One of the most popular ways to earn investment income in the crypto markets is staking crypto. As is the case with almost all kinds of investing, crypto staking also comes with a few risks. Therefore, in this article, we are going to cover some of the risks of staking crypto that you need to keep in mind before you decide to start.
Key Takeaways
- Crypto staking is when you lock up your crypto assets to act as a validator, and in return you are rewarded with newly minted cryptocurrency
- When you stake crypto you can earn much higher APY (annualized percentage yield) than in traditional savings accounts
- The main risks of staking crypto are liquidity risk, market risk, validator risk, validator costs, lockup periods, rewards duration, and theft/loss
- You need to consider the risks of staking crypto before you decide to do it
What Is Crypto Staking?
Long story short, crypto staking means locking up an asset in a decentralized crypto network to act as a validator. This way you ensure not only the continuity of the network but the integrity and security as well. The crypto stakers, also known as validators, are rewarded afterwards with newly minted currency.
Staking Crypto - Returns
Probably the main reason this way of earning income has become this popular is because it allows crypto holders to earn way higher APYs than they could with traditional saving accounts. You can earn upwards of 30% APY for staking certain assets.
Risks of Crypto Staking
As we have already mentioned, even though there are above-average returns for investors, crypto staking comes with a number of possible risks you need to be prepared for. Some of those risks are liquidity risk, market risk, validator risk, validator costs, lockup periods, rewards duration and last but certainly not least, theft or loss.
Liquidity Risk
Liquidity, or rather illiquidity, of digital assets is another potential risk factor you need to be aware of. If you are planning on staking micro-cap currencies that have very little liquidity on crypto exchanges, you are heading down the wrong path. The reason for that is that it's difficult to trade your staking returns into stablecoins or Bitcoin if there is little liquidity. Not only that but you will also find it difficult to sell your staked coin for fiat currency.
Market Risk
Potential downward price movement in a certain asset is among the biggest risks most investors will come across. For example, if you are earning 12% APY for staking a certain cryptocurrency, but the value of the coin drops 50% in value over a couple of months, you end up in a losing position. Every crypto investor has to choose to buy and stake crypto very carefully, doing thorough research. You should never choose to buy or stake a coin based solely on high APY figures.
Validator Risk
Remember that if you run a validator node to stake crypto, you must have the technical knowledge required to prevent any potential disruptions during the staking process. Moreover, validator nodes must have 100% uptime. This way they ensure maximum staking returns.
But that is not all. If your validator node accidentally misbehaves, for instance, it could result in penalties that will affect the overall return. The worst thing that could happen is having your stake “slashed”. This means that the share of stored tokens would be lost.
Validator Costs
There are also validator costs that you need to consider when staking crypto. Running a validator node will significantly increase hardware and electricity costs. On the other hand, when staking with a 3rd party provider the costs are usually lower.
All in all, costs are definitely something all investors need to take into account. Otherwise, they may end up wasting a large portion of their staking returns.
Lockup Periods
Keep in mind that some stakeable digital assets come with lockup periods. This means that during that period you won’t be able to access the staked crypto. Both ATOM and TRX are great examples of such cryptocurrencies. While it may not seem like an issue if you plan on holding your crypto in the long term, if the price of the staked coin drops significantly, you won’t be able to unstake it and sell it to prevent further losses.
One way to avoid this is by staking cryptocurrencies that do not have a locked period.
Rewards Duration
In addition to lockup periods, certain staking assets don’t pay rewards daily; you have to wait longer to receive your interest. While this doesn't affect the APY if you stake throughout the whole year, there is a downside to this. It reduces the amount of time you have to re-invest your rewards to earn compound interest. To avoid this problem, you should choose to stake assets that pay out on a daily basis.
Conclusion
Crypto staking is a great way to earn passive income. By holding digital assets in your digital wallet, you earn a high interest rate that can exceed 30% a year. However, without doing diligent research and understanding the risks, you may incur losses rather than rewards.
Therefore, before you decide to stake, thoroughly research the cryptocurrency you are interested in, and ensure you understand all the risks involved.
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