Cryptocurrency has caught the attention of many people all over the world. They are one of the novel financial instruments in the digital age. Without a clear understanding of ways to invest in cryptocurrencies, people could land up with irreversible financial consequences. Therefore, it is important to understand the potential risks of staking cryptocurrency.
In addition, it is also important to know how they are closely related to general risks associated with crypto investments. The following discussion offers you a detailed impression of risks associated with staking cryptocurrency. You can also explore a detailed understanding of how staking works in cryptocurrency. In addition, you can also find out some of the benefits of staking cryptocurrency alongside the risks.
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Risks of Investing in Cryptocurrencies
Investments in cryptocurrencies are a risky proposition, just like with investments in shares and stocks. Why? The foremost answer for such a question directly refers to volatility of cryptocurrencies. One cryptocurrency valued higher than others at one instant of time could be the least valued cryptocurrency within few minutes.
Therefore, you need to have a clear impression of general risks associated with crypto investments before diving into an understanding of staking cryptocurrency risks. Without any clear regulatory implications for cryptocurrency firms, it is quite crucial to understand the general risks associated with crypto investments. Here is an outline of the significant risks associated with investments in cryptocurrencies.
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Consumer Protection
Certain cryptocurrencies which claim high returns could not be subject to any regulations other than anti-money laundering requirements.
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Transaction Charges and Fees
Consumers would also have to incur a lot of costs in terms of transaction charges and fees, which could be easily more than regulated investment products.
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Product Complexity
The complexity associated with certain cryptocurrencies could also establish the foundation of staking crypto risks. Complex cryptocurrencies present notable difficulties in understanding more about the risks associated with the solution. In addition, the existing supply and demand variations in the market define the possibilities for conversion of cryptocurrency to cash.
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Price Volatility
One of the formidable risks of investing in cryptocurrencies is also evident in their price volatility. With the continuously rising and dropping values of cryptocurrencies and the difficulties in reliable pricing of crypto assets, investors are likely to face higher risks of losses.
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Marketing Resources
You would rarely find a cryptocurrency firm claiming that their token could land you up with losses. Cryptocurrency firms generally overstate the returns associated with the products while undermining the risks associated with the same. Therefore, one of the general risks of investing in cryptocurrencies could help you understand the risks of staking cryptocurrency.
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What is Staking of Cryptocurrencies?
If you are aspiring to become a cryptocurrency investor, then you are likely to come across the concept of staking quite often. Staking is one of the basic approaches which cryptocurrencies follow for verification of their transactions. At the same time, it also enables participants to earn rewards on their asset holdings.
However, staking crypto has come forward as a renowned approach for earning investment income on the crypto markets. Fundamentally, staking cryptocurrencies is just a process that involves a commitment of crypto assets for supporting a blockchain network alongside confirming transactions.
You should look for staking cryptocurrency risks in cryptocurrencies that use the Proof-of-Stake model. The PoS model delivers better energy efficiency in comparison to the Proof-of-Work model. In the Proof-of-Work model, blockchain transactions involved mining devices using computing resources for addressing mathematical equations.
Staking definitely offers a prolific opportunity for using crypto to generate a form of passive income due to high interest rates for staking with certain cryptocurrencies. Before diving into an outline of the risks of staking cryptocurrency, it is important to understand how staking works in crypto.
How Does Staking Work in Crypto?
Staking is the verification approach for adding new transactions to the blockchain in the case of cryptocurrencies using the Proof-of-Stake model. The approach involves participants pledging their coins to the cryptocurrency protocol. Then, the protocol would select the validators for confirming blocks of transactions from the available participants in the protocol. Users who can pledge more coins to the network are more likely to be selected as validators.
With the addition of every new block to the blockchain, the protocol mints new cryptocurrency coins and distribute them as staking rewards to validators for the concerned block. Generally, the rewards for staking come in the form of the cryptocurrency, which participants stake in the network. However, some blockchains could use different cryptocurrencies as rewards.
Another important factor in understanding staking crypto risks refers to the use of cryptocurrencies using the Proof-of-Stake model only. Investors could choose the amount of cryptocurrency they want to put at stake by using many renowned cryptocurrency exchanges. You still maintain possession over the coins when you stake them in a protocol.
All you are doing is just putting your assets to work to earn passive income for you. However, you can also take out the coins from a stake in cryptocurrencies when you want to trade them. The reverse process of staking cannot be as fast as you expected, and you might have to stake coins for a specific period of time.
Value of Staking Cryptocurrencies
Many people are so eager to find out answers for ‘are there any risks to staking crypto’ that they forget to look at the benefits of staking crypto. Staking has gained popularity in recent times with the facility for enabling cryptocurrency owners to achieve considerably higher APYs in comparison to money market funds and traditional savings accounts.
Therefore, you can clearly note how cryptocurrency staking could offer you a flexible approach for earning interest on crypto assets.
- Crypto staking does not imply the need for any advanced equipment and costly computing resources, like in the case of crypto mining.
- Staking presents better value in terms of environmental consciousness in comparison to crypto mining with a limited environmental footprint.
- Another prolific advantage of staking crypto is directly evident in the opportunity for participants to contribute directly to the security and performance of the blockchain.
