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Crypto staking is one of the most popular methods of earning a passive income on your coins, besides lending and mining. Staking involves locking crypto tokens into a Proof-of-Stake blockchain to verify transactions. In exchange for securing the blockchain, the network rewards users with newly minted tokens.
Staking your crypto assets has many advantages compared to other investment options. For one, you do not need in-depth technical knowledge if you stake your tokens on crypto platforms. Moreover, staking your tokens in Delegated PoS systems (DPoS) can grant you voting rights in addition to generating passive earnings.
Staking has grown in popularity since the Ethereum Merge of September 2022, when Ethereum transitioned from a PoW to a PoS model. In fact, the combined TVL of liquid staking protocols recently hit the $14 billion mark, making it the second-largest DeFi sector behind decentralized exchanges.
However, staking also has its own set of drawbacks that you should be aware of before you decide to invest in it. This guide goes over all the risks associated with staking your crypto tokens.
Risk of Loss
Staking crypto assets may cause a loss of investment due to the highly volatile nature of the crypto market.
Most Proof-of-Stake models require users to deposit their assets for a fixed period called the vesting period. During this time, you will be unable to unstake your assets, even if the price of your token sinks by a significant amount.
If the crypto market crashes during the vesting period, the staking yields may not be enough to offset the loss in the assets’ value.
Furthermore, if the blockchain were to undergo a forking event, the staked assets may lose their value and become worthless.
Limited liquidity
As mentioned earlier, users cannot liquidate their positions before the end of the vesting period. This means you will not be able to unstake your assets in an emergency. Moreover, you cannot trade your locked tokens for more profitable coins when they are locked in the network.
That being said, the liquid staking facility on platforms such as Lido and Ankr mitigates the issue of limited liquidity. Once users lock their assets in the blockchain, the platform deposits an equivalent amount of liquid tokens to their wallets. Liquid tokens have the same value as the original coins, thus maintaining the liquidity of the staked coins.
Technical complexity
Self-staking is a highly complex process that requires a lot of time and monetary investment to set up validator nodes.
On the software side, you will need to set up client tools and a staking deposit CLI/key generator. You may also need to configure your hardware before self-staking your tokens.
Although the hardware requirements for staking are much lower than those for mining, users will need a system with 24-hour internet access. You will also need to deduct the electricity costs from running your validator nodes from your staking profits.
You may also be required to deposit a specific amount of coins into the blockchain to activate the validator software. The number of tokens needed to begin staking varies depending on the network. Some blockchains, like Ethereum, require you to deposit as much as 32 ETH, while others, like Cardano, need a more modest sum of 340 ADA before allowing you to stake your crypto tokens.
Self-staking also has its own set of risks. If a third party can access your system, they can easily steal all the staked tokens.
Slashing Penalties
Many blockchains employ a practice called slashing to discourage validator misconduct. Validators perform two tasks: proposing new blocks and verifying or “validating” the blocks presented by other validators.
However, if a validator remains inactive or votes on an incorrect block, the network reduces its deposited assets. This is called slashing. The number of tokens slashed by the blockchain can vary from a small portion to the entirety of the validator’s locked assets.
Unfortunately, validator misconduct is not the only cause of slashing; validators can also qualify for slashing penalties due to technical errors. This means slashing can impact user assets staked via crypto platforms.
Environmental Concerns
Although staking uses less energy than crypto mining, it still has a considerable impact on the environment. This makes staking less environmentally friendly than other crypto investments like lending and trading.
Centralization Risks
Locking crypto assets on staking platforms makes the blockchain vulnerable to centralization risks. Having a majority of a token’s circulating supply on one platform can lead to devastating losses in the case of centralized hacking attacks and other tail events.
According to blockchain intelligence firm sentiments, as many as 46% of Ethereum’s staking nodes remain under the control of two addresses. Analysts speculate that the Ethereum network’s reliance on staking can expose it to a risk of heightened censorship.
Conclusion
Despite its disadvantages, crypto staking remains one of the most popular crypto investment options. Staking, just like any other investment, has its pros and cons that must be carefully considered before you begin staking your crypto.
You can visit our Crypto Staking Rewards page to compare the staking yield rates of different tokens. You can also choose the ideal crypto platform that fits your staking needs by browsing our Best Crypto Staking Platforms of the month.
