Before we dive into the fundamentals of staking it is important to understand the wider Ethereum network changes occurring today. Last year, Ethereum completed a long-awaited transition from a Proof-of-Work (PoW) to a Proof-of-Stake (PoS) consensus mechanism. This transition, dubbed “The Merge”, was Ethereum’s most ambitious and complex network upgrade to date and is expected to result in three major outcomes over time:
- Blockchain energy consumption reduced by 99%, as Ethereum’s network security now relies on a system of PoS validators rather than PoW miners to validate the state of the network.1
- Ether (ETH), the network’s native token will have the potential to generate rewards as a payment for helping secure the blockchain.
- ETH’s net token issuance to decrease to as low as 1.5% or even flip negative, which could result in a deflationary, store-of-value asset.
To participate as a validator or ‘staker’, one must commit 32 ETH (~$50k at time of writing) to a deposit contract (that remains inaccessible while performing validator duties) and run two instances of separate software: (i) an execution layer client (ETH1 client)—which processes transactions; and, (ii) a consensus layer client (ETH2 client)—which facilitates agreement among validators. Note that different implementations for ETH1 and ETH2 clients all perform the same duties to support the network but differ in the programming languages and are developed by different teams.
The basic structure of the blockchain is as follows—blocks filled with transactions are appended to the Ethereum blockchain every 12 seconds. Blocks are organized within a slot and are part of epochs that span every 6.4 minutes or 32 slots. In terms of responsibilities, validators are compensated every epoch for performing primarily two main duties—block proposals and attestations.
A validator is selected at random to be a block proposer for a given slot; the proposer is responsible for creating a new block and sending it to the other validators on the network. For each proposed block, validators within committees of a minimum group of 128 will each submit a message to confirm the accuracy of the block—this is called an attestation. From a validator’s perspective, attestations are far more frequent while block proposals are less so but receive a higher one-time reward.
There are four different ways for ETH holders to participate in staking:
- Custodial: custodial entities manage the entire staking process on behalf of users including handling both validator and withdrawal address private keys for users.
- Examples: Gemini, Coinbase
- Semi-custodial: semi-custodial staking providers handle the validator keys for users while users manage their own withdrawal address keys.
- Examples: Lido, Chorus One
- Non-custodial: non-custodial staking providers allow users to control all their private keys. Typically, these staking options are permissionless and streamline the validator management process.
- Examples: Rocket Pool, Blox Staking
- Solo Staking: solo staking refers to setting up a validator without a validator management service or requiring an additional protocol layer to facilitate the process.
- Examples: Using Ethereum.org’s Launchpad guide for setting up a validator
Figure 1 – Staking Methods
|Staking Methods||Managed staking system/th>||Who manages hardware infrastructure?||Keys Managed by Entity||Keys Managed by User||Fees to Entity||Permissionless?|
|Custodial||Yes||Entity||Node key, validator key(s), withdrawal address key||N/A||High||No|
|Semi-custodial||Yes||Entity||Node key, validator key(s)||Withdrawal address key||Medium||No|
|Non-custodial||Yes||User||N/A||Node key, validator key(s), withdrawal address key||None*||Yes|
|Solo Staking||No||User||N/A||Node key, validator key(s), withdrawal address key||None||Yes|
*While non-custodial node operators don’t pay a fee, note that Rocket Pool rETH stakers pay a commission to node operators
**Following the Shanghai upgrade, withdrawal keys will be required to move validator balances
Each staking option comes with tradeoffs for the end user depending on their needs. But for those who wish to fully control a validator end-to-end, non-custodial and solo staking are likely the best options though require more end-user involvement for set-up and maintenance. Custodial and semi-custodial options tend to charge fees to leverage their validator infrastructure and other services, sometimes taking as much as a 25% cut of validator rewards.
Within the staking ecosystem, at the time of writing this, the top 5 players in terms of volume of ETH staked are Lido, Coinbase, Kraken, Binance, and Stakefish, which represents a mix of custodial and semi-custodial options.1 To provide a sense of scale, Lido alone holds over 5.5M ETH at time of writing (approximately a third of the total staked ETH). Because of the substantial share of staked ETH that is centralized, these top 5 players alone carry heavy influence over the network. To minimize the risk of staking provider centralization, non-custodial solutions such as Rocket Pool as well as solo-staking can serve as viable alternatives for validators.
Liquid Staking Tokens
Liquid staking tokens (LSTs) allow one to delegate tokens to a service in return for a liquid, tradeable, and value-accruing version of ETH. LSTs allow users to avoid lockups and rather use a more liquid version of ETH. In the case of Ethereum, funds are currently inaccessible until a protocol upgrade called the ‘Shanghai upgrade’ occurs, which is estimated for April 2023. LSTs provide much needed liquidity to users who can then trade or potentially generate additional yield from the token.
