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Crypto Staking: What Is It and What Are The Risks Involved?

4.0 | by Josiah Makori

Key Takeaways

  • Crypto staking is a way of generating income on your cryptocurrency holdings, and usually involves locking up your cryptocurrencies to support a blockchain's security, integrity, and efficiency. 

  • Coinbase, Binance, and Kraken are three centralized staking platforms to consider.

  • Besides centralized staking platforms, you can also solo stake on the blockchain directly, engage in liquid staking, or join a staking pool.


Crypto Staking

Have you been HODLing cryptocurrencies and wondering how to benefit from them beyond capital gains or selling them? If so, you might be interested in staking, which is a way of earning income with your crypto holdings. It involves putting your assets to work to generate yield instead of leaving them idle in your wallet. Crypto staking has unlocked more opportunities for investors and is drawing attention from institutional and retail investors. 

A recent report from Staked, a crypto staking company, "The State of Staking," indicates that almost 10% of digital assets are currently staked. Besides, some ecosystems like BNB Chain have a staking ratio of 96.8%, according to Staking Rewards. Moreover, the recent Ethereum Merge, which saw the Ethereum blockchain shift from the energy-intensive Proof-of-Work (PoW) mechanism to the more energy-efficient Proof-of-Stake (PoS) mechanism, will inevitably pull more investors and capital into staking. To stake ETH, users can opt to solo stake as a validator, or join a staking pool. Liquid staking options have also emerged, and these liquid staking derivatives let users unlock the liquidity of their staked ETH, where users can indirectly use their staked ETH in DeFi activities like providing liquidity, lending it, or using it as collateral. 

This article presents a detailed discussion of crypto staking, the benefits and risks of staking cryptocurrencies, and three centralized staking platforms to consider. 

What is Crypto Staking?

Crypto staking is locking up your crypto holdings to support a blockchain's security, integrity, and efficiency. It's similar to the concept of earning interest on a savings account. The difference is that, with staking, you earn rewards for helping to secure a blockchain network.

It is important to understand how a blockchain works to understand how staking works. A blockchain is a decentralized, distributed ledger that records and stores transactions transparently and securely. It consists of a series of blocks containing a record of multiple transactions. For a new block to be added to the chain, it must be validated by network participants, known as validators.

Validators play a critical role in the security of a blockchain network. They are responsible for ensuring the integrity of the network by verifying transactions and preventing fraud using their stakes. In return for their service, validators are rewarded with a portion of transaction costs and/or newly minted coins. However, if a validator acts dishonestly, their staked crypto can be slashed.

To participate in staking, you must hold a minimum amount of a specific cryptocurrency and run a node on the network. A node is a piece of software that communicates with other nodes on the network to validate transactions and add new blocks to the chain. The more your stake, the more influence you have on the network, and the greater the rewards you can earn.

There are different types of staking, including Proof-of-Stake (PoS) and delegated PoS (DPoS). In a PoS system, the network chooses validators based on the amount of cryptocurrency they hold and stake. The more you stake, the higher the probability you will be selected to validate a new block. In a DPoS system, the validators are elected by the community and represent the stakeholders' interests.

Benefits of Staking Cryptocurrencies

These are the benefits of staking cryptocurrencies:

  • It's easier to generate interest on your idle crypto holdings than other investment strategies, like yield farming, as you just have to deposit and lock up your cryptocurrency based on the staking agreement. Even if you don't have enough crypto to operate as a solo staker, you can join staking pools and still earn a share of the staking rewards.

  • You don't have to purchase expensive mining equipment to participate in crypto staking like you would for crypto mining.

  • You help to maintain the security and efficiency of your favorite PoS blockchain.

  • With liquid staking, you'll even be able to unlock the liquidity of your staked assets, which you can then use for other DeFi activities.

Risks of Staking Crypto

After seeing what crypto staking can offer, you may wonder whether there are any associated risks. While staking offers good returns on crypto holdings and enables you to participate in securing your favorite blockchain, it presents some risks which you should be aware of when locking your cryptocurrencies in any platform. This section contains some risks of crypto staking:

Market Risk

Arguably, the most significant risk you should be aware of when staking crypto is a potential negative price movement in the cryptocurrency you have staked. Suppose you staked 1 ETH on January 05, 2022, when it was valued at around $3,500 with an Annual Percentage Yield (APY) of 12%. If the lock-up period was one year, you would withdraw your stake on January 5, 2023, at an average price of $1200. Even without going into many calculations, you will have made significant losses, even taking into account the yield earned.

