What is delegated staking and how to calculate its profitability?

Photo - What is delegated staking and how to calculate its profitability?
Delegated staking is the transfer of personal tokens to a trusted validator in order to earn income without setting up your own node. It's used in blockchains that rely on Proof of Stake (PoS) consensus algorithms.
If you own a cryptocurrency in a PoS blockchain, there are two ways you can earn rewards: by running your own stake pool (regular staking) or by delegating your stake to a pool managed by someone else (delegated staking).

Delegated staking has several advantages. First, it allows users who lack technical knowledge or resources to run their own node to earn a portion of the commission rewards and contribute to network security. Second, delegation helps decentralize the network by increasing the number of participants in the block verification process. 

How to participate in delegated staking

Delegated staking is used in many networks, such as Cosmos and Cardano blockchains. This feature was recently also activated in the Aptos network.

However, users of the Tezos blockchain are particularly active in using this feature. Tezos has a restriction for validators: they're only granted the right to create blocks if they have at least 8,000 XTZ in their balance. Regular users can join in by delegating their funds to a baker (the term used for miners in the Tezos network). 

Tezos operates on a variant of PoS called Liquid Proof-of-Stake. This means validators are incentivized to attract outside funds to their balances, since the amount of tokens they hold is directly related to the percentage chance of confirming a new block.

In this network, delegated staking allows token holders to contribute to a liquidity pool using a Tezos wallet that supports the process. 

Here's how the algorithm works:

  1. Users choose a baker they trust and delegate their XTZ to their address using the platform's built-in wallet. Users can delegate their entire balance or a portion of it.
  2. The validator includes these tokens in their staking balance and participates in block confirmation, taking into account the assets of users who have entrusted them with voting rights.
  3. As the baker receives rewards for their work, they distribute them based on the percentage of their staking balance that has been delegated.
  4. Users can switch to another validator after the lock-up period expires.
  5. Delegated staking doesn't require transferring ownership rights of tokens to the validator. The XTZ tokens remain under the user's control and ownership.

When it comes to preserving rights to their tokens, delegated staking is similar to soft staking, except that in the former case, lock-up periods are agreed upon in advance.

How to calculate income from delegated staking

The profitability of delegated staking depends on four factors:

  • the number of tokens being delegated
  • the duration of their lockup in the pool
  • the size of the staking rewards offered by the network
  • the commission charged by the validator for their services 

The general formula to help estimate the profitability of delegated staking looks like this:

Profitability = (A * B * C) - D

A represents the staking reward in the network. For example, if the network offers a 5% annual reward, this would be expressed as 0.05.

B represents the amount of tokens being delegated to the validator.

C represents the period of time for which the user is lending their funds. This is typically measured in weeks or months, but can vary.

D represents the validator's commission. This figure varies between platforms and is expressed as a percentage of the earned staking rewards.

The actual profitability from delegated staking may be lower or higher than the calculated amount due to fluctuations in commission fees and changes in asset value. However, it is essential to choose a validator with a good reputation to minimize the risk of losing your tokens.

Additionally, while the SEC conducts a mass investigation into staking service providers, it is not advisable to transfer your funds for an extended period.