Our lowdown on the top risks, ranging from experiencing impermanent losses to delayed rewards.
It is evident that cryptocurrencies are lucrative opportunities. After all, people have earned up to US$100 billion from them. What’s greater is that there’s no single way to earn cryptocurrencies. You can mine, trade, earn or even stake them.
What is staking in crypto?
Staking cryptocurrencies refers to, literally, locking your holdings of a certain cryptocurrency to support the blockchain. In return, you earn rewards for every block that is validated. The practice is analogous to holding shares in a company and receiving dividends at the end of the year.
Staking utilizes the Proof-of-Stake consensus mechanism, which is said to be better than the Proof-of-Work model based on the costs on the environment. Instead of mining to validate a transaction, you stake. In doing so, you contribute to the security and efficiency of the blockchain as you are actively (and financially) invested in it.
As of January 2022, people have staked over US$50 billion on the blockchain platform Solana alone. Indeed, staking is profitable. But it is not so without its risks.
So, what are the risks of staking crypto?
Here’s our round-up of the top five:
1. Incurring great losses
The first and most obvious risk is that you may experience losses. This can happen if the prices of the cryptocurrencies you’re staking decline suddenly. For example, if you stake Solana (SOL) and its price falls by 50%, you will have lost half your investment. This is especially a cause for concern with new projects that you know little about. While they may start off with a lot of promises, they can quickly crumble and lose all their value.
2. Being subjected to scams and theft
Theft and other crypto crimes are becoming more and more common by the day. Just last year, criminals made US$14 billion in cryptocurrency—an all-time high. When staking cryptocurrency, you’re trusting that the holder of the funds you’ve staked is not a scammer. If they are, they can easily disappear with your coins and there’s nothing you can do about it.
3. The “lock-up” period
Most staking platforms require that you lock up your coins for a certain period of time. This means that you cannot access or trade your coins during this time. This can be risky because if the price of the cryptocurrency you’re holding falls sharply, you will not be able to sell it and cut your losses.
4. Significant expenses
Though staking does not require heavy machinery like mining does, it is not cheap. You need to have a good internet connection and a powerful computer. In addition, you need to pay for the electricity used to power your computer. All this can add up, making staking not as profitable as it seems at first glance.
5. Delayed rewards
Many cryptocurrencies take a long time to provide staking rewards; it’s not something that’s done daily. Because of that, you might have to wait a long time to re-invest your earnings, thus affecting your overall portfolio. And, if the price of the cryptocurrency you’re holding falls during that time, you will have to wait even longer to get back to where you were.
So, is staking crypto worth it?
Well, it depends. The risks are many, but so are the potential rewards. Staking cryptocurrencies is a great way to earn passive income. By holding coins in a staking wallet, you can earn a high interest rate of more than 10 to 20 percent a year. That said, staking crypto can also lead to benefits being accessible to only a small group of people. To stake cryptocurrencies, many platforms have a minimum investment requirement. For instance, to stake Ethereum 2.0, you need to deposit a minimum amount of 32 ETH, which, at the time of writing this article, amounts to over US$85,000. That’s a large investment that, often, only a select few can afford.
Plus, many people join staking pools, where multiple users combine their computational resources to improve their chances of earning rewards. While it provides stability to validators, it can also create a biased environment. The Head of Growth at decentralized staking product Bancor, Nate Hindman, expounds, “If staking in liquidity pools is only profitable for the most advanced users, liquidity is likely to become concentrated in the hands of far fewer actors, reducing DeFi’s resistance to censorship and manipulation.”
Today, many renowned and high-valued cryptocurrencies, including Solana, Cardano, Polkadot and more, employ the Proof-of-Stake consensus. Staking is being considered widely as a more environmentally-friendly alternative to mining, which is much more energy-intensive. Instead of relying on heavy machinery, it relies on stakes.
All things considered, staking cryptocurrencies is a double-edged sword. It can be profitable, but risky at the same time. Before you stake, make sure to do your research and understand all the risks involved.
Header Image by Freepik
