Between a dangerous mining alternative and an attractive source of income
Interest rates for bonds continue to fall and it is becoming increasingly difficult to achieve predictable returns. It is therefore not surprising that staking attracts more and more investors. Instead of having to conduct complex mining, it is sufficient for staking to make its cryptocurrencies available to the network. In return, stakers can look forward to attractive interest income in the respective cryptocurrency. The truism that you have to be careful when something sounds too good to be true should also be a warning to staking enthusiasts. Why staking is a good idea, but you should also be aware of the pitfalls.
Staking cryptocurrencies is becoming increasingly popular. The mechanism, which is less energy-intensive than the proof-of-work process like Bitcoin, receives additional attention through Ethereum 2.0. Finally, Ethereum, which, like Bitcoin, still relies on mining, also wants to introduce a chain for staking with its update to version 2.0. Other cryptocurrencies such as Tezos or Cosmos are already attracting many investors who see staking as an attractive source of income.
In a nutshell - what is staking?
While the Bitcoin Mining (Proof of Work) calculator provides a race for the processing of blocks, staking (Proof of Stake) validators are selected that have a minimum number of the corresponding cryptocurrency stored in the wallet. The higher the deposited cryptocurrency volume, the greater the participation in the settlement volume of the blocks. The selected validators, ergo Staker, are therefore responsible for confirming the blocks, just like the miners. They receive a staking reward for participating in the consensus mechanism. How high this reward is can already be seen on sites like Staking Rewards.
Interest as a price for risk
If we are currently in a low interest rate environment, it will not be possible to achieve an almost risk-free return of 6 percent per annum. Although not obvious at first glance and due to the negligible size of the staking market, staking is also generally in competition with a German government bond or a bond from the Volkswagen group. Accordingly, one has to remain realistic about which returns can be achieved at which risk.
There is a reason why a rather large protocol like Tezos pays almost 6 percent staking reward and 50 percent and more are possible with a less established protocol like Fantom. These values change every second. Still, they explain well the market economy behind staking.
The less users are willing to stake, i.e. leave their native cryptocurrencies to the protocol or log in, the higher the yield. Security and decentralization of a network are not free of charge. For this reason, investors in German government bonds receive less interest - if they get any at all - than investors in Argentine government bonds.
Staking is still new territory
The fear of an unhealthy market development like that of ICOs in 2017 and 2018 is not yet necessary in the growing staking market. Nevertheless, we are in an absolute experimental phase. Even if we can theoretically name risks, there is no historical precedent from staking practice. There is a lack of empirical values that are important in addition to purely technical indications in order to understand a market. Pioneer investors can generate attractive returns because they are guinea pigs for a new financial economy. That is not a negative either. However, it should not lead to the fact that the fundamental principles of the market or the opportunity-risk relationship are ignored.
It should not be forgotten that this can cause exchange rate distortions of the cryptocurrencies. If a large part of a cryptocurrency is in the staking (pool), then the exchange rate is also supported or the tradable offer is reduced. For example, almost 80 percent of all Tezos are currently staking, so they are not available to the market and contribute to a shortage.
Volatility, slashing and centralization
A fundamental risk in staking is volatility. If the price drops sharply, there is little comfort in the fact that the payouts are high. After all, you shouldn't invest in stocks that pay high dividends, but perform poorly and fall in price. Just like high dividends, high staking income must be met in the long term by a solid business model or solid demand.
There is also the risk that you will be punished as a staking validator. In so-called slashing, a validator for "wrong behavior" is sanctioned. The sanction mechanism at Tezos works differently than at Cosmos, for example. If a validator node does not participate in the consensus network for a long time or misses several blocks, this can be charged to the staker by deducting the cryptocurrency inventory. Sanctions can also be imposed if blocks are confirmed twice or if votes contradict each other several times.
In addition, there are similar risks to staking as to mining. A tendency towards centralization, just like with mining companies, can also exist in the staking ecosystem. Scenarios such as a 51 percent attack are just as impossible. The examples show that the level of complexity is considerably higher than with a savings account, especially since there are even more risks.
Scams just a matter of time
When new business or investment models emerge that promise high returns, fraudsters are not far away. Be it the OneCoin pyramid scheme or the numerous Scam ICOs that were over all mountains after their token sale. If the awareness of the staking continues to increase, then it can be expected that there will be many fake staking offers in the coming months. Good times for pyramid schemes and criminals.
Keep an eye on the big picture
The emergence of dubious staking projects does not change the generally good idea. Staking can undoubtedly be a very attractive form of investment. As with any asset class, the principle here is that a staking portfolio should be based on different protocols, i.e. diversified. If the staking wealth is distributed among many different investors, the consensus mechanism is a very good alternative to more complex mining.
Among other things, this explains why Ethereum is going to use staking in the future. But outside of the crypto community, staking is also increasingly being considered. For example, the Telekom subsidiary T-Systems is working on a corresponding project. After all, not only are infrastructures required for communication, but also for the secure exchange of values. Staking can be the next logical step in the digitization and expansion of our current infrastructure.
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