The Web3 community recently met Ethereum's largest and most important upgrade with acclaim, where the blockchain’s fundamental consensus mechanism changed from mining-based, or "proof-of-work" model, to a staking-based model. Proof-of-stake is a concept that has floated around the crypto community for a while and has now been placed under the spotlight, with multiple projects now exploring following in Ethereum's footsteps with a transition.
Now, with The Merge complete, it’s worthwhile to take a dive into Ethereum 2.0 staking with an analysis including what staking is, the benefits, how to get started as an individual staker, and more.
What is Staking?
Staking is a fundamental concept in cryptocurrency – it refers to the process where users leverage their digital assets to support a blockchain network while earning rewards in the process. Users who stake their cryptocurrencies are known as “validators” or “stakers” and contribute to the operation and security of the blockchain.
This concept comes from the proof-of-stake (PoS) mechanism of consensus and operation. In this model, blockchain transactions and maintenance are handled by validator nodes, which are computers operated by users who staked their cryptocurrency. The stake is like a collateral of sorts to ensure validators carry out their responsibilities, with their collateral at risk of being slashed if they fail to perform.
Ethereum 2.0 operation is based on the PoS model, which is an upgrade from Ethereum’s original proof-of-work (PoW) mechanism. In the PoW model, transactions are validated by network computers that perform complex tasks, which is incredibly energy and time intensive.
The Beacon Chain is the consensus layer that underpins Ethereum 2.0’s PoS model of operation. It went live in December 2020 and will take over from the current PoW algorithm as the execution layer after The Merge. When Ethereum 2.0 is fully in place, the PoS system will experience significant improvements in energy efficiency.
Ethereum staking is the act of depositing a minimum of 32 ETH to activate validator software on the Ethereum blockchain. The staked ETH can only be withdrawn some time after The Merge occurs. Validator responsibilities include storing information, processing transactions, and adding new blocks to the blockchain. In exchange, validators receive interest on staked ETH and contribute to the security of Ethereum network.
Why Stake Your Ethereum?
There are a multitude of reasons to stake Ethereum. Staking is a great way to generate passive income, since rewards are provided for actions that help the network reach consensus. It also contributes to network security since nodes continuously add blocks and perform validation. Finally, staking is a more sustainable method of blockchain operation. Since validators don’t require a complex computer setup, Ethereum 2.0 will consume less energy and minimize long-term environmental impact.
How to Stake Ethereum
There are several ways to stake Ethereum, all with varying amounts of rewards, risks, and requirements.
Methods are generally categorized as non-custodial or custodial. Non-custodial staking is decentralized, where users retain full control over validator selection and their wallets, and is often grouped in the decentralized finance or "DeFi" category. To learn more about DeFi in general, check out this piece by Nansen!
Custodial staking is the centralized option and hands off keys and responsibilities to an exchange. In this section, we’ll go over three decentralized methods (solo home staking, staking as a service, and pooled staking) and custodial staking with exchange platforms.
Solo Home Staking
Developers and enthusiasts who are invested in the network health and overall decentralization of Ethereum considers this to be the gold standard of staking. In this case, a validator node is completely self-hosted and keys aren’t shared. As such, validators have full control and the operation is completely trustless. The user receives staking rewards directly from the protocol for batching transactions into a new block or checking validator work.
There are some risks with solo home staking. Staked ETH cannot be freely withdrawn, which poses a liquidity risk. Penalties are also applied if the node drops offline, and malicious behaviour will result in slashing and/or forced ejection from the network.
Solo home staking requires 32 ETH and hardware to run the node. The validator is responsible for setting up the hardware and ensuring the node is kept online 24/7, which requires creativity with computer setups. Staking Launchpad is an application that preps users for staking, including choosing clients, generating keys, and depositing ETH. A few examples of consensus layer clients include Prysm, Nimbus, and Teku.
Staking as a Service
SaaS is similar to solo staking, but hardware and node operations are entrusted to a third-party operator. The 32 ETH requirement is the same, but users hand off validator keys while keeping their signing keys. Users still receive native protocol rewards, minus the monthly fees for node operation. This is easier to accomplish than solo staking, since hardware setup, maintenance, and validator duties are outsourced.
