Is Staking Crypto Safe? Understanding the Risks

As a crypto investor in search of viable ways to earn a profit, staking is considered one of the most attractive options available. Not only are there few barriers to entry, but it’s also easy to do (unlike mining) and, once done, involves relatively little hands-on input or monitoring.

Given the increasing demands for passive crypto income-earning opportunities, more and more staking platforms are emerging. However, it’s important to understand the risks involved in staking in order to make informed decisions about your investments.

Oftentimes, these risks are closely aligned with the general ones associated with investing in cryptocurrencies—risks that can have a significant impact on your staking investment. For this reason and others, in the following article we’ll consider the extent to which staking is safe and, more importantly, profitable from a passive income perspective.

But let’s start off with the basics.

What is Crypto Staking?

Cryptocurrency staking is the process of committing a certain amount of a specific cryptocurrency for a particular period of time to support the operation of the crypto’s blockchain network. Those who stake their tokens earn rewards, making staking one of the more popular ways to earn passive income in crypto.

Staking is an important part of the crypto ecosystem because it helps to secure the network, making it function more smoothly and reliably. By participating in staking, you are ensuring that the network remains decentralized and resistant to attacks or other forms of interference.

Let’s consider a simple comparison using a legacy financial institution. Banks and other legacy institutions offer customers the option to deposit funds into a “high-yield” savings account, and the bank then basically borrows that money from the depositors to lend to other customers. Clients who participated by making deposits to provide the funds get to hold on to a percentage of the interest earned from lending.

Staking works in a somewhat analogous manner insofar as you are agreeing to lock up assets, thereby contributing to the functioning of the blockchain. As compensation, you receive rewards for contribution, and these rewards are calculated in percentage yields, which are often far higher than the interest rates that the majority of banks offer.

How Staking Works

Staking is supported by the Proof-of-Stake (PoS) consensus mechanism algorithm. As such, there are two main ways to go about staking. The first one involves users depositing funds in a smart contract to perform various network functions, such as validating transactions. These users, who are also referred to as “validators” or “stake pool operators,” stake their crypto tokens as collateral, and validators can earn rewards for their efforts at maintaining network security.

The alternative method of staking occurs through a process called "delegated proof of stake" (DPoS). In DPoS, token holders can delegate their staking power to validators, meaning that the stake is not solely derived from the validator’s assets. Validators generally opt to run a staking pool and gather funds from a group of investors, which makes it easy to participate in staking. The only thing you as an investor have to do is to stake your tokens in a liquidity pool and the pool operator takes care of the technical aspects.

Why Do People Stake Crypto?

There are a number of reasons why people decide to stake their crypto. Let’s consider a number of them below.

1. Passive Income: This is likely the foremost reason why someone will decide to stake their crypto. Staking allows individuals to earn a percentage yield on their cryptocurrency. As stated previously, these returns can be significant, often much higher than what is offered by traditional forms of investment such as savings accounts or bonds.
2. Eases Access: Staking is comparatively easy to get started. Mining, for example, is resource-intensive and dedicated mining rigs can be quite expensive. When staking crypto, a trader needs neither expensive nor complex equipment to participate; they can simply use third-party platforms, which handle setting up and running the validation node. In fact, investors don’t really need any technical knowledge to participate in staking.
3. Increases Influence: For the validator, staking brings increased influence over the network. Validators on a PoS blockchain often have more influence over the direction and decision-making of the network when compared to regular users. This level of influence can be particularly attractive to those who want to have a say in the governance of the blockchain. The size of a validator's stake is often directly proportional to their influence and voting power on the network.
4. Supports the Blockchain: With staking crypto enthusiasts get the chance to support crypto projects they like. Individuals can support the overall health and security of the blockchain. This can be particularly appealing to those who believe in the long-term success of a particular cryptocurrency and want to contribute to its development. Staking helps to secure the network by requiring validators to have "skin in the game" in the form of their stake, which incentivizes them to act honestly and in the best interests of the network.
5. Reduces Volatility: To a considerable extent, staking can provide a way for individuals to earn returns on their cryptocurrency without selling it, which can help to reduce the overall volatility of their portfolio. By earning passive income through staking rather than selling or HODLing, you can potentially avoid the impact of price fluctuations on your portfolio’s overall value.

How Safe is Staking Crypto?

As with most trading-related questions, there’s no clear-cut answer, as there are a range of factors and variables to consider. Generally speaking, staking crypto, particularly Ethereum, is a solid way of earning passive income.

Nevertheless, it's important to consider the overall security of the blockchain on which you are staking your cryptocurrency. Additionally, in the case of DPoS, you’ll want to consider the reputation of the validator to whom you are delegating your stake. If you’re holding your cryptocurrency on a centralized exchange such as Binance, then there is a risk that the exchange could be hacked and your funds could be stolen. To reduce this risk, consider holding your cryptocurrency offline in a “cold” wallet such as those offered by Ledger or Trezor rather than on the exchange.

Overall, by taking the necessary precautions and choosing reputable validators and blockchains, staking crypto can be a relatively safe and convenient way to earn passive income. Having said the aforementioned, let’s look at some of the risks (after all, nothing is risk-free).

