Ethereum prepares for merger
Ethereum is about to complete “the merger” to the Proof-of-Stake method, and ETH holders have a chance to capitalize.
The merger will allow the world’s second largest blockchain to abandon its Proof-of-Work consensus mechanism and move to Proof-of-Stake. In moving away from Proof-of-Work, Ethereum will rely on validators rather than miners to verify transactions. ETH holders can validate the network by putting their assets on the line. In exchange for their services, they can receive a return.
The merger is currently expected between September 13 and 15, but there are already several staking options for ETH holders. Ahead of Ethereum’s milestone event, this column details the main ways ETH holders can stake their assets.
Liquid Staking Protocols
One of the most popular ways to bet on ETH is through liquid staking protocols. The most prominent ones on the market today are Lido and Rocket Pool. Users can lock in their ETH and be rewarded with ETH tokens (stETH on Lido, rETH on Rocket Pool), which represent their deposited assets.
Delegating ETH to liquid staking protocols is easy; all you need is an Ethereum wallet. Lido currently offers 3.8% APR, while Rocket Pool offers 3.61% APR for staking, and 4.84% to those who want to stake their ETH and manage their own node. For comparison, solo staking on Ethereum currently pays about 4.1% APR.
The main benefit of liquid staking comes from receiving a liquid token. When users receive a staked ETH token representing their deposit, they can put it to work on DeFi protocols, increasing their return. For example, depositing Lido’s stETH into the Yearn Finance yield strategy protocol currently enjoys an APR of about 7%, bringing the overall yield to nearly 11%.
Liquid staking protocols like Lido and Rocket Pool carefully select the validators they work with. Lido has a whitelist of the industry’s leading staking vendors and maintains a list of community-owned validators to track the protocol’s staking performance. Rocket Pool, on the other hand, has a policy that specifies that any losses incurred due to untrusted validators are shared across the Rocket Pool network to minimize the impact on individual users.
While Lido and Rocket Pool are the largest players in the liquid staking game with $7.5 billion and $589.2 million in value respectively locked up, other major providers exist such as Stakewise, StakeHound, Stader, Shared Stake, pStake, Claystack and Tenderize. With Lido dominating the space, some members of the Ethereum community have expressed concern that the decentralization of the network is diminishing. According to Dune data compiled by hildobby, the protocol currently processes 30.4% of all ETH put into play.
One of the risks of ETH staking is slashing – when the network punishes a validator’s malfunction or bad behavior by burning the validator’s ETH stake. Lido and Rocket Pool have measures in place to limit slashing, but there are other risks associated with using them to stake. The protocols could suffer from bugs or hacks, and their governance processes can be captured. Lido’s stETH also briefly lost its 1:1 parity with ETH in June by more than 5%, indicating that stETH and rETH should not be considered ETH equivalents – they are derivatives.
Staking in the stock markets
Centralized exchanges offer convenient ways to stake ETH and earn returns. Most major crypto-currency exchanges, including Coinbase, Binance, and Kraken, offer staking services and plan to support Ethereum Proof-of-Stake after the merger. Coinbase currently offers an APR of about 3.28%, Kraken offers between 4% and 7%, and Binance offers “up to 5.2%.”
Staking on centralized exchanges is arguably the easiest way to earn yield on ETH. However, most exchanges require users to pass KYC (Know-Your-Customer) identification checks to open an account. In addition, these exchanges are custodial, which means that users entrust their funds to a third party. In the past, the crypto-currency industry has seen several cases of users losing everything after entrusting their assets to companies like Mt. Gox and Celsius.
Nevertheless, the major exchanges offer a convenient and relatively safe way to stake ETH. The most common assumption is that validators run by exchanges are not at risk of being hijacked. Coinbase has indicated that users can be compensated for reduced stakes, even when the cause is beyond the exchange’s control.
