Non-Custodial Staking: Explained

Introduction

Blockchain technology has continually evolved, with Proof of Stake (PoS) emerging as a prominent consensus mechanism. This shift has sparked a surge in interest in staking, a fundamental aspect of PoS, leading to a proliferation of staking service providers. However, amidst this growing trend, a challenge has arisen. Some entities, capitalizing on the popularity of staking, are offering services that diverge from actual staking - while using the staking tag. This has led to confusion and a dilution of its core attributes, particularly its non-custodial and transparent nature. This is hence a call for vigilance, and to define what is actual “staking.”

Understanding Non-Custodial Staking

If you've kept up with offerings from Luganodes, you'll recognize our special designation as a Non-Custodial solution. This label originates from our approach to managing fund ownership. PoS blockchain staking can take two forms: custodial and non-custodial. In a custodial setup, investors entrust a trustworthy custodian with their private keys, the allocation of rewards, and the management of their funds. An example is users staking on Centralized Exchanges (CEXs), which, despite its convenience, necessitates a dependable and established exchange due to the transfer of custody.

Contrastingly, non-custodial solutions offer complete autonomy over your funds, private keys, and reward receipt. Countering common misconceptions, there's no actual fund transfer from the investor to the validator. Validators simply manage the technicalities of staking in return for a service fee or a share of the rewards, typically under 10%.

The Mechanics of Staking

Staking serves as a security mechanism in a chain. Under the PoS model, a validator commits a certain quantity of coins, enabling them to propose blocks and validate transactions. This system discourages malicious behaviour, as it would risk the loss of staked funds. Anyone can invest in a chain’s security by setting up nodes and becoming a validator.

Becoming a validator, however, demands substantial resources and expertise, including technical know-how for node setup and operation. As a result, many investors prefer to rely on a validator to manage the nodes on their behalf.

In the non-custodial method, the investor, or delegator, never has to relinquish their private keys to the validator. The network merely links their wallet to the validator's infrastructure. Multiple delegators can utilize this setup independently, and funds are never pooled.

Regarding rewards, their distribution is automated via a smart contract: delegators receive rewards, and validators receive commissions. Some blockchains necessitate validator intervention for this process, while others automate reward distribution but require manual claiming of validator commissions.

In summary, as a delegator, you directly stake your tokens on your chosen chain, with a non-custodial validator merely facilitating the process. There is no ownership transfer of funds.

Identifying Misconceptions

So, where does the confusion lie? Why is staking still perceived as a high-risk investment? The issue lies in the misapplication of the term “staking,” which is being used to describe various forms of crypto asset lock-in for returns. This leads to confusion, as there are significant differences between different cryptocurrency investment methods.

This misuse is evident in Liquidity Pool Tokens (LP) scenarios, like those on Uniswap, where participants provide tokens for token swaps, earning transaction fees but also facing the risk of impermanent loss. This contrasts with traditional staking, which involves network consensus participation without actual token lock-in, as seen with non-custodial PoS validators.

Some services, reminiscent of staking but operating distinctly, have also adopted the staking terminology. For instance, the now-defunct Celsius combined staking and lending, diverging markedly from traditional staking practices.

Thus, risks can escalate if the term “staking” isn’t accurately delineated. This ambiguity can affect understanding of risk and returns, blur roles between traditional staking and investment on DeFi platforms, and create misconceptions about control and liquidity of assets.

Understanding the True Risks

The confusion around the term “staking” has broader implications, especially when conflating the risks associated with different types of crypto investments, leading to a skewed perception of PoS staking. Traditional on-chain staking risks are generally straightforward and include potential slashing (penalties for validator misconduct), the performance of the underlying blockchain, and the volatility of the staked asset’s value.

Conversely, risks in other DeFi services using the term “staking” can be more complex and opaque, involving protocol-specific challenges, smart contract vulnerabilities, and broader market dynamics.

The primary risks in staking pertain to slashing, where validators may be penalized for infractions like double signing. These violations can result in a reduction of staked tokens, impacting all associated delegators. Software vulnerabilities, including bugs in network updates, also pose risks.

However, these issues are relatively rare. Selecting a reputable validator is crucial to mitigate these risks. High uptime, consistent monitoring, and a solid track record can significantly reduce the likelihood of slashing. Additionally, some validators go one step further, like Luganodes - by going for third-party insurance as a part of the standard offering for institutional investors. While our dedicated 24x7 SRE teams take care utmost care, it is always in the best interest of our clients to opt for a safety net.

Conclusion

While we celebrate the diversity and creativity of investment options in the blockchain space, it’s vital to preserve the simplicity and integrity of a mechanism central to the PoS blockchain. As the foundation of blockchain security, clarity in its operation and investment appeal is essential to sustain the blockchain ecosystem.

PoS has addressed a significant energy efficiency issue in the blockchain sector, attracting global interest. With the blockchain ecosystem appearing more viable than ever, major financial entities are showing keen interest. Staking remains a secure investment avenue, contributing to the future of our economy. As non-custodial validators, our mission is to support the growth of this vital sector, not only by providing dependable services but also through education and clarification of its operations.

About Luganodes

Luganodes is a world-class, Swiss-operated, non-custodial blockchain infrastructure provider that has rapidly gained recognition in the industry for offering institutional-grade services. It was born out of the Lugano Plan B Program, an initiative driven by Tether and the City of Lugano. Luganodes maintains an exceptional 99.9% uptime with round-the-clock monitoring by SRE experts. With support for 45+ PoS networks, it ranks among the top validators on Polygon, Polkadot, Sui, and Tron. Luganodes prioritizes security and compliance, holding the distinction of being one of the first staking providers to adhere to all SOC 2 Type II, GDPR, and ISO 27001 standards as well as offering Chainproof insurance to institutional clients.