Staking has become a new and sustainable trend in the crypto industry. So much so that even well-known projects like Coinbase or Trust Wallet have announced their support for this idea. Therefore, we believe that you should definitely learn about the possible risks associated with the very concept of cryptocurrency staking.
Slashing
Slashing is a situation where a person to whom you have transferred part of your assets for the purpose of delegated staking is punished for their activity by the automatic mechanisms of the network, which are designed to limit the abnormal behavior of nodes.
What is important. In Liquid Proof-of-Stake (LPoS) protocols, such as Tezos, only the validator is punished in the event of an error, while in Bonded Proof-of-Stake (BPoS), such as Cosmos or IRISnet, restrictions are imposed on the validator, and those who delegated their funds to him.
This can happen in the following cases:
- Liveness error - when a node does not participate in the process of maintaining a network consensus for a long time and misses the confirmation of several blocks.
- Security error - When a node breaks the existing consensus mechanism and double-checks and validates the same block. This is the so-called "double confirmation" for the purpose of re-receiving the award.
- Management error - when a node votes for the same block several times, and the votes contradict each other, or do not affect the voting process at all.
For more information about what is considered a violation in a particular network, it is better to read the technical documentation for it.
Penalties for misconduct depend on the type of misconduct and the underlying protocol parameters. In most cases, we are talking about the loss of a certain percentage of tokens that are within the limits of the stake or safe deposit. On some networks, the offender can also be "jailed" - being banned from reconnecting to the network for a specified period of time. And, as mentioned earlier, in BPoS protocols, those who delegated their funds to the violator can be subject to the same punishment. So keep this in mind when choosing the platform you intend to work with.
Volatility of cryptocurrencies
It is the volatility that is the biggest risk associated with cryptocurrency staking. On the one hand, when the market is bullish, the profit from cryptocurrency dividends increases markedly. But on the other hand, with a steady decline in prices, which allows you to earn staking will not cover losses if you translate all this into traditional fiat currencies.
And it is extremely important to always keep it in mind since cryptocurrencies are a very volatile product with not always predictable price changes.
However, there are some points that will reduce the risk when working with PoS protocols. First, it is imperative to choose projects with real technology and an active community, rather than focus solely on the amount of reward. Secondly, portfolio diversification is mandatory, as this reduces potential losses. That is, work simultaneously with several tokens without focusing on any one.
Thirdly, you need to conduct your own research on the coin you plan to work with in order to understand if this is a real project or another scam. This is facilitated by specialized sites such as stakingrewards.com - they make it much easier to search for information regarding tokens and related profitability.
Hedging can also be extremely useful. For example, you can sell short positions when the price starts to fall.
In any case, you should always invest as much money as you can afford to lose, as even “guaranteed” returns can suddenly drop.
Refusal of validators to pay remuneration
Another fairly common risk is that you give your cryptoassets to the validators, but they do not pay you your due share of the reward.
This is an important point - in some projects, for example, Tezos, the first amount is paid only after 7 full work cycles, so about 20 days after the start of cooperation, you can check whether you receive your remuneration or not. To do this, you need to use the validator toolbar that provide various third-party services, such as Baking bad or Block explorer.
Of course, there is always a chance to run into a scammer, but there are not so many of them in the cryptocurrency community. But it's better to play it safe once again.
It is very important to remember that in most cases validators do not need to store funds directly in their wallet, so if they start asking for a transfer, something is wrong. Also, remember that you should never, under any circumstances, share your private keys and mnemonic phrases with someone.
Lost account
Mnemonic phrases and private keys are an extremely important element of blockchains, especially when it comes to cryptocurrencies. While it is imperative that you never share them with anyone, you need to be able to create and properly back them up.
If you lose your account, you will need to use a mnemonic phrase or private key to restore your wallet and access its contents. Different resources are suitable for correct storage, for example, the Ledger hardware module. Such modules are much more reliable than services or programs that have constant access to the network.
But there are some issues with Ledger. For example, you need to regularly update the firmware for it, as well as register the private key and mnemonic phrase separately. Otherwise, all wallets on the device will disappear. However, if you did everything right, you can always restore them using the Ledger Live service.
Network centralization
Also one of the most dangerous risks associated with partial network centralization is the classic 51 percent attack. This is a situation in which control of more than half of the network falls into the hands of an organized group. So by transferring your tokens to the validator, you are always contributing to either more centralization or decentralization.
A good tactic would be to transfer your bets not to the largest validators or staking pools, but to those who demonstrate continuous and high-quality work, self-sufficiency, respect for security practices, participation in the development of the community, an adequate approach to clients, reasonable fees for intermediation, etc. In addition, by rewarding small validators, you will increase the decentralization of the network and decrease the chances of a successful 51 percent attack.