Coinbase, Kraken, and Binance control 14.5%, 8.3%, and 6.6% of the total market share of staked ETH, respectively, making them the three largest staking entities after Lido. This has raised new concerns about centralization, particularly in light of the Treasury Department’s recent decision to allow ETH in a bill and sanctioned Tornado Cash. The main concern is that U.S. exchanges like Coinbase or Kraken could be asked to censor transactions on the Ethereum base layer (the Ethereum community could respond by lowering its bets). Brian Armstrong, CEO of Coinbase said he would rather shut down Coinbase’s staking services than censor Ethereum if the issue arose in the future, while Vitalik Buterin said he would consider censorship an attack on the network. For now, however, Treasury has not indicated that it plans to attack the Ethereum network itself.
Staking pools and SaaS providers
“Staking pool“Staking pool” is a generic term for any staking service provider that allows users to contribute small amounts of ETH to a pool. Since Ethereum requires users to deposit 32 ETH (over $54,000 at current prices) to become a validator, staking pools are popular options for those with a smaller stake to deposit.
Lido, Rocket Pool, Coinbase and Kraken all run their own staking pools. Multiple “independent” staking pools can be used to stake ETH and gain yield.
Providing ETH to an independent staking pool is, in most cases, just as easy as staking via Lido or Coinbase. The more difficult task is choosing the right staking pool. For smart contract platforms like Ethereum, it’s worth considering whether the pool is open-source, audited and untrusted, whether it supports permissionless nodes, whether a bug bounty has been issued and how diverse its set of validators is. For centralized entities, factors such as the staking provider’s track record, reputation, security architecture, and asset volume are important considerations.
Delegating to an independent staking pool helps increase Ethereum’s decentralization. Currently, independent staking pools and solo validators account for less than half of the network’s staking power. They also tend to offer higher returns than other services: stakefish, for example, currently offers an annual interest rate of 6.67%, while Everstake offers APR of 4.05%.
ETH holders can also use a Staking-as-a-Service (SaaS) platform to stake their assets. SaaS platforms offer a special type of staking service by allowing users with sufficient ETH to rent a validator and delegate operations to a third party. SaaS platforms are generally considered less risky than independent staking pools, and they generally offer higher returns. However, they are only available to users with 32 ETH.
It is important to note that independent staking pools and SaaS platforms can expose users to the same risks as liquid staking providers and centralized exchanges. Exploits, bugs, withdrawal freezes and outages are all possible.
Perhaps the most obvious option for ETH holders looking to stake their assets is to set up their own validator. This usually requires dedicated hardware, technical know-how, a solid internet connection and 32 ETH, but it’s probably easier than running a mining platform. According to Ethereum’s website solo staking currently earns 4.1% annual interest rate, but this figure is expected to rise above 8% after the merger.
Solo stakers participate in network consensus and contribute to the security and decentralization of Ethereum. In return, they receive rewards directly from the protocol without having to pay management fees. The Ethereum Foundation encourages solo validators: according to Dune data compiled by hildobby, Vitalik Buterin himself has staked 6,976 ETH on 218 of his own validators.
There are obvious risks associated with solo staking. Validators can have their funds reduced if their internet connection goes down. Solo validators must ensure uninterrupted network uptime, manage their own private keys, monitor their node, and regularly update their client software. So validation cannot be considered a “one-man band” strategy.passive income“. Furthermore, in extreme circumstances, users risk losing 32 ETH if they make a mistake when setting up their node. Ethereum transactions are irreversible, so there is a risk of losing assets forever. For these reasons, solo staking is generally only recommended for the most advanced users.
Final thoughts before the merge
Potential stakers should note that any ETH staked on the network is currently locked and will not be recoverable even after the merge. This applies to all Ethereum staking activity, whether through liquid staking protocols, centralized exchanges, independent staking pools or solo validation. Ethereum developers have stated that withdrawals will be enabled about six months after the merger, which is early 2023, but there is no set date. Those who can’t afford to wait to get their holdings back should consider whether ETH staking is the right option for them.
Finally, ETH holders should be aware that staking is not mandatory. Many ETH holders choose to hold their ETH in cold storage portfolios (arguably the safest way to gain exposure to the asset) or on centralized exchanges. While there is an upside to gaining yield, it comes with risk. Do your own research and proceed with caution.