Navigating the risks of crypto staking - CityAM (2024)

by Rosie Leheup-Ffoulkes, Product Lead atCoincover

It is rarely a good idea to reinvent the wheel but, every now and then, something comes along to improve the wheel – making it more efficient, resilient, and robust. In the crypto world, that ‘something’ is the growing phenomenon that is crypto staking.

Staking, which allows investors to put their crypto to work and earn a yield, has opened new opportunities for the crypto market and is catching the attention of a growing number of institutional and retail investors.Research shows that around 9% of cryptocurrenciesare currently staked – and the recent Ethereum Merge, which saw the Ethereum network move to proof-of-stake (PoS), will inevitably pull more institutions and capital into staking.

It’s a relatively new development in the crypto space, and therefore it comes as no surprise that there will be a huge learning curve for many investors.

One of the main concerns is that the stakes are, quite literally, high. If firms get it right, staking can offer huge financial rewards, but if they get it wrong, they can equally risk financial and reputational damage. So, how do investors get it right?

The hurdles ahead

First, it’s important to understand the hurdles ahead. The most obvious issue is the rise of hackers, and crypto staking isn’t an exception. As crypto hacking continues to soar – with areportfinding loses from hacking reached nearly $2 billion in 2022 already – it’s likely that crypto staking will be placed firmly in hacker’s crosshairs.

In fact, most PoS systems require computers to be constantly online which increases the user’s risk of being hacked since the IP is exposed for longer, uninterrupted periods. Therefore, even when funds are “locked” during the staking period, this doesn’t mean that they’re entirely safe.

While the risk of crypto hacking is ubiquitous across the industry, staking is subject to unique, and arguably more damaging, risks: slashing and penalties. The staking process requires investors to be responsible for validating transactions via their validator key. However, should a firm be unable to use its validator key – which can be caused by anything from system failures, downtime, or human error – the network penalises them and a portion of their staked currency is taken away.

A bigger risk is slashing, which is used to deter bad actors. However, slashing can happen due to mitigating downtime and causing transactions to be double signed. On the Ethereum network, for instance, investors can lose up to 50% of their stake and be ejected from the network.

The stakes have never been higher

Though at first it may seem like crypto staking is a financial and reputational blackhole, institutional and retail investors do have options.

Importantly, the risk associated with staking are more often than not related to human error, rather than hacking, which means that firms can control a lot of the downside. To mitigate against human error, firms must protect staked assets from any kind of outage or disaster scenario. This requires putting systems in place to prevent losses and this can be achieved by having their validator key backed up with a third-party. By implementing third-party technology, investors will add an extra layer of security, providing reassurance and building trust.

More broadly, the industry must move in a direction that sees crypto companies pre-empt, plan for, and prevent risks like this before they cause problems and deter people from investing. In short, prevention is far easier than a cure, especially in the context of staking.

While many will undoubtedly seek to put their crypto to work and earn a yield, the nature of the process means that investors can be subject to huge losses. Soon, we will reach a point where crypto staking becomes too big to fail – and with so much on the line, it’s important that the industry puts the right measures in place to create a safer environment for crypto investors.