The Pros And Cons of Staking: How Can You Benefit Despite Market Swings?

Crypto staking is one of those unique elements of Web3 that combine traditional ideas with new ways to use blockchain technology.  It examines how these crypto-based systems are set up foundationally and aligns the needs of the crypto platform itself with the motivations of its members. Staking helps stabilize a platform, and those participating can earn various rewards and returns on their staking investment.

However, if finance has taught us anything, there is no such thing as a free lunch.  So why does staking seem like such a safe bet, especially compared to the incredibly complex alternatives such as synthetic assets, derivatives, etc.?  For one thing, the risks are more direct for staking than they are for other crypto instruments.  For another, many different flavors of staking can fit just about any risk appetite, so as long as you understand the finer points of the platform you are using, you can enter the world of staking without any unpleasant surprises.  

Are there objectively better staking strategies? Absolutely. There is a range of quality within your staking options, and it’s a no-brainer to identify and stay away from lower-quality options.  However, within the higher quality options, there are many choices with small differences that can make a difference. Let’s dive in to see what key elements to look for in staking (we will even touch on rare elements like dYdX’s stablecoin staking rewards), what some of the more creative options are, and how to increase your chances of gaining rewards regardless of market conditions.

Staking Recap

Let’s quickly review staking to see some of the more popular variations (this list is by no means comprehensive).  At its highest level, the staking process looks like this:  you select a crypto platform, purchase some tokens, and then stake them by agreeing to lock them for a certain period. Doing this will earn some reward, and the platform encourages staking because it builds up liquidity and stability for the token itself, and the entire platform by extension.  A first differentiator for staking is whether your staking is passive or active.  Passively staking is easy enough, as you lock in your tokens and earn rewards over time.  Active staking is more complex, as you agree to lock in tokens and make the platform operate through activities like validating and creating blocks.  Active staking generally offers high reward for the effort.  

Trying to make your rewards count for more can be done in various ways. Delegate staking allows you to lend your staked tokens to a validator who actively participates, giving you a higher reward rate than passively staking without actually participating.  Pool staking combines the staked tokens of a group, giving advantages to a more significant percentage of the staked tokens on a platform.  Some platforms even allow exchange staking, where the platform takes the tokens you’d like to stake and acts as an agent to find and stake them, giving you rewards (their cut of the rewards as a fee will vary).  Liquid staking is a growing trend where you stake tokens and receive representative tokens that you can still use on the platform to trade, lend, etc.

Risk/Reward Comparison

Each of these forms of staking offers a benefit to the platform but also carries some amount of risk. So how do you find the balance between the two?  

On the risk side, it’s important to read and understand as much as possible about the platform, token, and market.  You might get lucky guessing, but it’s not a great strategy.  Due diligence is important to identify and understand risks.  The biggest risk is the market itself:  is it moving up or down, is it volatile, and what are the chances of a sudden dip?  Since staking is a longer-term process depending on how long your lockup period is, the daily volatility doesn’t matter as much as the market’s movement.  Looking closer, it’s critical to know about the platform and token you are using.  Does the platform have a good reputation?  Are they centralized with a risk of internal fraud?  Are the tokenomics set up to allow the team to pull a rug? What are others saying about the platform?  For the token, it’s important to know the supply, the inflation/deflation policy, and how it has performed.  

A key risk to consider is your loss of liquidity and what else you could do with your money instead of staking. This opportunity cost should not be overlooked for any investment, and examining all investment opportunities is important.  The minimum amount of tokens required to stake and how the rewards vary is also important, which might indicate that delegated or pool staking is necessary.  However, if your delegate misbehaves, there is a risk of tokens being slashed, which could cause you to lose your tokens altogether.

Thoughts to Consider for Better Benefits

Key to this process is a review of potential risks to potential rewards.  You can avoid sketchy platforms and reduce the risk of delegating to low reputation validators.  However, it’s just as important to maximize the possible rewards.  This is where putting in the work to compare platforms is important.  For example, there are platforms whose staking rewards depend heavily on how well the token does in the market, or how much activity the platform has, but the staking rewards are whatever is left after the platform, the founders, and others get their cut.  Alternatively, and in most cases, staking rewards are paid in the platform token, meaning that if you are already taking a hit by your locked up tokens losing value in the market, getting rewarded in these same tokens with diminished value is not helpful.  As a rare example, dYdX has launched a staking program that actually provides rewards in USDC, giving much more stability to rewards. In fact, in only 5 months, over 20 million USDC have been distributed to date by the protocol to more than 18,000 stakers. It’s also one of the platforms that puts all of its fees, minus community maintenance and validator fees, into staking.  This aligns incentives among all the key players (founding team, validators, speakers, users), giving the active participants a strong incentive to ensure the platform has liquidity and runs extremely well and giving the users incentives to be on the platform, knowing its quality will be higher.  This balance of incentives is the foundation of staking.

In 5 months since full launch the dYdX Chain has distributed $20M $USDC to Stakers

18.5% APR according to @mintscanio
150M staked DYDX
75% of ethDYDX bridged to DYDX pic.twitter.com/y0MhWqDepn

— dYdX (@dYdX) April 30, 2024

Wrapping Up

Staking can be a powerful part of your Web3 portfolio. However, there are both good and bad ways to go about staking, and it is critical to do your homework to understand the risks and potential opportunities for a good experience. Understanding how you want to stake, the opportunity costs, examining the market, platform, and token, and understanding how to maximize your benefits are all critical to success.