Although SaaS providers handle various aspects of staking and validating in a professional manner, this method also introduces third party risk. Since validator keys are entrusted to the provider, there is the possibility of malicious behaviour or becoming the target of a hack. Additionally, risks from solo staking also apply here, since staked ETH cannot be withdrawn and the operator may incur penalties.
Users deposit their ETH into a pool and the third-party operator handles all validator duties, including hardware and node operations. There are numerous platforms that offer this service with varying APRs, but rewards generally depend on how much ETH is deposited. Platforms usually have liquidity tokens that represent the amount of staked ETH and the share of validator rewards. These tokens have the additional benefit of being tradable anytime, some with deep liquidity, and potentially being used on DeFi platforms.
The risks depend on the method of pooled staking. There are the standard third-party operator risks, such as liquidity, smart contracts vulnerabilities, platform integrity, and more.
Pooled staking has the lowest entry cost, with some projects having no requirements at all. Depending on the platform, users can deposit their ETH directly from their wallets to staking pools, or they can trade ETH for liquidity tokens. Pooled staking operators usually take a percentage of yields in exchange for services, and popular options include Lido and Rocket Pool.
The last way of staking is through centralized exchanges, like Coinbase or Binance. This has the most straightforward setup and usually doesn’t require a minimum amount of ETH to stake. Exchanges typically offer derivative tokens, making staked assets more liquid. However, compared to other staking methods, this usually has the least rewards since CeFi exchanges often take a percentage of yields, which includes the cost of operation.
Users would have the least impact on the health of the Ethereum network, since staked assets are managed by centralized exchanges. CeFi platforms have less transparency and maintain control over the user’s keys, so there is a higher risk from platform hacks, poor management, insolvency, and more.
Is Staking Ethereum a Good Idea?
Staking Ethereum has numerous benefits, but also comes with potential risks. As previously mentioned, staking yields passive income while contributing to network validation. Ethereum staking is a good way to mitigate losses from market volatility, since stakers earn rewards even with ETH devaluation.
However, there are several risks to consider. Staked ETH will be locked up for an undetermined period until after The Merge is completed. The long-term value of staked ETH in Ethereum 2.0 is still unknown and market movement can affect its price.
Validators also face the risk of penalties or slashing for improper behavior or disconnecting from the network. Moreover, there is the issue of client diversity on the Beacon Chain. Most validators use Prysm, meaning a large number of nodes are vulnerable to potential software bugs. Users not staking natively face standard custodial risks from third-party platforms and must go to lengths to keep their keys safe.
Best Places to Stake Ethereum
This section will mainly focus on third-party platforms that offer users the option to stake their ETH. Since solo staking or SaaS have a high entry barrier, pooled staking or centralized exchanges offer more beginner-friendly options.
Lido is a non-custodial liquid staking platform which allows users earn rewards without needing to lock their cryptocurrencies or maintain their own nodes. It complies with ETH staking standards by maintaining pooled stakes from multiple users, so users don’t need to meet the minimum 32 ETH requirement. When ETH is deposited, users receive a derivative token, stETH (staked ETH), which is redeemable 1:1 for Lido’s staked ETH at some point in the future. stETH is a ERC20 token that provides liquidity since it can be used for other DeFi products in the ecosystem. To learn more about stETH, check out Nansen's research report here!
Lido is governed by a DAO, which handles management, operations, fund distributions, and more. It also has its own native token, LDO, which grants governance rights to holders and is used in community voting to decide the future direction of the platform.
Nansen's DAO Paradise and DAO God Mode highlights the ongoing activities of several DAOs.
The staking APR fluctuates as market conditions change. At the time of writing, Lido is offering 3.9% APR with a 10% staking fee. Some risks that exist with Lido include potential vulnerabilities in smart contracts, slashing, and DAO key management. Moreover, much like other staking platforms, there is uncertainty around ETH 2.0 technicalities and adoption.
Lido is supported on Nansen and provides great insight into various aspects, including ETH deposited, token price movement, staking transactions, DAO voters, and more! The dashboard can be seen here.