Two examples of LSTs include Lido’s stETH and Rocket Pool’s rETH. At the time of writing, stETH is a top 15 coin by market cap with a market cap of $8.8B while rETH sits outside the top 100 with a market cap of $0.3B. As of August 2022, Coinbase also launched its own LST cbETH to offer users who are staking greater liquidity. While these example tokens are intended to track the value of staked ETH, these tokens may trade at a slight premium or discount. A common use case of LSTs is for users to stake the tokens on a decentralized exchange (DEX) such as Curve to generate additional returns via liquidity pools.
Ethereum clients—software programs that store a copy of the blockchain and participate in the consensus process of the Ethereum network—are essential to running validators and by extension the Ethereum ecosystem. Client diversity is a critical but often overlooked security issue for the Ethereum network. For context, Ethereum nodes are controlled by the client software that they run on; to run a validator, both an execution client and consensus client are required to process transactions. In the event of an issue with a client, validators using the client may experience downtime. When more than 1/3 of validators experience downtime, the network is halted as blocks cannot be finalized.2 Hence, it is important that validators choose non-dominant clients to reduce the risk of such an event that could jeopardize the network as well as individual validator funds.
The above visuals show the estimated distribution of (a) consensus clients and (b) execution clients at the time of writing. Client diversity for consensus clients is healthier with 40% share for the leading client compared to execution clients where Geth holds over 55% share.3 Overall, client diversity is expected to play a key role in network security and warrants close monitoring by validators.
At the time of writing, roughly 550,000 validators are active on the network and have collectively staked 17 million ETH (~15% of circulating supply). The estimated rewards (sometimes also referred to as an annual percentage yield or APY) for staking ETH is ~4%—this figure is not guaranteed and is variable depending on the number of validators staked as well as other variable factors such as rewards from maximal extractable value (MEV) and priority fees, which will be covered below.
ETH token Supply Issuance
Pre-Merge, the PoW execution layer executed the vast majority of new ETH token issuances, with 90% of rewards going to miners and 10% going to PoS validators. Post-Merge, the consensus layer issues all new ETH tokens, approximately 1,600 ETH per day. Over time, the rate of token issuance is expected to be ~0.50% annually (a net reduction of roughly 90%) and may even turn negative for sustained periods depending on the burn rate. Ethereum’s London upgrade in August of 2021 included EIP-1559, a network improvement proposal that set a fixed per-block burn fee aimed to reduce circulating supply over time. The amount of ETH burned increases with more network activity, specifically as gas fees increase given growing demand for block space. These changes combine to strengthen the fundamental investment profile of ETH as a deflationary store of value.
Ethereum Network economics
While Ethereum is currently supported by more than 550,000 validators and ~17 million staked ETH, as shown in Figure 2 below, the more total ETH staked the less total rewards distributed among validators; in other words, as of March 2023, the APY is ~4% (excluding priority fees & MEV rewards) but is variable depending on the active number of validators.
|Amount of ETH Staked (across validators)||Total Staked ETH (%)||ETH Reward per year||Est. Annual Return (%)|
**Return shown is not an indication or guarantee of future performance
In PoS chains, a higher number of independent validators means a more secure overall network as more individuals participate in overseeing the transaction verification process. This makes validator rewards crucial to post-Merge Ethereum. The effective balance for all validators is 32 ETH—while validators may deposit and hold a balance over 32 ETH, rewards are only based on 32 ETH (i.e. a validator with 32 ETH will reward the same rewards a validator with 100 ETH).
Every epoch (occurs every 6.4 minutes) rewards are transferred to validators. The reward amount earned varies on the validator’s duty and performance. Validators that perform poorly are penalized and their balance is either decreased (in the case of missed attestations) or fail to realize net new rewards (in the case of a missed block proposal). Although the current estimated annual return for a validator is ~4%, additional returns are heavily dependent on the variability of priority fees & MEV rewards, which are further explained below.
As detailed in the below table, validator rewards are broken up in the following two categories:
- Consensus Layer Rewards (inaccessible until withdrawals are allowed post Shanghai upgrade)
- Attestations: validators attest to blocks that are proposed to signal agreement
- Sync Committee: group of 512 validators that are chosen by the system randomly about once a day. These validators will sign and confirm important information for the Ethereum network, to support users with light clients.
- Block proposals: every slot a new block is proposed (every 12 seconds) and a randomly selected validator must propose the block
- Whistleblower rewards: validators are rewarded for flagging dishonest validators who act in a manner that appears to threaten the network
- Execution Layer Rewards (rewards accessible immediately)
- Transaction Tips (otherwise known as priority fees): transaction tips previously sent to miners in a PoW system are now sent directly to validators
- MEV rewards: MEV rewards are sent to validators who take payouts for transaction sequencing, and this reward was also formerly distributed to miners under a PoW system. Validators can adopt software such as MEV-boost to capture these extra rewards.
