This article was kindly contributed by Guest Author, Jonathan Wai.
In our earlier article about crypto staking, we explored the mechanism behind POS blockchains and how staking is an integral part of ensuring the integrity of the blockchain’s transactions.
As investors, staking can also be an excellent way to gain additional yield while holding our favourite crypto-assets on their moonward journey. However, the volatile and unregulated nature of the crypto-verse means that investors should take care to understand the risks involved before jumping in.
Many of the risks associated with staking are similar to those in crypto-lending, which we explored in this article, because of exposure to the same underlying crypto-assets. Thus, investors should first familiarise themselves with crypto-assets’ inherent risks such as market and legal risks. After investors have understood and are comfortable with the risks associated with crypto-assets, particular focus can be placed on risks specific to crypto staking, which primarily involve validator selection.
Becoming a validator in a POS blockchain not only requires a high level of technical expertise but also a substantial amount of a blockchain’s token. Most retail investors, therefore, are unlikely to participate in crypto-staking by becoming validators themselves but will usually delegate their tokens to established validators to have crypto-assets staked on their behalf.
Investors will thus have a choice of validators to stake with; choosing a good validator to stake with can ensure that the promised returns materialise, while choosing an unreliable validator can lead to a potential loss of capital.
Many blockchains will allow investors a choice of validators to stake with, and staking platforms usually provide key metrics to aid the investor in making a decision. While the precise staking mechanism varies from blockchain to blockchain and different blockchains may require the consideration of different metrics, most would include the following considerations.
Slashing
Slashing is a mechanism of POS blockchains that serves as a deterrent against validator misbehaviour by causing validators to lose a part of their staked crypto-assets. This is the primary risk that investors face: that their staked crypto-asset is “slashed”, placing them at risk of capital loss. As such, investors should look to delegate to validators with little or no history of receiving slashing penalties.
While it has been explained that staked crypto-assets may be slashed when validators attempt to validate false transactions, other circumstances also typically result in slashing.
Uptime
Uptime is usually represented as a percentage and represents the amount of time that the validator is available to perform its validation function. When a validator is offline, out of sync with the chain, or is otherwise unable to perform validation, it affects the validator’s uptime metric.
As validators are needed to validate blockchain transactions, incentivising validator uptime serves to preserve the integrity of POS blockchains and validators with an uptime lower than a specified percentage can be subject to slashing penalties. This specified level varies between blockchains.
Investors should thus delegate to validators with a history of high uptime, which suggests that the validator has the hardware and software capabilities to continue performing validation at acceptable levels that reduce its risk of receiving slashing penalties. Some platforms offer the “downtime” metric instead, in which case investors should prefer validators with low downtime.
Double signing
Double signing occurs when one validator signs two blocks of transactions simultaneously. This is similar to one person casting two votes when only allowed to cast one, which affects the consensus mechanism.
Double signing can be caused by a deliberate attempt to falsify transactions, or accidentally by validators who run backup validation nodes that come online too quickly and cause a single private key to be used to sign multiple blocks. Validators that are too keen on maintaining uptime can become overzealous in activating backup nodes when primary nodes go down, resulting in double signing.
Rewards and commission
Rewards for staking are generally determined by a central mechanism and will apply equally to all validators. This would then be subject to a commission charged by validators in order to cover the costs of providing the staking/delegation service.
Validators may charge different amount of commission, resulting in different levels of after-commission yield. For example, where staking rewards are 10% and a validator charges a 10% commission from that reward, an investor would receive a 9% yield.
While it would be intuitive to select the validator with the lowest commission to obtain the highest after-commission yield, investors should not rely on commission as the only metric for selecting validators. Rather, investors should consider all the abovementioned metrics of the validators, along with any that are blockchain-specific.
Only when the peculiarities of each blockchain are well understood can investors fully appreciate the risks involved in the staking of that blockchain’s crypto-asset and made wise decisions.
This article was kindly contributed by Guest Author, Jonathan Wai.
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