Does Ethereum's Move to Proof of Stake Affect ETH Staking

Cryptocurrencies
Does Ethereum's Move to Proof of Stake Affect ETH Staking

Ethereum successfully made a full transition from a Proof of Work to a Proof of Stake consensus mechanism on the 15th of September 2022. It was one of the biggest transitions in the blockchain industry’s history which will see the Ethereum network be about 99.95% more energy efficient and increase its scalability.

“What about staking? Does Ethereum’s move to Proof of Stake affect ETH staking?”

Staking allows ETH investors to potentially increase their returns and earn passive income thus any potential changes to ETH staking from the Ethereum Merge can and will have an impact on ETH investors. In this article, we look to answer the above questions.

ETH Staking: Pre Merge

Pre Ethereum Merge, if an individual and/or group of individuals wants to stake ETH, they had two options:

  • Stake ETH on the Beacon Chain (after December 1, 2020)

The Beacon Chain was launched to the public towards the end of 2020 and it served as a Proof of Stake testnet for Ethereum before the Ethereum Merge. According to the Ethereum website, the Beacon Chain “was created to ensure the proof-of-stake consensus logic was sound and sustainable before enabling it on Ethereum Mainnet.”

The Beacon Chain allowed participants to officially stake ETH on the Ethereum blockchain for the first time. Instead of competing against other miners to verify transactions, an algorithm selects validators based on their amount of staked ETH. In return for creating and validating new blocks in the chain, validators are rewarded with ETH. One thing to note is that until the Shanghai upgrade, staked ETH and staking rewards will be locked.

  • Stake ETH with third parties

Before the Beacon Chain and subsequently the Ethereum Merge, investors who were looking to stake their ETH can utilize liquidity staking services such as Lido Finance and Rocket Pool. In fact, as of April 2022, Lido Finance and Rocket Pool together make up 90.5% of the total ETH staking pools market.

ETH Staking: Post Merge

Ethereum’s move to Proof of Stake consensus mechanism has opened up more ways to stake ETH. Here are the four staking options currently available to participants:

  • Solo staking

Solo staking allows participants to set up and be their own validator. Participants are required to have dedicated hardware, technical know-how, internet connection, and 32 ETH. This staking option has the highest barrier to entry (technical and economic) however it also comes with the most benefits.

Because of their direct participation in Ethereum’s network security and consensus, participants receive rewards directly from the protocol without having to pay the management fees that the other staking options typically charge. Solo staking not only allows participants to potentially earn more rewards but also allows participants to have full control over their keys.

  • Staking as a service

Staking as a service is a form of staking service where participants deposit their 32 ETH to be a validator on Ethereum’s blockchain but delegate node operations to a third-party operator. Participants will allow the third party to operate the validator on their behalf in return for a monthly fee.

This is an option for participants with the necessary 32 ETH required to be a validator but without the technical know-how of running a node. A potential downside for staking as a service is that the third-party operator may act maliciously or become a target of attack or regulation themselves which can cause the participant to lose his or her staked ETH.

  • Pooled staking

Unlike staking as a service, pooled staking allows participants to be a validator with any amount of ETH. Staking pools allow participants to come together to pool their resources to reach the 32 ETH that is required to become a validator. These staking pool providers will run the validator for participants in exchange for a fee. As pooling functionality is not natively supported within Ethereum’s blockchain, these pooling services are currently built out separately either through smart contracts or off-chain.

A major downside with staking directly on Ethereum’s blockchain is that participants’ staked ETH and rewards are locked until the Shanghai upgrade. With pooled staking, participants receive liquidity tokens when they stake their ETH. Participants can redeem these liquidity tokens for ETH, sell, spend, and even use these liquidity tokens as collateral for on-chain lending. The downsides in using pooled staking are the potential risks that pooling services fail to properly perform validation causing participants to lose their staked ETH and the fees that these services charge.

  • Centralized exchanges

Many centralized exchanges provide participants with a convenient way to stake ETH. The process is typically straightforward and there are low to minimum staking requirements. The tradeoffs of using centralized exchanges are the fees and potential security issues. As centralized exchanges usually consolidate large pools of ETH, they become a “large centralized target and point of failure, making the network more vulnerable to attack or bugs.” This can put participants' staked ETH at risk.

Ethereum’s move to Proof of Stake has opened up more options for participants who are looking to stake their ETH. Participants can now directly contribute to the security of Ethereum’s network on top of just receiving rewards from staking. Participants who do not have the technical know-how can still stake their ETH using options such as staking as a service or centralized exchanges.

Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.