Opportunities and risks with staking Eth

If you're not familiar with Ethereum, then there are a few things that you should know. Ethereum is a cryptocurrency invented in 2015, 5 years after the launch of the Bitcoin network. The founders decided that a successful cryptocurrency ought to have programmable functionality to it. They created the Ethereum network to operate as a virtual computer, hosted by permissionless nodes tied together with a native currency, Eth, secured by a proof-of-work (PoW) algorithm. Ethereum differentiates itself from Bitcoin with its native ability to use "smart contracts," which can automate payments and provide contract finality and immutability.

Since 2015, much development has occurred; interest in the crypto space has grown, Eth usage has grown, and cryptography has made significant developments. Ethereum is now working towards a significant change to its protocol to address some current challenges and provide a better, faster, more efficient network. This article discusses Ethereum's current challenges, the proposed change to allow staking and potential opportunities and risks with the upgrade.

Why Ethereum is evolving – heat, fees and speeds

Two of the main problems for users of Ethereum are the cost to transact and the speed of the transaction. Recent periods of high volume saw transaction fees go above the equivalent of 14 USD. The upgrade will also address the vast amounts of energy consumed with PoW.

Decentralized finance(DeFi) has grown this year from 670 million to 14.4 billion USD in locked contracts. These contracts are primarily held on the Ethereum network and provide decentralized financial instruments. This year, the average transaction fee has grown from about 0.09 to around 2.00 USD, driven by transaction volume growth. These high transaction fees show that Ethereum's current max transaction rate of 15 transactions per second is inadequate to meet current demand. Since the transaction volume is limited, users increase their transaction fees to ensure their transactions are included in the next block.

Bitcoin, Ethereum and most other cryptocurrencies rely on PoW to secure their network. This network activity uses vast amounts of energy. Essentially, computers are engaged in a competitive guessing game where the winner gets a reward in the native currency and the right to validate the next block in the blockchain. When a new block is created, the other computers quickly check to see if the new block satisfies the requirements then moves onto the next guessing game. There is a block in Bitcoin every 10 minutes; in Ethereum, it's about 8 to 12 seconds. PoW incentivizes honest players because there are real costs associated with mining equipment and operations. These networks are now large enough that would-be attackers would need billions of dollars of equipment to pull off a brute force attack.

Since 2013, custom hardware has been manufactured to mine bitcoin. Since then, bitcoin mining has gradually consumed more and more energy. Current estimates put global bitcoin (just bitcoin) mining energy requirements between 60 and 70 Twh per year. This is in the ballpark of the annual energy consumption for the nations of Switzerland or Austria. Burning energy to solve "arbitrary math problems" fuels much criticism against PoW blockchains.

Staking explained

Proof-of-stake (PoS), as opposed to PoW, secures the network by using posted collateral to give validators the right to create blocks. Rather than mining, a user can deposit a sum of value (in Ethereum, Eth), which gives them the right to be a validator. However, if that validator is found to be dishonest or fails to perform its validation correctly, it can have some or all of its deposit slashed (destroyed). A crucial implication of the shift to PoS is that it uses magnitudes less energy than PoW.

There are several blockchain networks that are secured through PoS, hundreds. Seven have market caps above 1B USD: Cardano, Polkador, Binance Coin, Stellar, Neo, Cosmos and Dash. Proponents of these chains are likely to point out that they are already functioning and have higher throughput capabilities than Ethereum. Additionally, Ethereum's move to PoS is complicated because it started with PoW and needs to include the PoW chain into the new protocol. Proponents of Ethereum may point out that the total market cap of all existing PoS chains is 28 billion USD. In comparison, Eth is 67 billion USD, not to mention tokens are running on the Ethereum network which amount to more than 30 billion USD.

The transition to PoS will take several steps and will result in what is being called Eth2. Eth2 will be a PoS network that will implement sharding to have several blockchains working together in the same network. This upgrade will theoretically increase the transaction throughput from 15 to 100,000 transactions per second and reduce the power requirements by several orders of magnitude.

Ethereum Staking

So how does one stake?

As a solo validator, you are required to have 32 Eth to stake, roughly 19,000 USD currently. Then you need to run a validator node, which can be as minimal as a micro PC, with decent RAM and a large enough SSD. A validator node doesn't require excessive power but should be continuously online to avoid the risk of having some of your 32 Eth stake slashed. Other than a constant internet and power supply, the computer hardware required is minimal compared to the value of staked Eth. The reward for running a validator node will range from 1.56% to 18.10% ARR depending on how many validators are running. A stake of 32 Eth could be worth 37.792 Eth by the end of the first year. Will 37.792 Eth be worth more than 19,000 USD?

Staking Risks

The transition to Eth2 will be completed in several steps. The first live step, beacon chain, has just recently launched. With beacon chain, enthusiastic, long-term investors can begin to stake their Eth. However, it should be considered as a very high-risk endeavour because the Eth staked on the beacon chain will not be eligible for withdrawal until Eth2 is launched at the end of 2021 (best case scenario), or an alternative means of withdrawal is developed.

There are several real risks to being a validator at the start of beacon chain. You could make a mistake and send your funds to the wrong address, losing your stake, or you could be connected to a client that has a network-wide failure, which could cause your stake to be slashed. Or, if there is price fluctuation, up or down, you may want to withdraw your funds to take advantage or stop losses.

Staking Opportunities

Aside from the opportunity to earn Eth as a reward for being a validator discussed above, there are generally three different business opportunities to support the Eth stakers. Creating and hosting validator pools, hosting validator nodes and providing developer tools and services.

As with PoW mining, there will be pools whereby validators can combine their Eth to meet the required 32 Eth for staking. Pools will allow would-be stakers with less than 32 Eth with the ability to be a validator in exchange for a fee taken from the revenues going to the pool operators.

Node hosting services allow a third party to host the validator node for the staker, reducing the skills and equipment required to be a staker. Successful node hosting businesses will need to have redundant power and internet sources and have stringent physical and digital security.

Rocket Pool has been around since 2017 and has made significant progress in offering services to stakers, having launched a beta product before the beacon chain went live. They will be providing a decentralized pool service, a node hosting service, and development tools for dApps, wallets, and DEXs to offer staking services. However, their services will not be available until a few other conditions are met, such as a withdraw contract being enabled.

Staked is a business poised and ready to host your Eth2 validator node. They have the infrastructure to provide non-custodial node hosting through third-party platforms AWS and Google Cloud.

Many businesses operating within the Eth1 community provide developer services that are undoubtedly going to provide services to assist those working on Eth2. ConsenSys, arguably the largest blockchain software technology company, has a relatively exhaustive list of developer tools here.

There are surely many more business opportunities not discussed here which will arise from Eth2 should it be successful. Just remember, early stakers have the potential for high rewards but also carry considerable risks.


"Steak" by tarale is licensed with CC BY-SA 2.0. To view a copy of this license, visit https://creativecommons.org/licenses/by-sa/2.0/

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