The long anticipated (and delayed) Ethereum Merge has finally happened on September 14-15. It was the second of a multi-phased upgrade of Ethereum 2.0, or ETH2, which attempts to improve the Ethereum (ETH) network’s scalability and security by making infrastructure modifications, specifically moving from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) consensus mechanism. The move to PoS from PoW will make the Ethereum blockchain not only more scalable but also more energy efficient.
In terms of Scalability: Under PoW, Ethereum 1.0, the Ethereum blockchain was able to handle 15 transactions per second (TPS), which is relatively slow in the context of financial transactions. Visa, for example, processes about 1,736 TPS, while MasterCard processes 5,000 TPS.
PoS is expected to enable the processing of 100,000 TPS, far exceeding even conventional financial payments services, considerably expanding the breadth of projects and applications that can be built on the Ethereum blockchain.
In terms of energy efficient improvement: According to the Ethereum Foundation blog, Ethereum blockchain should now consume 99.9% or so less energy. This is a significant improvement and should not be taken lightly. In addition, there is a move to use more green energy facilities such as solar or wind for mining (PoW) and staking (PoS).
Indeed, the criticism on the consumption of energy related to blockchain technology is warranted. But those in the blockchain ecosystem are mindful of the environmental implications, constantly making an effort to become more energy efficient both in term of implementing innovative consensus mechanisms to validate transactions and in terms of the use of green energy facilities.
What Does it Mean to Stake Ethereum?
On a PoS blockchain, staking is the process of actively participating in transaction validation (similar to mining or PoW). In contrast to PoW, which requires miners to compete for rewards based on the amount of computational power they can acquire, the proof-of-stake mechanism randomly selects validators relative to the total amount and time their ether has been staked.
Unlike proof-of-work, PoS validators don’t need to mine blocks to maintain the network. Instead, they need to create new blocks when chosen, and validate others when not. Once a participant has validated the latest block of transactions, other contributors can attest the block is valid. When enough attestations are made, the network adds a new block.
Rewards are then distributed in ether by the network in proportion to each validator’s stake.
The Pros and Cons of Staking
Passive investment: Like using a money market account or a certificate of deposit in traditional personal finance, staking Ethereum is just putting your tokens to validate the blockchain. After agreeing to the terms and conditions, no additional work is needed on your end in managing your ETH. You earn rewards; according the Ethereum Foundation, the annual APR is currently averaging 4%. With the minimum requirement of 32 ETH, you may earn about 1.3 ETH per year (as of this writing, the price of one ETH is about $1,320).
Sense of community: If you are passionate about Ethereum and believe in its value, you can aid the network by staking Ether. Nodes, which are individual computers that have staked ETH and are functioning, must validate the network to be legitimate. Staking could be for you if you want to validate the network, increase its health and security, and gain a reasonable payout in the process.
Comparatively low risk: Compared to other cryptocurrencies, Ether is a stable staking option. Its popularity, global use, and security give it an advantage over most other tokens. We are currently experiencing a crypto winter, but no season lasts forever, and spring will arrive and its value will increase once again.
Withdrawal unavailable: Currently, you cannot withdraw any staked Ethereum until the release of Ethereum 2.0, which may take 12 to 18 months, assuming no further delays. If you have liquidity constraints, staking may not be a suitable option, unless you stake with a centralized crypto exchange, such as Coinbase or Kaken (more on that below).
Fees: Fees may apply if you are staking either with centralized crypto exchanges or other staking services. Staking fees may vary, so there is a trade-off between liquidity costs and staking fees.
Validator penalties: Though this might be rare, Ethereum can penalize validators for being offline or for validating incorrect transactions. When this happens, there can be a penalty or some of the validators staked ETH can be permanently removed, which can affect returns.
Custodial staking risks: If you stake with a crypto exchange or a staking service, then staking options are custodial, meaning that your ETH is not in your private wallet but held by the exchange or the service you use. These types of services could be susceptive to hacks, counterparty failure or government actions.
How Do You Stake ETH?
There are a few options to stake, with a tradeoff between level of difficulty and risk compared to rewards gained from staking.
Running a validator: You can earn the most by running a validator, but you will need 32 ETH to get started in most cases (which would cost roughly $42,240 as of this writing). In addition, other hardware requirements can add to start-up costs. Notably, Ethereum validator staking requires the staker to store data and process transactions on the blockchain. This requires the use of devices that can handle the computing process, as well as a solid internet connection, so the costs of running a validator can easily outweigh the benefits of staking ETH. New services now offer an easier setup if you decide on running a validator node. Costs can vary from one-time setup fees to monthly fees.
Validator pools: Staking to a pool means pooling your available ETH with other stakers to reach the 32 ETH required to run a validator. The advantage of this structure is that you don’t need as much to get started but you can enjoy many of the benefits of running a validator without the large financial commitment. Another advantage is that in most cases, you can keep your ETH. The stake is non-custodial but subject to restrictions that apply to the network.
Exchanges: The best crypto exchanges now offer staking for ETH. The advantage to using exchanges is convenience. You will often find low or no minimum staking requirements, making it easy for anyone with any amount of capital to participate in staking. After purchasing some ETH, you can immediately start staking. The disadvantages to staking on exchanges concern security and fees (Coinbase, for example, charges 25% commissions on rewards). When you stake through an exchange, your ETH is not held in a private wallet, but rather a custodial wallet. In addition, threats such as platform hacks and government actions can put your staked ETH at risk.
Liquid staking: The major downside to staking ETH is the long-term commitment. Staked ETH cannot be withdrawn because the blockchain does not support that feature yet. Liquid staking offers a solution with tokens that can earn staking rewards yet can be withdrawn or used in many of the ways you currently use un-staked ETH. Typically, liquid staking services swap your ETH for a receipt token, which you keep in a private crypto wallet as a proof of ownership and can be used for trading while the original token continues to earn rewards.
Furthermore, liquid staking does not require any additional actions to stake your ETH, you get a staked-ETH token for the ETH you stake, which you can then use the staked-ETH token to swap or trade
The largest staked ETH service is Lido Finance, which accounts about a third of all staked ETH. Lido will give you an ERC20 token called stETH in exchange for the ETH your stake. Like any ERC20 token, stETH is tradable. It should be pegged to the value of ETH, but due to its low liquidity and volume, it is valued less than ETH.
Another risk that you should bear in mind is that since stETH does not have any utility value like ETH and is used merely for liquidity and financial operations, such as trading or collateral, it could very likely be classified as a security. This would have both regulatory and tax implications.
Staking ETH is an easy way to earn yield on the Ether you already own. If you like to buy and hold ETH, staking takes the effort out of earning on it. However, if you are someone who trades crypto frequently, staking may not be a suitable option for you. Whether you are an investor or a trader, do your research diligently before you decide where to invest/trade and how.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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