The Risks of Staking

Why participate in Staking?

It all started with mining Bitcoin, you needed to have a mining rig in order to participate in securing the Bitcoin ledger. But this required very expensive equipment and considerable amount of electricity, just to be able to mine a single coin.

When Proof of Stake was introduced, it paved the way for everyone to become part of the governance of a project. By simply holding your funds, you earn rewards by Staking and also support the operations of a blockchain network. This is the main reason why Staking has been the focus of many DeFi projects.

The allure of earning additional tokens by just holding your funds has certainly piqued the interest of many. But be wary of the risks involved in staking, as it is something that should not be ignored.

What are the Risks of Staking?

In order to stake your assets, certain requirements have to be met. And rewards are not always certain because these are always subject to change by the network and can also be affected by external factors.

Factors that can affect Staking Rewards:

  • Locking period
  • Liquidity and Volatility
  • Validator Status
  • Validator Commission
  • Rewards Duration

Locking Period

When you stake your token, they will be set to a locked state. During this time, the tokens cannot be moved or traded. This is true in most cases, like with Tron and Cosmos. While some tokens does not require you to lock your tokens, they have certain ways to check your balance on a wallet. A periodic snapshot is being done to monitor and calculate the rewards given. Some examples are with Tezos, VeChain and Algorand.

There are some staking mechanisms that just require users to hold their tokens on wallets or exchanges. But there is also the fear of losing access to their tokens, if you do not own the keys then there is a chance that you lose access to your assets.

Liquidity and Volatility

The behaviour of the market is something that we cannot control. The price may go up and go down in a matter of seconds. When your tokens are locked, there is nothing that you can do but watch the direction of the market. There is also risks that the tokens will lose its liquidity and thus result to a lower price.

The release of new tokens on the market can also directly affect the token price. Due to the sudden increase of circulating tokens, the demand will also lessen, and thus price volatility might happen.

Validator Status

The Validator nodes involved in the operation of a network have higher requirements for equipment operation and maintenance. There are certain factors that they need to maintain in order to be recognized as an active validator in the network, namely:

  • Network uptime is a crucial factor and they need to be always operational. If the node encounters problems or in a worst case goes down, it will experience block loss and double signing.

  • Validators need to have "skin in the game, or a collateral in order to be recognized as an active validator. They can self-bond or delegate tokens to themselves, and they can also receive delegations from any other token holders.

A validator may become inactive or jailed if they fail to meet the requirements mentioned above. Staking rewards will be halted, or in worst cases, they will be subjected to a Slashing penalty as enforced by the staking mechanism of the network. Slashing may take some of the tokens staked by the validators or even from the users.

Validator Commission

With Proof of Stake, there is still a requirement of hardware to run the nodes, as well as a number of tokens that has to be submitted to be considered a full fledged validator. Basically, there are operational costs, and these cost are being taken from the rewards gained thru staking. Validators are those responsible for governance and their active participation in the network is required. In turn, users select their desired validators in terms of their reliability as well as the percentage of the rewards allocated to the users.

The validators may set the percentage of the commission at any time without the consent of the users. It is the users responsibility to be always monitoring these changes and adjust their stakes if needed.

Rewards Duration

As soon as you stake your assets, rewards can either be credited right away or it would take a certain time before they get released. It can take days or weeks depending on the network that you choose to participate on.

In some networks, Validators have full control over the rewards that they release to the users. After taking their commission, they then calculate the rewards per individual users that have chosen them. This process can be immediate or it can also be delayed. Better check with the validator to know how they distribute the rewards.

To Stake or Not to Stake?

The question you need to ask yourself is, what risks are you willing to take? It is always better to understand how the system works and be aware of what the project is trying to achieve. In the end, we are still not certain on what will happen to the network we choose to support. Always be informed, and do your own research.

Learn more here:
The Rise of Staking: From Theory to Building Large Infrastructure | Binance Research