POS Bakerz, a Staking-as-a-Service (SaaS) provider that “offers public delegation services to Tezos (XTZ), Cosmos (ATOM), and IRISnet (IRIS) token holders,” has published a blog post in which it revealed the inherent risks involved with staking cryptocurrencies.
Acknowledging that staking has become “a new trend” in the crypto space, as Coinbase Custody recently announced its support for staking on Tezos, POS Bakerz explained in its blog, posted on April 24th, 2019, how proof-of-stake (PoS)-based networks deal with dishonest actors or malicious behavior.
Tezos Only “Punishes Bakers,” Cosmos And IRISnet “Punish Validators And Delegators”
As mentioned in POS Bakerz’ blog, “slashing” occurs on PoS chains when a “validator/baker” is “punished for a fault” or dishonest behavior they engaged in, and “it is a mechanism by which the network disincentivizes” malicious actions. For instance, in “Liquid Proof-of-Stake (LPoS) protocols such as Tezos only the baker is directly punished in case of a fault,” POS Bakerz wrote.
Bakerz added that “in Bonded Proof-of-Stake protocols (BPoS) such as Cosmos or IRISnet, both the validator and its delegators are directly punished.” As noted in Bakerz blog, slashing can occur in cases where there’s a “liveness fault” detected on Cosmos or IRISnet. This occurs when the “validator node does not participate in the network consensus for a long time and misses several blocks.”
Additionally, POS Bakerz mentioned that there could be a “security fault” on Tezos, Cosmos, or IRISnet and “most” other PoS protocols when an entity “disturbs the network consensus by validating/verifying twice or more the same blocks.” Such types of security faults, POS Bakerz’ explained, are “also called double-baking or double-endorsing in the case of Tezos, or double-signing in the case of Cosmos & IRISnet.”
Finally, there’s the “governance fault” which can occur on Cosmos or IRISnet, and in this type of fault “the validator [may have] voted multiple times on the same consensus process, and these votes contradict each other, or [the validator] did not [actually] vote at all.”
Penalties And Punishments in Proof Of Stake Networks
The penalties assigned on PoS chains “depend on the kind of misbehavior and on the parameters of the protocol,” POS Bakerz noted. In most cases, the “validator/baker is punished [by confiscating a] certain percentage of tokens [they’ve] staked.”
“In some protocols,” Bakerz noted, the “validator can also be jailed, a process prohibiting [them] from re-entering the networks for a certain period of time.” Meanwhile, in BPoS) protocols such as Cosmos and IRISnet, the “delegators are also at risk of punishment,” so POS Bakerz recommended that users “carefully choose [their] validator.”
According to Bakerz, one of the “most dangerous risks in staking is the volatility.” The validator mentioned that “earning” cryptocurrency dividends on staked funds could seem promising or lucrative at first; however, in bear markets, the value of the staked assets may depreciate to the point where it may no longer be feasible (or profitable) to continue staking.
POS Bakerz recommended that users stake their funds on networks that have solid technological foundations and a supportive and an active “community behind [them], and not only the ones that pay [the] most rewards.” POS Bakerz further noted that its team “also thinks that diversification” in the staking business is a good strategy, where users can become a “multi-protocol player.”
Going to suggest that those interested in staking first do their own research, POS Bakerz stated that users can check out stakingrewards.com if they are planning to learn more about “staking tokens” and the return on investment (ROI) they can expect.
Notably, POS Bakerz is also currently assessing whether it’d profitable if staking could be extended to “hedge positions.” For now, the Bakerz’ team recommends simply shorting the actual POS cryptocurrency to potentially reduce, or minimize, losses when prices go down.
Another potential risk factor pointed out by POS Bakerz is delegating tokens to validators who may not pay rewards. With some PoS protocols “such as Tezos,” Bakerz noted that the first set of “rewards come after 7 cycles, so approximately 20 days and people [typically] do not check if they’ve well received their rewards.”
In order to check whether users have received rewards on staked funds, Bakerz highly recommends using Baking Bad on Tezos, a delegator auditor, and/or block explorers to see if payment was actually made.
Stakers Contribute Directly to “Centralization or Decentralization Of Network”
According to POS Bakerz, validators need not have “custody” of staked user funds, so it is recommended that the funds “not be sent directly” to the validator’s wallet. There’s also a guide which POS Bakerz suggested that potential stakers follow for further instructions.
As noted by Bakerz, when users stake funds on PoS chains, they are “directly contributing to the centralization or decentralization of the network.” For example, the “percentage of voting rights” retained by the “top 10 block producers (BPs)” on Cosmos stands at 57.3% (as of April 13th, 2019). Voting rights for the top 10 BPs on Tezos and IRISnet is currently at 28.8% and 34.3% respectively.
A good strategy, POS Bakerz believes, for staking tokens is to “not necessarily delegate to the largest ones, but rather to choose your validator based on its uptime, self-bond, security practices, community involvement, customer service, service fees, etc.”
Moreover, Bakerz noted that “by encouraging smaller validators, [users] will contribute to the decentralization of the network, which is great.”