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Binance is one of the largest centralized exchanges, with offerings ranging from trading, wallets, lending/borrowing, staking, and credit cards. It has two staking offerings: Locked Staking and DeFi Staking. Locked Staking requires users to lock their cryptocurrencies for a set period of time, and Binance handles blockchain network operations. DeFi Staking is governed by smart contracts, and users can choose from “Flexible” or “Locked” staking periods. However, private key management, validator operations, and node maintenance are all still controlled by Binance.
Ethereum staking on Binance is only available through DeFi staking. Independent validators using Binance will need to deposit the full 32 ETH, whereas the minimum amount for pooled staking is 0.001ETH. Users will receive BETH (Beacon ETH) as proof of staked ETH in a 1:1 ratio, which can be used for trading, withdrawals, and other transactions. There are no fees required to lock funds or to stake tokens, and the estimated APR is up to 5.2% for fixed duration staking.
Risks include slashing, wallet/smart contract hacks, technical problems, or market volatility. Slashing and wallet attacks are risks common to staking in general, though Binance claims to mitigate these through some unspecified protections.
Rocket Pool is a liquid staking platform that provides infrastructure and liquidity to people wanting to run their own nodes or to stake. When users deposit ETH, they receive rETH (Rocket Pool ETH), which is a liquid, yield-bearing ERC-20 token that represents staked ETH. For users who want node operation responsibilities, they can offer 16ETH, which is then added to 16ETH from staking pools. Validators would have responsibility over their own 16ETH and the protocol’s 16ETH.
Like Lido, governance is managed by a DAO and smart contracts control all operations, including withdrawals, rewards, and delegation. Rocket Pool has its own protocol token, RPL, that can be staked for additional network security. In the future, it will also be used in governance.
The current APR is ~4.03% for stakers and up to 6.36% APR for validators. The minimum deposit is 0.01ETH for staking and 16ETH for node operation.
Kraken is one of the longest-operating cryptocurrency exchanges and supports trading, staking, and 120+ currencies. Users can either stake as validators or with pools. To independently stake as a validator, the full 32 ETH is required. Meanwhile, 0.0001 ETH is the minimum amount required to join a staking pool.
Kraken also charges a 15% administrative fee, which is directly deducted from rewards. The expected returns are between 4% - 7% per year and depend on the rules of the Ethereum protocol.
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How Much Do You Make Staking Ethereum?
The returns depend on where and how much Ethereum is staked. If the pool of total staked ETH decreases, the annual interest rate (APR) increases, and vice versa. However, it is important to note that until ETH can be withdrawn some period after The Merge, the amount of staked ETH will not decrease. As well, total rewards/incentives are proportional to the amount of ETH that is staked.
For those solo staking on the Ethereum blockchain, the base reward (“B”) is the fundamental primary determiner of Ethereum 2.0’s issuance rate. It is inversely proportional to the square root of the total balance of all Ethereum 2.0 validators. Simply put, more validators translates to lower base reward per validator. Block proposers get 1/8 B whereas attesters get 7/8 B at most, depending on how quickly they submit their attestation. The APR varies between 6% - 15%.
SaaS or pooled staking offer similar rewards, minus third party operation and maintenance fees. Centralized exchange rewards depend on the platform and are typically around 4% - 6%.
The Future of Ethereum Staking
ETH staking is the backbone of Ethereum 2.0. Following The Merge, Ethereum 2.0’s energy consumption will be reduced by an estimated 99.95%, compared to the current PoW mechanism. This improves the long-term environmental feasibility of maintaining the blockchain. Moreover, there will also be improvements to processing speed and scalability.
Analysts predict better returns following The Merge, approximately in the range of 7% - 12%. As it stands, ETH staking is an exciting opportunity to contribute to the future of the network while earning rewards in a relatively safe manner. This significant change will usher in a new era – perhaps one with Ethereum as the dominant web3 blockchain.
Nansen can provide data on many aspects of staking, and is a fantastic tool for discovery and due diligence. Blockchain analysis is available for Ethereum, which shows active addresses, transactions, and more.
For a comprehensive overview, Nansen's ETH2 deposit tracking presents the total ETH deposited, top depositors, their addresses, and more.
This article covered the basic concepts in Ethereum staking – its benefits/risks, the process, and more. With The Merge rapidly approaching, Ethereum 2.0 is at an exciting transition point and staking is more relevant than ever.
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