Staking has become a new trend in the crypto industry. With Coinbase or Trust Wallet announcing their support for the staking economy, we believe that it’s important mentioning what are the risks associated with cryptocurrency staking.
This article will highlight the key risks when it comes to staking.
Slashing
What is slashing?
Slashing is the fact of your validator/baker being punished for a fault he conducted, it is a mechanism by which the network disincentivizes abnormal behaviors.
Who gets punished?
While in Liquid Proof-of-Stake (LPoS) protocols such as Tezos only the baker is directly punished in case of a fault, in Bonded Proof-of-Stake protocols (BPoS) such as Cosmos or IRISnet, both the validator and its delegators are directly punished.
When does it happen?
Slashing can happen in several cases:
- Liveness fault (Cosmos, IRISnet): The validator node does not participate in the network consensus for a long time and misses several blocks.
- Security fault (Tezos, Cosmos, IRISnet and most of the protocols): Disturbs the network consensus by validating/verifying twice or more the same blocks. Such security faults are also called double-baking or double-endorsing in the case of Tezos, or double-signing in the case of Cosmos & IRISnet.
- Governance fault (Cosmos, IRISnet): The validator voted multiple times on the same consensus process, and these votes contradict each other, or he did not vote at all.
For more detailed information on slashing with the protocols mentioned above, please see their respective documentation: Tezos, Cosmos, IRISnet.
What are the punishments?
The penalties depend on the kind of misbehavior and on the parameters of the protocol. Most of the time, the validator/baker is punished with a certain percentage of token he has under staking or within a safety deposit. In some protocols, the validator can also be jailed, a process prohibiting him from re-entering the networks for a certain period of time. In Bonded Proof-of-Stake (BPoS) protocols (Cosmos, IRISnet), the delegators are also at risk of punishment: carefully choose your validator.
Crypto volatility
Probably the most dangerous risk in staking is the volatility. In fact, earning a crypto dividend on your stake could sound nice and be very profitable if the market is in a bull run. On the other side, if price depreciates too much even what you’ve earned through staking will not cover the token loss when measuring the final return in terms of fiat currencies.
So it’s important to know what you are dealing with and to understand that, for now, it is something with risk as cryptocurrencies are highly volatile products.
Here are some of our tips if you want to reduce risk while staking PoS crypto. First, it’s important to select protocols with a real tech and community behind and not only the ones that pay most rewards.
At Stakin, we also think that diversification on this field is something needed this is why we are a multi-protocol player and do not focus on one.
Then, we also advise you to do your own research on each coin you will select and be sure to understand what the project does and that it is not a scam. You can use websites such as stakingrewards.com if you want to find more info about staking tokens and yield associated with these.
Another solution we are working on is to hedge your position. You can subscribe to our newsletter if you want to be in touch when this functionality will become available.
As for now, you can also find a solution to short the crypto in order to hedge you if the price is going down.
It’s import to invest what you can afford to lose, even if the yield is guaranteed by the protocol, the crypto staked could go down.
Validators not paying their rewards
One of the other forms of risk is to delegate your hard earned token to validators that do not pay rewards.
This is an important factor. As in some protocols such as Tezos for example, 1st rewards come after 7 cycles so approximately 20 days and people do not check if they’ve well received their rewards.
You should absolutely use a validator dashboard such as ours or 3rd party solutions such as Baking bad on Tezos or block explorer to check if your rewards are paid.
As we hope it’s a trusted industry, not many people are scammers but you should always be worried.
It’s also important to repeat that in more cases, validators do not need to have custody of the funds, so you should not send directly your funds to their wallet, follow this guide if you need a tutorial on how to delegate.
You should never communicate with a validator or to anyone your private key or mnemonic.
Account lost: Mnemonic / Private key backup
Mnemonic and private keys are really important concepts in the blockchain world especially when it comes to cryptocurrencies.
If it’s absolutely important to never communicate this document with anyone, on the other hand, it’s something you absolutely need to save and back up properly.
In case your account is lost, you will need to use a mnemonic or a private key to recover your previous wallet.
This is something you absolutely need to back up offline and in a secure way.
We recommend that you use a Hardware module such as Ledger to keep your funds safe and your mnemonic offline in a secure manner. We highly advise not to keep your mnemonic online.
Ledger problem
Sometimes, if you use Ledger you will need to update the firmware or you will encounter another problem. This is why it’s very important to register the mnemonic of the key as, in case of mishandling, all wallets may disappear from it.
Don’t worry and don’t panic. If you have registered your keys properly you will be able to recover your previous setup using your mnemonic.
If wallets disappear, after having restored your account from your mnemonic, simply reinstall them from the Ledger Live.
Network Centralisation
To conclude this article, one of the other risks on a global scale for a blockchain protocol is a 51% attack.
As explained in the video, a 51% attack refers to an attack where a group of miners owns more than 50% of the network.
When staking your tokens to a validator, you directly contribute to the centralization or decentralization of the network.
The table below illustrates the % of voting rights detained by top 10 block producers on Cosmos, Iris, and Tezos. As you can see, on Cosmos, the top 10 producers own more than 50%+ of the staked tokens.
A good behavior when staking your tokens is to not necessarily delegate to the largest ones, but rather to choose your validator based on its uptime, self-bond, security practices, community involvement, customer service, service fees, etc. By encouraging smaller validator, you will contribute to the decentralization of the network, which is great.
Looking for a trusted operator to stake your PoS cryptocurrencies?
Try out Stakin and enjoy low fees and automatic payouts at the end of each cycle: www.stakin.com
*DISCLAIMER: This is not financial advice. Staking and cryptocurrencies investment involves a high degree of risk and there is always the possibility of loss, including the loss of all staked digital assets. Additionally, delegators are at risk of slashing in case of security or liveness faults on BPoS protocols. We advise you to DYOR before choosing a validator.