Above all, staking crypto risks, the primary advantage of staking in earning more crypto, and generous interest rates draw attention towards staking. For example, Algorand, Cosmos, Tezos, Tron, and Kava offer almost 6% to 12% APY directly to wallet apps. As a result, the earning potential serves as a formidable factor to overshadow the staking cryptocurrency risks. Another important factor associated with staking which can drive its popularity is the involvement of investors with the element of control over verifying transactions as well as network security and performance.
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Risks of Staking Cryptocurrencies
With a clear impression of the benefits of staking, it is reasonable to ask, ‘Are there any risks to staking crypto.’ Staking can provide promising returns on crypto-assets while also providing better control over the security and performance of the protocol. However, it can also present some notable setbacks which you should take into account before staking cryptocurrencies. Here is an outline of the top risks you can find with cryptocurrency staking.
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Market Risk
One of the biggest risks for investors in staking cryptocurrency refers to the possibilities for the adverse price movement of the assets they are staking. For instance, you could earn 15% APY for staking a cryptocurrency. However, you are likely to incur losses when the value of the cryptocurrency drops by half throughout the year. Therefore, market risks are one of the prominent entries among staking crypto risks, and investors must carefully select the assets for staking.
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Liquidity Risk
The concerns of volatility and liquidity also play a critical role as one of the prominent risks of staking cryptocurrency. Issues of liquidity with the asset that you are staking also present another formidable risk factor. Furthermore, you don’t have any control over the behavior of the market.
As a result, you cannot bypass the issue of volatility in the crypto market. If you are staking assets with limited liquidity on different exchanges, then you can encounter difficulties in selling the asset or converting the staking returns to other cryptocurrencies. However, investors could opt for staking with liquid assets featuring higher trading volumes on exchanges for addressing liquidity risks.
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Lockup Duration
The locking period is also one of the prominent entries among the staking cryptocurrency risks for the right reasons. Upon staking cryptocurrencies, they are configured to a ‘locked’ state. Some of the crypto assets which you can stake generally feature lockup periods when you could not access staked assets.
Popular examples of such cryptocurrencies include Cosmos and Tron. In the event of substantial drops in prices of the staked asset, investors could not take out their staked assets. As a result, you can encounter formidable losses in the overall returns. You could attempt to address the lockup risk by staking in cryptocurrencies that do not come with a lockup period.
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Rewards Duration
The rewards duration is also another notable entry among risks of staking cryptocurrency for investors, as the lockup period. Some staking crypto-assets do not provide daily staking reward payouts, thereby forcing investors to wait longer for their rewards. Although you wouldn’t experience any issues with the APY, you would lose time in re-investing your staking rewards for earning more yield. In order to address the risks of long reward durations, investors could select crypto assets for staking which offer regular staking rewards.
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Validator Risks
Staking cryptocurrencies also brings the concerns of validator risks as operations of a validator node for cryptocurrency staking required technical know-how. Validators must ensure limited disruptions in the staking process with 100% uptime for nodes to ensure improved staking returns.
Furthermore, discrepancies on behalf of a validator node could affect the overall staking returns of an investor. Worst of all, validators could also have their stakes reduced or ‘slashed’ abruptly, thereby resulting in the loss of a share of staked tokens. You can address such staking crypto risks of operating your own validator node by using providers for delegating stake to third-party validators.
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Validator Costs
Choosing a third-party provider for working as a validator node also comes with certain costs. In the case of Proof-of-Stake, you need hardware for running the nodes alongside submitting the required number of tokens for qualifying as a full-fledged validator. You can find operational costs, which are deducted from the staking rewards of the validators.
Validators are responsible for the governance of the protocol and actively participate in defining network performance. Subsequently, users could select the desired validators according to reliability and the percentage of rewards allocated for users. If you run your own validator node, then you have to incur high costs in hardware and electricity. Therefore, it is important to monitor the changes in commission rates of validators and make necessary adjustments in stakes.
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Loss or Theft of Assets
Just like any other asset, cryptocurrencies are also vulnerable to mishaps like theft or loss. You need to note that loss or theft presents staking cryptocurrency risks because of the possibility of forgetting your private keys. In some cases, lax security safeguards for crypto-assets can also lead to events of theft and loss.
Irrespective of the way you are staking cryptocurrencies, you should pay adequate attention to taking a backup of your wallet. In addition, you should also ensure safe storage or private keys to ensure the safety of your crypto assets. Therefore, apps that enable users to hold control over private keys are a better choice in comparison to custodial third-party staking platforms.
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Bottom Line
The hype around cryptocurrencies has faded away, and investors are able to witness the true potential of cryptocurrencies. Apart from general crypto holdings and the prospects of higher returns with crypto investments, investors could also capitalize on staking. Cryptocurrency staking offers an ingenious approach for earning additional income on the crypto assets in your possession.
However, the risks of staking cryptocurrency would always play a crucial role in defining your approach towards staking. The most important question for investors wishing to stake cryptocurrencies deals with the risks that they are willing to take. With a better understanding of how staking works and its value benefits alongside risks, investors could find better ways for capitalizing on staking. Learn more about staking cryptocurrencies before you plan to invest.
*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. 101 Blockchains shall not be responsible for any loss sustained by any person who relies on this article. Do your own research!
