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Cryptocurrency staking has risen to stabilize the energy demand associated with mining coins. Bitcoin uses the Proof of Work (PoW) protocol to verify transactions. The electrical energy demand associated with the PoW consensus mechanism is high.
Ethereum and some other blockchains are working on using the Proof of Stake protocol to address the energy issues associated with traditional mining. Due to this energy reduction trend, cryptocurrency staking is emerging. The concept revolves around the PoS protocol.
We will examine the basis of cryptocurrency staking and how you can engage in it. You will also learn the potential risks associated with it.
What Does Staking Mean?
Staking digital coins means purchasing and store a specified quantity of tokens to become an active node for the system. You become a validator to maintain the integrity of the network. Staking helps to maintain the operation of a blockchain-based on the Proof of Stake (PoS) protocol.
It works the same way as mining does to reward the participants in the Proof of Work scheme. When a buyer hoards these digital assets, the individual will become an integral piece of the network and will receive the newly minted coins. The digital asset owner will receive some form of interest. The interest rates will vary from one platform to another.
Potential Risks Associated With Cryptocurrency Staking
The popularity of cryptocurrency staking has grown because of the rewards that hoarders can receive. For some popular cryptocurrencies, the interest rates can increase to 5% per year.
With cryptocurrency staking, you have a chance of earning higher APYs compared to traditional money markets. However, staking comes with potential risks that you should know. They include:
Cyberattacks, Losses, And Thefts
A major cyberattack can wipe all the tokens that you have in an online exchange. You could also lose the private keys to your wallet. It is best to backup your wallet and store your private keys somewhere secure.
To solve this problem, most crypto investors resort to cold storage. It involves storing your tokens in a hardware wallet. This will eliminate the risk of an online attack. However, you can still lose or damage the storage medium.
Market Risk And Liquidity Risk
If you stake an altcoin that has near-zero liquidity on trading platforms, you find it almost impossible to convert your rewards to a fiat coin. People who stake should pay attention to the liquidity of the assets that they want to buy.
The market value of the cryptocurrency assets that you are holding can move in a negative direction. This is a big risk that investors face. If the Annual Percentage Yield (APY) of a coin you are staking drops by a reasonable percent through the year, you will make a loss. It is best not to select coins for staking by looking at the APY values.
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Technical Risks Associated With Network Nodes
There is a need to have a little technical knowledge while running a validator node. To get the maximum possible staking revenue, the network nodes have to operate at the maximum level every time. When your validator node malfunctions, you might get your reward slashed as a penalty.
Cryptocurrency enthusiasts now know that staking is a way to earn income from holding digital coins. The Proof of Stake protocol will also address the energy concerns associated with traditional mining. Crypto staking has the potential to help investors gain many financial earnings.
However, staking has its risks. You can lose your coins due to a cryptocurrency breach. A major downturn can significantly reduce the value of your assets. Calculate the risk/reward ratio of the assets you want to stake. Review the rewards and reliability of the blockchain you want to use.