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Risks of Staking Cryptocurrency

an Ethereum coin - Risks of Staking Cryptocurrency

In the cryptocurrency markets, staking crypto has become a very popular strategy to earn investment income, and crypto staking works but not for everyone. Like all types of investing, staking comes with its own set of risks. In this article, we will be looking at the risks that come with staking crypto.

Different Risks Associated with Staking Cryptocurrency

Regulatory Risks

Staking cryptocurrency is still a new concept. Governments can decide to regulate it, which could lead to confiscating the coins by government agencies or exchanges who hold them on behalf of their users. The good news is that decentralized crypto and staking platforms are hard for governments to regulate.

Wallet Risks

Cryptocurrency staking requires that you leave your coins on an exchange or wallet connected to the internet, which makes it vulnerable to attacks by hackers and viruses. Storing your coins in cold storage can make it difficult if you want to stake them until you get a software update for your wallet.

Also, if the private keys to access your wallet get lost, you lose access to your funds forever and cannot recover them unless the staking network allows for the recovery of lost funds.

Cryptocurrency Market Risks

The risk of losing your investment is real, and it can happen to anyone, regardless of their financial situation. Other market risks that might affect you are price changes and currency fluctuations. For example, if you earn between 10% to 15% Annual Percentage Yield (APY) for staking a particular asset, but it loses 40% or 50% of its value over the year, you will still have lost money.

So, one should advisably not choose their staking assets based on APY figures alone.

Liquidity Risks

Another risk factor worth considering is liquidity or rather still illiquidity. How fast and easy a crypto asset can be unstaked or converted into another coin or spendable cash is known as liquidity. 

In the crypto market, prices are volatile and can drop quickly. This volatility can affect your investment at any time, whether you are staking or not. This means that your coins will be affected by the fluctuation of the market.

This risk primarily affects the micro-cap cryptocurrency networks because they are more volatile, but some large networks also suffer from low liquidity, especially if they do not have a continuous rewards distribution system in place (i.e., you have to wait until certain conditions are met before you can claim rewards).

The risks, however, don’t stop here. Liquidity in crypto staking, in particular, brings various financial and non-financial risks along multiple dimensions. For example, The big players in the staking pool may already have a considerable amount of power over market participants since the staking power will always be proportional to the percentage of assets being staked. 

In the worst-case scenario, a major validator’s default will undoubtedly cause others to liquidate their positions, worsening the situation. When it comes to the oversight of these networks, all of this can be risky because it is simply unpredictable where it will go.

Lockup Periods for Staking Crypto

The length of time your tokens remain locked up is an essential factor in deciding whether you are staking or not. When you lock up your tokens, they’re not available for trading or selling until the lock period ends.

Most times, the more people who want to unstake at the same moment, the longer it takes for their transactions to be enabled by the network. The same can be said for the entrance queue.

Some cryptocurrencies have long-locked durations in which you won’t have access to them. Polkadot and Cosmos (ATOM) are two examples of many others. If the price of your staked asset decreases enough and you are unable to unstake it, your overall gains would suffer a maximum loss.

Some staking programs have one-year lockup periods, but there are also two-year programs and three-year programs (though you’ll want to read the fine print as to what happens during the lockup period). 

If your crypto value plummets during that time, you may lose a huge chunk of value. This can happen for several reasons; the market might just find another coin that’s doing better and dump the one you staked, or other factors may affect the coin’s value.

Validator Risk

Validators are nodes that validate transactions, and to maximize returns, a validator needs 100% uptime. If a validator isn’t online or makes mistakes, that would affect any staker who has staked their funds with them at that time.

Also, hackers can attack validators and compromise them, losing funds for everyone who stakes through them. 

The validator network itself is another element of risk. Validator nodes run on specialized software, allowing them to verify transactions on the network. They’re paid a fee for their work once every 24 hours or (in some networks) once every seven days. 

This means that anyone who wants to run a node has an incentive to make sure their node does more work than other nodes or at least tries harder. If one node is determined to do more work than everyone else, at some point, it will overtake them and earn more fees than they can collect from their clients. 

That can lead to situations where nodes “front-run” other nodes’ transactions simply because they have an incentive to do so without thinking about whether this might create problems for clients down the road.

A bad actor becoming a validator for a cryptocurrency is one of the biggest challenges facing crypto staking. The stakes are high because if a malicious actor gets control of a blockchain’s validator node, they could start to perform acts that can manipulate the market and staked coins. However, most protocols have mechanisms to recognize malicious actors and code and kick them out.

Staking Pool Saturation

There is also a risk that you will receive a lower reward than expected because others stake too, which typically happens when the cryptocurrency is popular. However, you can address this particular risk by getting accurate information on how much reward to expect and how many people are staking.

Rewards Duration

Staking rewards may be credited right away, within a week or a much longer time, depending on the network you participate in. Also, on some networks, validators fully control the release of rewards; after taking their commission (which they can increase at any time), they then calculate the rewards per user and release them. That process can be quick or delayed.

Slashing

Slashing is the process that occurs when a validator misses a block or double-signs one. You can think of this as a fine or a fee for not doing their job. This is a built-in risk mitigation measure designed to discourage malicious behavior on the network.

In general, Proof of Stake networks have three conditions to avoid that, if violated, can lead to slashing:

Double Signing: Occurs when a signer signs two blocks at the same height or two transactions sending funds from a specific account to two accounts.

Equivocation: occurs when a signer signs conflicting messages during a single consensus round.

Inactivity Leakage: occurs when a signer becomes inactive for more than some specified period.

Usually, slashing affects the validators and not the users, but there are times when slashing takes some of the tokens staked by the users.

Project Failure

If the project team fails to deliver on their road map or exits the space, your tokens will be dead weight. The value of your tokens may also be diluted if the project issues additional coins.

Many blockchain projects are still in their early stages. The most promising ones might fail. Whether it be due to regulatory issues, competition, or just plain bad luck, there is a risk that a project will fail. This can hurt the value of your staked coins and could even lead to a complete loss of your investment.

This is the most obvious risk of staking crypto, but it’s not unavoidable. You can mitigate this risk by researching the company and its team before investing in it.

Conclusion

The modern cryptocurrency market is facing many risks. Some are inherent to high-growth markets, and some are not. You can be mindful of the risks of staking crypto and take measures to protect your hard-earned investment. There are many ways to lose your crypto; make sure it won’t happen because of something you could control.

However, staking is a strategy that requires patience. You can earn yield over a short time, but the amount you earn is most certainly not going to be worth it if you have to take out your money early.

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