Staking Explained: Rewards, Withdrawal Rules and Risks

Introduction To Staking

Staking helps secure certain proof-of-stake networks. Depending on the network, a participant may run a validator or delegate to one and receive protocol rewards. Simply holding a coin is not always staking, and exchange programs can add separate custody and contractual risks.

Staking is a way for individuals to contribute to the security and efficiency of a blockchain network while earning passive rewards. It’s a process specific to proof-of-stake (PoS) blockchain networks, which use staking as a consensus mechanism instead of the traditional proof-of-work (PoW) system.

• Proof-of-work (PoW) uses computational work for block validation.

• Proof-of-stake (PoS) uses staked crypto and validator consensus.

With PoS, for example, if you ask the group how many grams are in a kilogram and everyone agrees the answer is 1,000 grams, then there is broad consensus over the transactions in each block, and it will validate.

In PoS, validators are chosen based on the amount of cryptocurrency they have staked on the network and are responsible for validating transactions and creating new blocks in the chain. By staking, users pledge their crypto to verify the answer in exchange for generous yields annually on their staked holdings.

Rewards can take the form of newly minted coins or transaction fees distributed in proportion to the amount of cryptocurrency staked. So, the more a user stakes, the more rewards they can earn. Some staking networks also have minimum staking requirements and lock-up periods, meaning users must stake a certain amount of cryptocurrency for a specific minimum time frame to participate in the network and earn rewards.

Many networks offer staking - here are some of the most popular:

Ethereum (ETH), Cardano (ADA), Solana (SOL), BNB Chain (BNB), Polygon (POL), Tron (TRX), Algorand (ALGO), Avalanche (AVAX), Cosmos (ATOM), Near (NEAR), Velas (VLX)

But What’s Really At Stake?

While crypto staking can be lucrative, like any investment decision, it isn’t without risk, and there are drawbacks and perils you should be aware of before jumping in.

1. Access to funds: Some networks impose an unbonding period; others or their staking products use different exit rules. Check how withdrawal works, whether a receipt token is transferable and which risks remain while waiting.

2. Crypto Market Volatility: Cryptocurrency markets are notoriously volatile, which means the value of staked funds can fluctuate significantly throughout the staking period. If the value of the staked cryptocurrency decreases significantly, users may lose underlying asset value - even if they earn staking rewards.

3. Centralization: Some staking networks may become centralized over time, as prominent players with significant amounts of cryptocurrency can exert more control over networks - this could lead to decreased decentralization and security of the network.

4. Regulation: Access to a staking service can depend on jurisdiction and product structure. Check the relevant terms and effective rules for the service being used.

Liquid Staking - An Alternative To Traditional Staking

We previously mentioned the lock-up period, where users cannot access their assets for selling, exchanging, or collateralizing. In other words, their assets are illiquid.

Staking only part of a balance can limit the amount exposed to staking-specific restrictions. The remaining assets still carry their own custody and market risks.

However, liquid staking on specific protocols solves this lock-up/liquidity issue by allowing holders of staked assets to get liquidity in the form of a derivative token that they can use as their staked assets continue to earn rewards. This allows them to access other DeFi services, such as lending and borrowing. It’s a way to maximize earning potential while having the best of both worlds, but there are risks here too:

1. Complexity: Liquid staking involves several complex technical processes, including creating and managing liquid staking tokens and integrating multiple protocols and systems. This complexity can make it difficult for non-technical users to understand.

2. Security: Liquid staking networks rely on specialized wallets and smart contracts to manage the staking process and generate liquid staking tokens. Any vulnerabilities or flaws in these systems could result in the loss of staked funds or other security issues.

3. Liquidity: The value of liquid staking tokens may be influenced by market conditions and other factors, which can impact the liquidity and tradability of these tokens making it more difficult for users to convert their liquid staking tokens back into their original cryptocurrency or other assets.

4. Fees: Liquid staking may involve additional fees and costs compared to traditional staking, including transaction fees and fees for creating and managing liquid staking tokens.

5. Regulatory Risks: Liquid staking is novel, and there is a risk that regulators may introduce new regulations or restrictions that could impact the ability to participate in liquid staking networks. See ‘controversy’ below.

Controversy

The U.S. Securities and Exchange Commission (SEC) has not been shy in its opposition to most cryptocurrencies - which they view as illegally unregistered securities in violation of U.S. securities laws.Interestingly, Bitcoin (BTC) does not fall under this categorization in the U.S., where it is treated as a digital commodity.

In February 2023, Kraken agreed to end the US staking-as-a-service program covered by an SEC settlement. The case concerned that particular program and was not a Supreme Court ruling that all staking is a security.

The settlement included a $30 million payment. It is a dated enforcement example, rather than a complete description of current US staking availability or law.

Regulatory treatment depends on the service, its terms and the jurisdiction. Protocol staking, a custodial yield program and a liquid-staking product should not be treated as identical arrangements.

Conclusions

Staking is a novel, unique, and potentially lucrative way for users to earn passive rewards while contributing to the security and efficiency of blockchain networks.

Staking is not without risk, and we favor decentralized, self-custodial staking, where users can delegate their assets while retaining custody of their private keys. As with all investments, there is no such thing as a “sure thing” - your original assets are at the mercy of market conditions.

However, as the popularity of cryptocurrencies continues to grow, staking is likely here to stay but will face more regulatory scrutiny over time.

Key takeaway: You must do your research, understand the risks involved, and only invest what you can afford to lose.

The Self-Serving Bit

Unitywallet provides access to staking options for supported assets. The network, validator and any service provider determine the conditions of a particular position.

In Unitywallet, check the current staking screen for supported assets, validator fees, estimated rewards and withdrawal conditions. Displayed APY is an estimate, not a fixed return; availability and network rules can change.