Figure 3 – Validator Reward Types
|Reward Category||Reward Accessibility||Reward Types|
|Consensus Layer Rewards||Inaccessible until withdrawals are supported in the Shanghai upgrade||Attestations, Block Proposals, Sync Committees, Whistleblower rewards|
|Execution Layer Rewards||Accessible immediately||Transaction tips (otherwise known as priority fees), MEV rewards|
Penalties and Slashing
Although there is the opportunity for rewards, validators are not guaranteed a positive return. Validators face the risk of financial loss if their performance (i.e. uptime) is poor or appear to threaten the Ethereum network. In other words, a validator’s responsibilities—to facilitate and secure the blockchain—can also be used to harm the network. There are two primary types of consequences to disincentivize poor validator performance or dishonest behavior:
- Slashing when the network detects malicious behavior, which could lead to more severe loss of funds
- Minor penalties when validator duties are missed because of downtime (i.e. less than 100% uptime)
Validators have their existing stake taken or “slashed” if they act in a manner that constitutes an attack on the network. Validators’ stakes can be slashed for the following two offenses: proposing more than one block in a single slot; and submitting contradictory attestations considered malicious by the network.
How much a validator’s stake is slashed depends on how many other validators are also slashed at the same time: the more validators that are slashed, the higher the slashing penalty. One common mistake that leads to slashing includes mishandling validator keys—in other words using the same validator keys on two servers simultaneously. Note that slashing doesn’t necessarily require malicious intent—it could happen by mistake from mishandling keys.
Validators are also penalized for downtime. A validator that is offline and not performing duties when called upon will face penalties roughly equivalent to the reward they would have received had they been online and performed duties. In the event where more than 1/3 of validators experience downtime for the duration of 4 epochs and blocks cannot be finalized, the blockchain enters an ‘inactivity leak’ mode where penalties become more severe.
The most common causes of downtime are loss of internet connection and hardware issues. For a sense of the severity of penalties, at the time of writing, one missed attestation equates to roughly 10,000 gwei ($0.02 USD) deducted.
To summarize, staking serves a key role in both the transaction verification process and securing the Ethereum network. By staking ETH and becoming a validator, individuals can contribute to the network's health and growth while potentially also earning rewards. To maintain network health, it is important that validators and other ecosystem participants weigh security considerations such as staking provider centralization and client diversity alongside economic incentives. As Ethereum continues to evolve, staking is likely to become an increasingly important aspect of its ecosystem, providing new opportunities and challenges for developers and users alike
Block: A unit of information that includes an ordered list of transactions and other blockchain information
Burn Rate: Annual rate at which tokens are removed from circulation due to fee burn implemented in Ethereum proposal EIP-1559
Deposit Contract: Public Ethereum address at which network participants transfer funds to as part of a process to become a validator on the network
Epoch: 32 slots totaling 6.4 minutes
Full client: Software used to interact with Ethereum. Full nodes store a copy of the blockchain enabling users to verify incoming data against a source of truth.
Gas fees: Virtual fuel used in Ethereum to execute transactions
Light client: A version of the full client software that does not require as much disk space or compute power. Light clients don’t maintain a copy of the whole blockchain and rely on full clients for many tasks.
Maximal Extractable Value (MEV): The maximal extractable value a validator can profit from reordering transactions within a block
Permissionless: Refers to a system or network in which participants can interact without needing approval from any central authority or any other participant
Priority Fees: An optional fee, or a tip, paid by a user to incentivize a validator to include the user’s transaction in the next block
Private Key: A private key is a string of characters that is used to approve transactions and prove wallet ownership
Proof-of-Stake: Consensus mechanism that requires validators to stake the native asset to assist in the transaction verification process
Proof-of-Work: Consensus mechanism that requires miners to expend effort solving computational puzzles
Shanghai Update: Forthcoming Ethereum upgrade in 2023 which will including, among other features, add the ability for validators to exit and withdraw funds
Slot: A period of time, 12 seconds, in which new blocks can be produced
Store of Value: An asset that can be saved and normally retains purchasing power into the future
Yield: the variable annual percentage yield (APY) a validator can expect to earn in ETH terms
- Ethereum’s energy usage will soon decrease by ~99.5%. Carl Beekhuizen. Ethereum Foundation. May 2021.
- Proof-of-Stake Rewards and Penalties. Paul Wackerow. Ethereum.org. November 2022.
- ClientDiversity.org. January 2023.
The Ethereum Merge. Jack Neureuter, Daniel Gray. Fidelity Digital Assets. September 2022.
Digital assets are speculative and highly volatile, can become illiquid at any time, and are for investors with a high-risk tolerance. Investors in digital assets could lose the entire value of their investment.
Staking digital assets involves a number of significant risks including but not limited to the loss of value of the token being staked due to excessive fluctuations in the crypto market; lack of liquidity or ability to withdraw the staked tokens; rewards being slashed due to malicious acts or inadvertent mistakes by staking providers; or the complete loss of staked assets due to a hack attack on a provider. Earning a return is not guaranteed. Staking is a highly complex activity that requires expertise and appropriate understanding of the technology involved.
The information provided herein is for informational purposes only and is not intended to constitute a recommendation, investment, tax, accounting or legal advice of any kind, or an offer or the solicitation of an offer to buy or sell securities or other assets. Please perform your own research and consult a qualified advisor to see if digital assets are an appropriate investment option.
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