One of the most significant recent developments in the blockchain space happened towards the tail end of last year. The journey to realizing the ambitious Eth2 vision for Ethereum officially kicked off on December 1, with the long-anticipated launch of the so-called Beacon Chain.
Eth2, or Ethereum 2.0, is set to be the next chapter for the world’s second most popular blockchain protocol. It aims to boost Ethereum in terms of scalability, sustainability and security, while also ensuring that the network stays as decentralized as possible. It is a multi-stage project that is expected to complete sometime in 2022.
While the launch of the Beacon Chain is only the first of several planned upgrades to the Ethereum platform, it is perhaps the most important one. It is designed to usher in the age of Ethereum staking or, in other words, it aims to facilitate Ethereum’s transition from a proof-of-work to proof-of-stake consensus. Since December 1, the Beacon Chain has already generated a lot of buzz, with many queueing up for a validator role on the new chain. It is also prompting crypto service providers to come up with new ways for people to earn money from ETH.
We already examined proof-of-stake in our detailed piece on Eth2, but for the purposes of this article, here is a brief summary on Ethereum staking and why it’s viewed as a foundational component of the Ethereum 2.0 project.
Staking is the mechanism that allows for people and organizations to become validators on the Beacon Chain. More specifically, validator candidates are required to stake at least 32 ETH in order to join the Beacon Chain. Once a stake has been provided and locked in the chain, its holder gains the ability to validate blocks. An algorithm selects randomly who gets to validate a new block at any given time. The chosen validator receives an ETH reward for successfully approving a new block. In this system, stakes are meant to ensure that validators perform their duties responsibly. A validator can lose a portion or even the entirety of their stake, if they fail to support the network (for example, go offline) or engage in fraudulent activities.
By introducing Ethereum staking and PoS consensus, the Ethereum platform aims to become more energy efficient and secure, as well as enable more people to take part in the validation process by removing the need to use specialized mining equipment.
While Ethereum staking is an important part of the Eth2 project and could be a sound investment opportunity, there are a couple of potential drawbacks that need to be noted. The first is an obvious one: while switching to a PoS consensus removes one barrier to entry, there is still a pretty substantial financial barrier in the form of the required ETH stake. At current price levels, 32 ETH are worth roughly $52,000, which is an investment not everyone can afford to make.
Another important thing validator candidates need to consider is that they won’t be able to collect their staking rewards possibly until the Eth2 project is finalized and merged with the existing Ethereum network. The merge is expected to take place in 2022.
Fortunately, service providers, such as crypto exchanges and others, are already looking for ways to address these challenges.
In a recent piece on what to expect from the blockchain space in 2021, our experts predicted that the arrival of the Beacon chain would prompt blockchain companies to start offering services built around staking. It’s a reasonable expectation, especially given the issues mentioned in the preceding section. In fact, some of the industry’s most prominent players are already working on addressing those challenges.
1. Staking pools
For people who cannot afford to meet the hefty financial requirement but still want to become validators in the Beacon Chain, staking pools present an interesting opportunity. A staking pool allows people to join forces with other stakeholders to meet the 32 ETH requirement. In that sense, they are similar to mining pools, as well as traditional investing schemes such as mutual funds and real estate investment trusts.
Staking pools also allow for people to skip the technical aspects of Ethereum staking, such as choosing a Beacon Chain client and running a node. These services also plan to issue their own ERC-20 tokens to serve as 1:1 representation of the Ether staked in their nodes. That way pool members will be able to earn staking rewards in the form of tokens and use the tokens they have (stake + yield), as they see fit.
Some of the more prominent staking pool services include RocketPool, Lido and STKR.
2. Cryptocurrency exchanges
Some of the world’s largest crypto exchanges have already announced plans to support Eth2 and staking. The largest US crypto exchange, Coinbase, announced prior to the Beacon Chain launch that its customers would be able to “convert ETH in their Coinbase accounts to ETH2 and earn staking rewards”. The platform also intends to enable trading between “ETH2, ETH, and all supported currencies, providing liquidity for our customers”.
A number of other major exchanges, including Binance and Kraken, have announced similar plans.
Ethereum staking vs DeFi
Twenty-twenty was undoubtedly the year of DeFi, with services like Uniswap, Compound and Yearn.Finance rising to prominence. DeFi apps provided crypto aficionados with new ways to use their token holdings to earn assets.
As an investment mechanism, Ethereum staking shares many similarities with DeFi. For example, both involve lending crypto assets out to some sort of a blockchain collective and receiving financial return based on the amount of the crypto assets provided. With that in mind, the question is whether staking can compete with the hottest blockchain investment trend of 2021.
Currently, expectations are that, on an annual basis, Ethereum staking rewards will compare favorably, or at least be competitive, with yields from DeFi products and services. In fact, early adopters enjoyed staking rewards of nearly 20%. This rate will inevitably drop as more validators join the Beacon Chain and is expected to settle somewhere between 4.5% and 7%. Currently, the reward rate is at around 9%.
People who consider staking as an investment alternative to DeFi need to consider a couple of potential drawbacks. Firstly, third-party providers typically charge fees, sometimes quite hefty at that, for their services (this is somewhat offset by the fact that using DeFi products also comes at a cost). Secondly, keep in mind that if you run a validator on your own, you will not be able to access your stake and the awards you’ve accumulated for the foreseeable future. In contrast, DeFi allows you to freely move your assets between different projects to maximize the potential return, a practice commonly known as ‘yield farming’. Stll, the inconvenience of having your assets locked away gets you to support perhaps the most significant development in Ethereum’s history, which might be a worthy trade-off.
A promising start
So far, the figures suggest that the community is embracing the concept of Ethereum staking. The launch of the Beacon Chain required 16,384 validators to come on board and stake a total of 524,288 ETH in BC nodes. This threshold was reached on November 24, which allowed the new network to launch a week later. Some two months later, the amount of staked Ether has increased more than fivefold. According to data from the Eth2 Launch Pad, more than 2,700,000 ETH have already been locked in the network. With such strong early support for the project, it seems that the ‘sequel’ has a good chance of surpassing the original.