Several factors can contribute to market risk in crypto staking, including:

  • Volatility: The value of cryptocurrency is highly volatile and can fluctuate dramatically over short periods. This means that the value of the staked crypto could drop significantly during the staking period.

  • Competition: As more people begin staking a certain crypto, the competition for rewards increases, leading to a decrease in the reward earned for each stake.

  • Regulation: Changes in government regulations can also impact the market risk of staking crypto. For example, in January 2022, the cryptocurrency market experienced a crash when the Russian Central Bank proposed a crypto ban.

Lock-up and Waiting Periods

Though there are certain staking opportunities that do not impose mandatory lock-up periods, most of the existing staking platforms have lock-up periods. They involve your stake being locked and inaccessible to use or withdraw throughout the period. Besides, if you defy the lock-up period and decide to unstake your funds before the time is up, you may have to wait almost three weeks for your assets to be unlocked. 

Suppose you urgently need your stake or want to undo a poorly executed investment decision by unstaking your funds; there is no quick way to go about it other than watching the clock tick sluggishly until the waiting period expires. As such, you should consider the lock-up period and your liquidity needs before staking on any platform. 

Counterparty Risk

Counterparty risk refers to the risk that the other party in a financial transaction may fail to fulfill their obligations. In crypto staking, there are a few potential sources of counterparty risk that you should be aware of:

The first source of counterparty risk is the crypto exchange or platform on which you are staking your crypto. If the exchange or platform fails to secure your assets properly, or if it becomes insolvent, you could lose your staked crypto. To mitigate this risk, choosing a reputable exchange or platform with a strong track record of security and financial stability is important. You may want to ensure that decentralized platforms have passed smart contract audits, and that centralized platforms have proof of reserves.

The second source of counterparty risk is the validator node to which you choose to delegate your staked crypto. If the node behaves or tries to behave dishonestly against the protocol rules, it could result in your staked crypto being slashed (i.e., a portion of your staked crypto being confiscated). To mitigate this risk, it is important to carefully research the validator nodes that you are considering delegating to and ensure that they have a good reputation within the community and a stellar track record of uptime.

Finally, there is also the risk that the network itself could fail or become compromised, which could result in losing your stake. This is an inherent risk in any decentralized network, and there is no perfect way to mitigate it. However, you can reduce your exposure to this risk by diversifying your staked crypto across multiple networks and validator nodes.

Custody Risk

Custody risk refers to losing access to or control of digital assets due to the failure or inability of a third-party custodian. This can be caused by the following:

  • Hackers breach the custodian's security systems and steal the assets.

  • The custodian goes out of business or becomes insolvent, like the FTX collapse.

  • The custodian loses the private keys or fails to secure the assets properly.

One way to reduce custody risk is by embracing solo staking instead of delegating your crypto to a validator node or a staking pool to stake on your behalf. In solo staking, you retain control of your assets, while in the other options, you entrust your assets to a third party. Regardless of your staking decision, you must keep your private keys safe to avoid exposing them to unauthorized individuals or misplacing them. 

In centralized crypto staking, the staking platform manages your stake. You can lose your stake through hacks, fund mismanagement, or insolvency. Therefore, you should choose a staking platform that can refund your stake in the case any of the above happens, by checking that they are able to supply Proof of Reserves to ensure that the institution has sufficient reserves to back the deposits is a key part of due diligence.

Validator Costs

You should factor in validator costs, especially if you plan to become a solo staker or validator. Validator costs sometimes surpass the rewards you generate. Therefore, calculating your expenditure and earnings is essential when applying to be a validator. The major cost comes from electricity bills – remember, you will be running a node 24/7 and you will be penalized for being offline. 

Besides, you may be required to purchase external hard drives to provide adequate storage space for solo staking. This will undoubtedly increase the overall cost of running a node. Therefore, the validator costs may be problematic if you are operating under a tight budget or your staking profits are small. 

