There are undeniable benefits to putting money into staking work in the crypto scene, not least the opportunity to earn passive income and grow cryptocurrency holdings easily. Proof-of-Stake itself is also friendlier to the environment as a consensus mechanism. Using Proof-of-Stake also makes it far easier for newcomers to participate in the actual process of running a blockchain network, compared to Proof-of-Work crypto like Bitcoin.
However, like any other form crypto investment, there are also inherent risks that you should be aware of before you decide to stake coins.
Challenges to staking crypto
1. Complex technical knowledge required
To directly participate in staking as a Validator actually requires a high level of technical knowledge, since you will need to process transactions and add blocks to the blockchain network. Mistakes won’t go unpunished and networks tend to be unforgiving. The costs incurred in terms of penalties, loss of stakes or even reputational damage from making the wrong calls can take their toll on your income.
2. Stakes can be exposed to cyberattacks
Needless to say, there are always people looking to exploit security flaws or loopholes in cryptocurrency. Some staking mechanisms and some staking pools could unknowingly be vulnerable and if you happen to have your crypto staked there when a hack occurs, you could very well lose your funds.
3. Crypto volatility can nullify rewards
It is not uncommon in crypto to see staking APYs that far outstrip traditional savings interest rates. However, crypto prices by nature are highly volatile and you could easily lose out in sharp price movement in your staked assets. So, while a 30% APY might sound highly attractive, if the crypto loses 40% of its value over the year, then your crypto holdings would still end up in the red. The risk is even higher if you’ve committed to lock-up periods, since you won’t be able to unstake in periods of high volatility without incurring costly penalties.
Minimising the risks of staking crypto
1. Use a staking pool
Stake into an appropriate pool and simply earn rewards even more passively than if you were to stake directly. You do give up some of the income as fees or commission, but at least you won’t have to deal with the technical complexities of processing transactions and creating new blocks.
2. Use cold staking
Choosing the right crypto wallet for staking is important as you want to minimise the ways your coins could get hacked or stolen. Cold staking is a term used when you stake funds from a cold wallet or hardware wallet, that is, a wallet that is offline or not connected to the internet. The idea here is simple – if your wallet isn’t online, no hacker can access it electronically.
Not all Staking Pools are created equal
As discussed in a previous section, Staking Pools offer different incentives to try and attract more individuals to join them. Earnings are also far more predictable than solo staking, and stakers find they can more easily determine the Annual Yield Percentage (APY).
For the pools themselves, there is the obvious economic incentive, as larger stakes give these operators a higher probability of getting selected by the network to validate. They also stand to gain from more fees and commissions levied on the individuals staking crypto in their pools. However, they can also benefit in terms of their say in the network development.
In the Proof-of-Stake consensus mechanism where Validator stakes also represent their governance power or voting rights, there is a danger that one or more pools are too powerful as a result of delegated voting rights, granted when individuals commit their stakes to the Validator’s pool. In a decentralised system that works hard to prevent giving a single entity too much power, this can be an unhealthy situation.
Imagine a situation where a Validator creates the most lucrative pool to attract the most stakes in the network, rising to become the single most powerful voter. Since that validator has the majority vote (by having the majority stake), they would be able to determine development decisions like network upgrades that otherwise the majority of individual participants would be against. Worse, Validators that are negligent or irresponsible
Simply put, you should always do your best to examine each pool operator individually, not merely to maximise your earnings but also to ensure that their track record and past behaviour align with your principles.
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