptocurrency that uses this mechanism with Bitcoin(BTC) as the base currency. PoX-lite , a lighter version of PoX is also set to launch this year.
How does Stacking work?
To work on an STX block, a miner needs to give up a certain amount of the base currency, in this case, that is BTC. Where does this bitcoin go? Instead of being sent to a burn address as in PoB, it is sent to multiple addresses as a reward for actively participating in the consensus algorithm(stacking). As a reward, the miner that works on an STX block gets 1000STX.
How much Bitcoin does the miner give up?
Firstly for STX mining to be profitable, the miner should give up BTC that is worth less than 1000STX. This amount of BTC should also be higher than the bids placed by other miners who want to work on an STX block. Think of it like an auction system where the highest bidder gets to work on an STX block.
So how much BTC should a miner give up? That now depends on the current value of 1000STX and how this relates to the price of BTC. To explain this further I will use a bunch of scenarios.
The Big Picture.
Let’s assume that Bitcoin and Stacks are at equilibrium, with unit prices of $60,000 and $2 respectively. Let’s also assume that the stacking reward at this equilibrium is 10% APY. This means that any changes in the prices of these assets can change the stacking yield.
In this scenario, let’s assume that the price of 1 STX goes all the way up to $3 with the price of 1BTC staying constant or dipping below $60000. This is similar to what happened on 4 April 2021. On this day the stacking reward increased as seen in the picture below posted by the COO of OKcoin, Jason Klau on Twitter (11 April 2021). You can see that between 4 and 6 April the stacking reward increased from an average of $0.50 to $0.70+.
The reason for this increase was because the price of a unit of stacks increased ,causing the value of an STX block to increase. This also happened whilst bitcoin was consolidating. The miners then placed higher bids to get an STX block, since its value had increased to $3000($3/STX*1,000STX) from $2000($2/STX*1,000 STX) in our assumed equilibrium. Note that the value of an STX block is simply the value of the 1000STX mining reward.
But what happens if the price of bitcoin increases while the price of stacks is constant or falling?
If the price of bitcoin increases with the price of stacks falling or remaining fairly constant, the APY drops below 10%. The logic behind this is as follows. With an STX price of $2 per token, the value of a block is $2000, and if the price of one bitcoin rallies above $60000 one would need to bid less BTC to get an STX block. This would mean less bitcoin for the stackers and a lower APY.
We can also take a look at other scenarios. Let’s assume that the equilibrium remains constant at $60,000/BTC and $2/STX, this will mean that the APY also remains constant at 10%.
If both assets are bullish, and their prices increase by the same percentage then the APY will remain at 10%. This is because in the pair BTC/STX the price remained unchanged so neither asset has an edge over the other. If BTC price increases more than STX price(percentage-wise) then miners will bid less BTC than before. This is because an STX block now has a lower value in comparison to BTC, so stacking rewards will decrease. If BTC price increases at a lower % than STX, miners will bid more BTC to work on an STX block resulting in a higher yield for stackers.
Let’s be honest, these assets can also drop in value due to a number of reasons and this can also affect the APY for stackers. If both assets drop by the same %, then the APY remains at 10%, similar to the bullish scenario. If BTC price drops more than STX price (percentage-wise), miners give up more BTC for an STX block resulting in higher APY for stackers. If STX price drops more than BTC price, the miners will bid less BTC and the stacking rewards will be reduced.
In conclusion, the APY for stackers is always changing. It depends on the miners whose decisions are influenced by the price of BTC in relation to STX.