Loss or Theft

Even excluding the algorithmic failure of Terra’s LUNA and UST, and the collapse of FTX, Celsius, and Voyager, losses from crypto hacks and exploits reached a high of $2.8 billion in 2022, with these taking place across centralized and decentralized networks, based on data from DeFiYield’s REKT Database. 

Even if you avoid using DeFi platforms due to a fear of hacks, the likelihood of misplacing or losing your private keys if you fail to practice good online hygiene remains. For example, Luke Dashjr, one of the first Bitcoin Core developers, lost a whopping 216.9 BTC (currently valued at around $3.6 million) through an online attack on January 01, 2023. Generally, regardless of whether you are staking through a centralized or decentralized platform, it's important to do your own research around the potential platform you're looking to use, and store your private keys safely and offline.  

Centralized Staking Platforms

As mentioned above, centralized staking platforms offer a simple and convenient way for users to start staking cryptocurrencies. Moreover, they also offer multiple asset staking options, where the centralized platform manages the staked funds for you in exchange for a fee. Here are three centralized staking platforms to check out:

Coinbase

Coinbase staking

You can earn up to 5.75% APY on your crypto holdings by staking with Coinbase. Coinbase staking is available in more than 70 countries. You sign up with Coinbase (if you don't have an account yet) and buy your preferred staking and standard reward asset. To generate yield, you stake ETH or lock assets in the available DeFi yield and agree to the staking terms and conditions. 

Yield rates are set by the DeFi protocols – Coinbase passes through the yield to you after deducting a fee of between 25%-35%, depending on the protocol. It's also important to note that some crypto like Algorand (ALGO) earn rewards via inflation or community rewards when staked. Basically, newly minted coins are included in the blockchain at a rate set by the Algorand protocol and allocated to holders as rewards. 

Binance

Binance DeFi Staking Rates

You can earn up to 5.39% APY on your crypto with Binance DeFi staking. Like Coinbase, Binance acts on your behalf in chosen DeFi protocols, obtains and allocates generated rewards, and helps you to take part in DeFi staking with one click. To help mitigate some crypto staking risks, Binance staking has laid out some protection measures such as:

  • Slashing risks: Binance takes care of all slashing fines, meaning you will receive the same amount of assets you staked at the end of the staking period.

  • Wallet attacks and scams: You minimize wallet attacks and scams when you stake with Binance since you don't have to transfer assets to delegators and staking pools or manually stake. Binance does everything on your behalf. 

  • Technical risk: Binance staking offers an easy, single-click-to-stake feature for over 100 assets. Besides, you can lock, unlock, or reinvest your rewards with minimal technical requirements.  

Despite the above customer protection measures, there will always be risks associated with staking as mentioned above, so do your own research before choosing which platform to stake with. 

Kraken

Kraken Staking

With Kraken staking, you can earn up to 24% APY on your crypto holdings. Some assets available for staking on Kraken include ETH, DOT, ADA, SOL, ATOM, FLOW, KAVA, ALGO, and more. This is how to go about it:

  • Acquire staking assets: Purchase or fund your Kraken account with any assets listed for staking. 

  • Choose an asset to stake: Pick from the available cryptos in your spot account.

  • Generate Rewards: You will earn rewards twice a week from your staked coins, although the distribution schedule might change depending on the crypto. 

Conclusion

Staking cryptocurrency offers users a way to put their crypto to work and earn returns on their crypto holdings, while maintaining ownership of their assets. There are many ways to stake crypto; from centralized exchanges, to solo staking, and even liquid staking through an LSD staking pool. However, crypto staking comes with several risks, such as market risk, lock-up and waiting periods, counterparty risk, custody risk, and validator costs. As such, it's important to thoroughly research and understand the specific staking process before participating, and ensuring that the staking platform or validator is reputable and secure is critical. 

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Josiah Makori
Josiah Makori

Josiah is a tech evangelist passionate about helping the world understand Blockchain, Crypto, NFT, DeFi, Tokenization, Fintech, and Web3 concepts. His hobbies are listening to music and playing football. Follow the author on Twitter @TechWriting001

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