What Are the Risks of Staking Crypto?

The crypto space is full of bad actors, and so it’s imperative to be aware of the potential risks whenever exploring possible options for earning additional income through your crypto holdings.

1. The Vesting Period: When staking crypto, you may be required to lock up or "vest" your cryptocurrency for a certain period. This means that you won't be able to transfer or withdraw your crypto during this time, even if you urgently need access to your funds. (You may also want to pull out your stake to avoid losses if the price of the asset changes significantly.) Furthermore, should there be any favorable price movements, investors will be unable to trade their tokens during the vesting period, meaning that they can’t take advantage of these price changes.
2. Market Fluctuations: Cryptocurrencies fluctuate significantly over short(er) periods, and this market volatility can impact the returns earned through staking. As stated earlier, if the value of the cryptocurrency you are staking decreases significantly, this decrease could offset any rewards earned through staking. The aforementioned period can be considered a drawback in a situation such as the ongoing crypto bear market.
3. Liquidity Risk: Another risk to take into account when staking is the liquidity of the asset. If the asset you are staking is illiquid, it can become challenging to sell or trade it for other cryptocurrencies such as Bitcoin or stablecoins. A good way to address this risk is by staking tokens with higher trading volumes and listings on popular exchanges.
4. Reward Duration: Unlike many staking assets, which provide regular payouts, certain assets have a different reward distribution schedule in which rewards are not dispensed on a daily basis, but rather at longer intervals. This type of arrangement can obviously make it difficult for stakers to reap their rewards in a timely manner, thus limiting the potential for reinvesting rewards for higher yields. Investors can opt instead for staking assets that provide more frequent payouts, such as daily rewards, thereby ensuring that their staking rewards are continuously working for them, rather than being held in a crypto limbo.
5. Slashing Risks: To ensure proper validation and maintain the integrity of the blockchain network, validators who violate the rules of the blockchain face a penalty known as “slashing.” For the staking pool operator, slashing is the portion of the stake that will be removed. Two common offenses that can lead to slashing are double-signing and being unavailable to validate new blocks during periods of downtime. Although the risk is generally low, it's important to be aware of the policies of the blockchain on which you are staking as well as the potential consequences of violating them. Also, opt for well-established validators with a strong track record.
6. Validator Costs: It is undeniable that the PoS consensus mechanism is not as resource intensive as mining. Nevertheless, running a validator node can attract significant costs. When it comes to operating a node, it is important to consider the costs of hardware and electricity, which can become quite high, especially for newer investors who may not have the resources to invest in expensive equipment. Additionally, staking through third-party investors comes with its own costs, typically in the form of a small percentage of the staking rewards. Be sure to keep an eye on these costs, as they can quickly eat into your staking returns if not properly managed.
7. Hacks: There is always the possibility of your staking pool being hacked, potentially resulting in a loss of your stake or a decrease in the value of the cryptocurrency. With no insurance protection, there’s very little hope that investors will receive compensation. The same is true if you are holding your cryptocurrency on an exchange. The hard reality is that exchanges are hacked and funds are stolen, which is why self-custody is so important. As they say, not your keys, not your crypto.

Can You Lose Crypto and Money by Staking?

As indicated by the existence of the aforementioned risks, it is possible to experience losses when staking crypto. If the price of the cryptocurrency you are staking decreases significantly, you could end up losing money. Additionally, if the staking pool or platform falls victim to a cyber attack, malicious actors could make off with your funds.

But staking is a comparatively safe way of earning crypto. The real downside (if we want to use this term) is that staking offers a glass ceiling of rewards since its income characteristics are fixed. Remember the example of the savings account. A similar principle applies: there is a threshold beyond which you will not earn any additional income, making staking a rather conservative approach when compared with other options such as yield farming or liquidity mining.

Is Staking on Binance Safe?

Binance is the world’s largest and most trusted centralized crypto exchange, and it allows users to participate in staking through what it calls locked staking—a passive income-earning offering under their Binance Earn program.

Binance also offers users some additional risk protection, such as taking on slashing risks (meaning that users will receive the same quantity of tokens they staked if an incident takes place). While it isn’t exactly possible for the platform to eliminate all of the risks involved in staking, Binance has managed to reduce them considerably.

Staking on Binance allows users to take advantage of a variety of different opportunities. First, by analyzing the options available on the platform, users can choose the one that best fits their needs and risk tolerance. Some staking options offer high annual percentage yields (APYs) but come with a higher level of risk, while others have lower APYs but are considered lower-risk investments.

Flexible saving options offer rewards on a daily basis, but at a lower rate of return, while locked savings options offer higher returns after the expiration of the term. Ultimately, the choice of which staking option to choose will depend on the individual's goals and risk appetite.

Final Thoughts on Staking Crypto

Although there are some risks when staking your crypto, staking itself remains a relatively safe and effective way to earn passive income.

If you’re looking for alternatives to HOLDing, then staking just might be a smart move. By diversifying your investment and only staking money that you can afford to lose, you can help to spread out the risk, while managing to add some returns to your portfolio, even under the most challenging of market circumstances.

As always, be sure to do your own research and never risk more than you can afford to lose (or stake for a specific period of time).