What you need to know about staking

When staking cryptocurrencies you can contribute to the security of a blockchain based on a proof of stake consensus mechanism while potentially generating an attractive return as an investor. However, before you start delegating (investing) your coins and tokens, you should familiarise yourself with the possible staking risks. This is because your rewards could suffer due to lock-in periods, slashing penalties, or simply the volatility of the staked cryptocurrency. In the worst-case scenario, you could even incur losses if the value of your investment drops.

To help you minimise the risk of losses, our guide explains how different factors can impact your staking rewards and what you should be mindful of when staking coins and tokens.

What are the risks of staking?

When staking coins and tokens, you need to consider risks related to fluctuating liquidity, high asset volatility, the credibility of the staking project, the sustainability of annual percentage yield (APY) rates, the length of the lock-up period, and validator fees.

Liquidity

Liquidity refers to how quickly and easily staked cryptocurrencies, like Ethereum (ETH), can be converted into cash or other assets. With low liquidity, it can be difficult to sell staked coins and tokens flexibly. If you’re forced to sell at an unfavourable time or can’t respond to market opportunities, your risk of staking losses increases.

Volatility

Volatility refers to the frequency and intensity of price changes in cryptocurrencies. High volatility increases the risk of staking, as the value of your rewards and the staked coins or tokens can fluctuate significantly. This could lead to considerable losses if the market value of the cryptocurrency suddenly drops.

Project integrity

The credibility or integrity of a staking project is a crucial risk when staking cryptocurrencies based on a proof of stake consensus mechanism. Projects with poor management or uncertain future prospects carry the risk of total loss of the staked funds. This is particularly true for new or less well-known blockchains or staking pools, where reliability and long-term stability may be questionable.

Annual percentage yield (APY) 

APY refers to the expected annual return from staking. A high APY can be risky, as it may indicate an unsustainable model or even fraudulent intentions. Unrealistically high returns are a red flag and can lead to disappointment if the promised yield isn’t achieved.

Lock-in periods

The lock-up period refers to the time during which staked assets cannot be sold or traded. A long lock-up period increases the risk that you won’t be able to respond to market changes. This can lead to losses if the market situation worsens and you are unable to take action.

Validator fees

Validator fees in cryptocurrency staking arise when you delegate your coins or tokens to network validators, who confirm transactions and add new blocks to the proof of stake network. These fees compensate validators for their technical and operational efforts, such as server maintenance and electricity costs. However, high validator fees can reduce the profitability of staking, as they are deducted from the generated staking rewards.

Slashing penalties

Staking protocol penalties, known as “slashing penalties”, are sanctions that can be imposed on validators and their delegators (investors) in the event of network misconduct. Slashing can occur if validators approve fraudulent transactions or fail to perform their tasks correctly.

The consequence is often a loss of staking rewards or even part of the staked capital. To avoid protocol penalties when staking, careful selection of trustworthy validators is essential.

Risks of different staking options

For staking, meaning participation in transaction validation, you have several options. These include crypto brokers, crypto exchanges, or decentralised finance (DeFi) platforms. You can also operate your own validator node, for example on the Ethereum (ETH) blockchain, to stake assets directly and add new blocks to the blockchain. In our detailed guide, you can learn how to get started with staking and what distinguishes the different options.

Below, we explain the staking risks associated with the various options. This will help you weigh up the potential dangers of each option and find the best way to stake your crypto coins and tokens for blockchain security and attractive returns.

Risks of staking with crypto brokers

Like all crypto investments, staking with crypto brokers is subject to the risk of volatility and market fluctuations. Falling prices can also cause your staked capital to lose value. You need to account for this potential loss when calculating your return and comparing it with possible staking rewards.

When staking through a crypto broker, you entrust your cryptocurrencies to a third party, who performs the staking on your behalf. The risks of staking with crypto brokers may vary in terms of security standards, transparency around fees, or the selection of staking projects. Therefore, choosing a reliable broker is key to successful staking.

With Bitpanda Staking, your staked crypto coins and tokens are not tied to long lock-in periods, and you retain full control of your assets at all times. Sit back and enjoy weekly rewards.

Risks of staking on crypto exchanges

Crypto exchanges also often offer staking services. The main risks here relate to platform security and the specific terms of the exchange, which could include minimum deposits or lock-in periods. There is a risk of hacker attacks or even platform outages. Additionally, changes in staking terms can affect your investments.

Risks of DeFi platforms

Decentralised finance platforms (DeFi) often offer innovative staking options. However, they also carry the risk of smart contract errors or platform instability. A key feature of DeFi platforms is the use of smart contracts. Smart contracts are self-executing contracts where the terms are triggered automatically under specific conditions. While they automate and simplify many processes, they also pose the risk of coding errors, which could lead to losses.

Another risk with staking on DeFi platforms is potential instability. Since many of these platforms are relatively new, they may be more prone to technical issues or security vulnerabilities. Additionally, DeFi platforms are generally less regulated than traditional financial institutions. This means they are not subject to the same strict regulatory and security standards, increasing the risk for users.

In summary, staking through DeFi platforms means you have to contend with the risks of smart contract errors, technical weaknesses, and less regulation.

Risks of running your own validator node

Running your own validator node for staking comes with specific risks. A validator node is a critical part of a crypto network, such as the Ethereum (ETH) blockchain, responsible for validating transactions and adding new blocks to the blockchain. This requires extensive technical knowledge. Mistakes in setup or maintenance can lead to significant problems.

As validator nodes are attractive targets for hackers, robust security infrastructure is important. Additionally, high ongoing operating costs for hardware, software, and electricity can be financially burdensome if rewards are low. Furthermore, there is the risk of protocol penalties (slashing) if the node malfunctions or is mishandled. Therefore, a validator node requires constant monitoring and maintenance to remain efficient and secure.

Risks of staking pools

The risks of staking pools lie in the behaviour of the pool operator, the potentially unequal distribution of rewards, and possible security vulnerabilities in the project. These risks arise from working with many different stakers in the pool and transferring control to the pool operator.

Staking pools allow individual investors to pool their resources. Trust in the pool administrator is crucial. An incompetent or unreliable staking pool operator can increase the risk of losses, such as through protocol penalties, and reduce rewards. High pool fees also reduce overall returns. Since staking pools are attractive targets for hackers, potential security vulnerabilities are also a significant risk.

Conclusion: How to minimise your staking risk

To minimise staking risks, investors should compare various security factors before deciding on a staking option. These include, for example, checking the regulations and licences of the respective platforms. This ensures they comply with common standards and legal requirements. It is also important to consider user reviews and testimonials to get a realistic picture of the platform’s reliability and performance. Other security features that can reduce your risk as an investor include implemented security protocols such as two-factor authentication, data encryption, and secure asset storage. The insurance coverage of a platform for stored cryptocurrencies is particularly important in the event of a hack or other security incidents.

By carefully weighing these factors, investors can reduce the risk of losses. Conducting thorough research and comparing different providers will enable you to choose the safest staking option that aligns with your investment goals.

More on staking

Want to dive deeper? Check out our additional articles on staking and learn what really matters.

• What is staking?

• How do I start staking cryptocurrencies?

• What criteria should I use to choose a staking pool?