By adopting proof of stake, experts say the Ethereum merge will reduce the network’s energy consumption by 99.95% and boost transaction speeds.
But what exactly is proof of stake? How can regular investors partake in Ethereum staking themselves?
What Is Ethereum Staking?
You’ve probably heard of cryptocurrency miners who validate transactions on proof-of-work blockchains like Bitcoin.
Crypto miners solve complicated mathematical puzzles with high-powered computers that use large amounts of electricity.
Some leading cryptocurrencies that employ proof-of-work models—especially Bitcoin—have drawn widespread criticism for their rapidly growing energy consumption.
Rather than employing high-powered computers to solve mathematical puzzles, Ethereum staking involves locking up ETH on the blockchain—staking it, as it were—to earn the opportunity to validate transactions and yield more ETH as a reward.
How Does Ethereum Staking Work?
To become a validator—otherwise known as a staker—network participants need to lock up 32 ETH on the blockchain. That’s a tidy sum worth more than INR 39 lakh at today’s ETH prices.
Validators are then randomly assigned the responsibility of validating transactions, constructing new blocks and maintaining the overall functionality of the blockchain. In return for locking up their ETH, stakers earn a yield paid in ETH.
The yield will fall if a validator fails to validate a block once assigned the responsibility.
Validators can also be penalized under “slashing”—when the network confiscates some or all of a validator’s staked ETH—for engaging in malicious activity, such as colluding to validate blocks incorrectly.
Theoretically, these incentives encourage validators to behave appropriately to earn passive income and avoid slashing.
In fact, Ethereum validators have been staking for a few months already. The Beacon Chain, the upgraded proof-of-stake network that will be “merging” to become the main Ethereum network around Sept. 15, was originally launched on Dec. 1, 2020.
Since then, investors have been able to participate in staking on the network. Their ETH, once staked, has been locked up until after the newly upgraded blockchain is up and running.
Ethereum Staking Pools
Given current prices, 32 ETH is a very high threshold to get involved in Ethereum staking. Most ordinary investors are not in a position to lock up this amount of ETH to become validators.
That’s where staking pools come in. They provide a way for individuals to collaborate to fulfill the minimum mark of 32 ETH required to become a validator. Corresponding rewards are then divided pro-rata among pool participants.
Ethereum lacks a native protocol that supports staking pools. Many big cryptocurrency exchanges, such as CoinDCX and Binance, and third parties offer Ethereum pooling features.
For example, CoinDCX users can stake their Ethereum for 5% – 20% annual percentage yield (APY).
Staking pools, including those offered through crypto exchanges, allow more ETH holders to participate and earn passive income.
The chart below shows that more than 13 million ETH is currently locked up in staking contracts, much of it through third-party mining pools. This is equivalent to $22 billion around INR 1 trillion of ETH, nearly 11% of the total supply.
It is important to note that the merge will not allow current validators to withdraw their staked ETH. Withdrawing will only be possible once the Shanghai upgrade is completed at a later date.
Lido DAO and Ethereum Staking
Current Ethereum validators have options to get liquidity before the next upgrade occurs.
Lido DAO is a liquid staking solution. Here’s how it works: In return for stakers locking up their tokens, they receive liquid tokens called stETH, or staked ETH.
This solution launched in December 2020, a few weeks after Ethereum’s Beacon Chain enabled staking. It has since become the dominant market leader for Ethereum liquid staking, amassing over an 80% market share early this year. It is also decentralized, unlike a lot of liquid staking options.
Using Lido, stakers receive the ETH staking rewards yet can also use the stETH tokens they receive to earn extra yield or trade across the decentralized finance ecosystem.
While the stETH/ETH relationship should theoretically be 1-to-1, this hasn’t always been the case. Amid the contagion crisis that eventually saw the centralized crypto lender Celsius file for bankruptcy in June, stETH was trading at a discount to ETH of up to 8%.
This reflected the extreme fear in the market and the knowledge that Celsius was holding a lot of stETH on their balance sheet, desperate for liquidity when they had suspended customer withdrawals.
How Much Can You Make Staking ETH?
There is no fixed rate for how much ETH staking pays. Instead, it will vary depending on the number of participating validators at any given time. When fewer validators exist, the protocol increases rewards to incentivize more stakers to join.
Currently, stakers are earning roughly 5% to 20% annually. But some analysts predict that this could jump up to 8% or higher once the merge occurs before dropping back down.
In terms of dollar gains, the percentage rate for the yield earned will be contingent not only upon this gross rate but also upon the Ethereum price, which has shown extreme volatility. ETH has shed more than 54% of its value this year alone.
Is Staking Ethereum a Good Idea?
If you anticipate holding Ethereum over the long term, staking could be worthwhile. The incremental yield earned will boost the total ETH you hold.
There are situations where staking may not be suitable. For one, you sacrifice liquidity as the ETH will be locked up for several months.
While protocols such as the aforementioned Lido can help, there’s no guarantee that market sentiments won’t suddenly change and change the stETH/ETH rate off a 1-to-1 ratio. The stablecoin market meltdown in May 2022 offers a cautionary tale.
The most important consideration here is your time horizon and willingness to hang on to ETH.
Ethereum, like other cryptocurrencies, is a volatile, high-risk investment that can quickly shift directions. Before investing in Ethereum or any crypto, you should do your due diligence and be prepared for the volatile nature of this type of investment.