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The common understanding that crypto staking helps investors earn rewards while holding onto certain digital assets becomes an attractive sentiment for many in the decentralized finance (DeFi) space.
However, just like investing in stocks and cryptocurrencies, staking can be a complicated and risky process, especially for new investors.
What are some of the main risks of staking crypto, and what should investors keep in mind?
Key Takeaways
- Crypto staking allows investors to earn rewards by locking up tokens to help secure blockchain networks.
- Staking involves the risk of slashing, where validators can lose tokens due to network rule violations or errors.
- Investors should differentiate between legitimate staking that secures networks and risky, misleading schemes offering unsustainable returns.
- The SEC’s scrutiny over staking services highlights the potential for regulatory changes, especially as crypto staking may be considered a securities contract.
- Staking is more suited to experienced investors due to its complexity, requiring thorough due diligence and an understanding of network rules to maximize rewards and minimize risks.
Why Stake? It Keeps a Blockchain Running
Not all cryptocurrencies allow staking. However, some solely depend on it.
Graeme Moore, the head of tokenization at Polymesh Association, said:
“For Proof of Stake blockchains, staking keeps a blockchain running! For investors buying tokens, staking can be a great way to receive more tokens than simply holding.”
Bitcoin (BTC) is notoriously known for not supporting staking, due to its Proof of Work (PoW) consensus mechanism, however, crypto enthusiasts are already trying to change that through the introduction of new initiatives that aim to alter how the BTC consensus mechanism operates.
Rich Rines, a contributor at Core, the first live BTC staking protocol, told Techopedia:
“Staking gives holders access to minimally risky yield while also securing the network upholding their token. It’s a win-win in terms of user-network alignment… Historically, demand for staking yield has been a challenge for Bitcoin, which does not rely on a Proof of Stake consensus.
“This is partially why Core introduced Non-Custodial Bitcoin Staking to the world. It allows Bitcoin holders to earn staking rewards by contributing to Core’s security while still maintaining full control of their coins.”
But is staking crypto safe, and what should investors look out for?
Is Staking Crypto Safe? Three Risks to Consider
Experts explain that the three main staking risks crypto investors must consider prior to staking their tokens are slashing, fake staking, and a changing regulatory landscape.
1. Slashing
Slashing is one of the biggest risks industry experts are quoting when it comes to staking, which is essentially a penalty mechanism used in the PoS consensus mechanism to ‘punish’ validators for their improper behavior.
Validators are responsible for confirming transactions and securing the network, and when they act against the network’s rules, such as by being offline for extended periods or attempting to validate fraudulent transactions, their staked tokens can be slashed.
Patrick Gruhn, CEO of Perpetuals.com and former head of FTX Europe, explained:
“Unless the investor is also very technically oriented, it is currently infeasible to run and maintain one’s own Validator node on most PoS blockchains (and financially infeasible on Ethereum due to the 32 ETH minimum threshold to run a Validator).
Therefore, an investor must delegate their stake to a third-party validator they trust to not be malicious and to not mistakenly conduct slashable offenses (inactivity, errors from not upgrading clients, etc.).”
2. ‘Real’ vs. ‘Fake’ Staking
Another staking crypto risk investors should consider is the ability to differentiate ‘real’ vs. ‘fake’ staking, Johnny Gabriele, the head of decentralized finance at CryptoOracle Collective, said.
Gabriele explained that real staking involves lending crypto assets to secure the network.
Sticking with a trusted third party to do this or learning how to run a node is one of the safest ways to both get some yield, as well as help secure the safety of the blockchain on which validators are staking their tokens. He highlighted that this involves staking assets like Ethereum (ETH), Solana (SOL) and Cardano (ADA).
Fake staking, on the other hand, is when a project incentivizes holders to lock up their tokens with the idea of receiving more tokens over time.
“With enough due diligence, this could be a smart move. However, most of the time, this is a one-way ticket to losing money,” Gabriele said.
3. SEC Could Deem It a Securities Contract
One of the most prominent ongoing court cases between the US Securities and Exchange Commission (SEC) and the cryptocurrency industry is the SEC vs. Coinbase case where the SEC deemed that Coinbase’s retail staking services could be considered a security.
According to a press release issued by Coinbase, “staking is a core part of ensuring that the cryptoeconomy functions for hundreds of millions of users around the globe” with the company pledging to continue its commitment to protecting access to staking for everyone.
However, as the SEC continues to push for staking to be considered a securities contract, validators should continue to exercise due diligence, Polymesh Association’s Moore noted.
How to Gain Maximum Profit & Avoid Risks: Expert Tips
Know the Risks & Complexity of Staking
Knowing the risks associated with staking is the first step investors must take in order to maximize their profit and avoid risks.
CryptoOracle Collective’s Gabriele highlighted that while staking is primarily one of the biggest reasons some of the larger blockchains continue to securely operate, it is also 99% more energy efficient than PoW. However, as an investment opportunity, staking is more of an intermediate than a beginner move.
“There are a lot of edge cases many new investors are not aware of. But going down this path and doing your own due diligence will make you smarter than 95% of investors out there, and that will actually lead to higher returns in the long run.”
Evaluate More Than Staking Yields
Polymesh Association’s Moore added that one of the most common mistakes validators make is looking at the staking yield in order to determine whether a token is “good” or “bad.”
The staking yield is only one piece of information to assess.
- What is the token’s new supply rate compared to the staking yield?
- Is there a lock-up period?
- If there were no staking yield, would I still want to hold this token?
“These are a few questions crypto users need to answer instead of simply thinking ‘high yield = good,'” Moore said.
Understand Protocol-Specific Staking Rules
Other things investors should keep in mind in order to gain staking rewards and minimize losses are the specific rules set by protocols using a given restaking protocol to know what the exact risks and rewards are.
Core’s Rines added that compounding is another thing investors should keep in mind.
“Compounding is a superpower, and it depends on sustainable sources. Sustainability depends on aligned incentives between stakers, the network, and all other involved stakeholders. Alignment is why Core is adopting a Dual Staking model, whereby Bitcoin stakers can get access to higher Bitcoin staking yields by also staking CORE tokens.”
The Bottom Line
While crypto staking offers an attractive opportunity for investors to earn rewards and contribute to the stability of blockchain networks, the process is best suited for more seasoned investors due to the significant risks involved.
Slashing, the danger of fake staking, and potential regulatory scrutiny, particularly from entities like the SEC, are just a few of the key considerations investors should be aware of before proceeding.
Investors must conduct thorough due diligence, understand the technical and security aspects of staking, and consider factors beyond high yields prior to staking their tokens.
FAQs
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References
- Polymesh | A blockchain for security tokens (Polymesh)
- Decentralized Applications Secured by Bitcoin (Coredao)
- Investing in Future Technologies (Cryptooracle)
- Why we stand by staking (Coinbase)
