Saturday, January 16, 2021

Introducing Valid Points: The Risks and Rewards of Staking on Eth 2.0

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It’s alive! Welcome, everyone, to the first issue of Valid Points. 

Today, we’re commemorating the historic launch of Ethereum 2.0, which marks the beginning of Ethereum’s live transformation into a proof-of-stake blockchain. The new blockchain is said to be several times more efficient, scalable and secure than the current decentralized application network. 

While Ethereum 2.0 will take years to build out fully, its first phase of development, Phase 0, is now officially underway. With the activation of Phase 0, there’s a new use case for Ethereum’s native cryptocurrency, ether (ETH). It’s called staking. 

What is staking? How does it work? What is the risk/reward profile of using ether to stake on Ethereum 2.0? These are a few of the pressing questions that we’ll start to unpack over the next several months. We’ll also discuss the ramifications of Ethereum 2.0 development on the growing decentralized finance ecosystem, as well as on the competitive landscape of smart contract blockchain platforms. 

Our newsletter, chronicling the progress of Ethereum 2.0, beginning with its launch, will go out every Wednesday. To support our coverage of the network, CoinDesk will be staking its own funds – 32 ETH to be exact. The goal: deepen CoinDesk’s editorial coverage of Ethereum 2.0 and gain an unvarnished perspective on the next major iteration of the Ethereum blockchain. To that end, we’ll also be donating all proceeds from our staked ETH to charity. Read more about CoinDesk’s fact-finding mission on Ethereum 2.0 here. 

Now, let’s get started!

Pulse check

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Data as of Dec. 1, 22:58 UTC
Source: Dune Analytics and Beaconcha.in

There is a total of 900,129 ETH (roughly $532 million at time of writing) staked on Ethereum 2.0. That is 66% above the initial target for network launch. 

eth-2-valid-points-image-3

With more than enough funds and user participation to secure network operations, Ethereum 2.0 has successfully worked through its first epoch, meaning it has worked through its first cycle for creating and processing new blocks. 

As of 22:58 UTC on Dec. 1, a total of 100 epochs have been finalized through the participation of 21,291 validators. Validators can be thought of as the equivalent to miners on Ethereum who are responsible for securing the network and its data. 

Active validators on Ethereum 2.0 are on average earning 0.00403 ETH/day, or $2.36/day at time of writing, for their participation on the network. This amount will likely decrease as the number of validators on the network rises. 

income_distribution_v1
(Data as of Dec. 1 @22:58 UTC)

Each day, a maximum of 900 new validators can be onboarded to Ethereum 2.0. There are approximately 6,200 validators in the activation queue as of Tuesday waiting for entry into the network… and the CoinDesk Eth 2.0 validator is one of them. 

Read more on the status of our Eth 2.0 validator below. 

Charting New Frontiers

If you had invested in ether on Jan. 1, you’d be up 364% to date, according to the CoinDesk 20. 

And while that’s impressive, assets built on top of the Ethereum blockchain have seen even greater gains this year. Take, for example, this decentralized finance (DeFi) “blue chip” token: YFI – robo-hedge fund Yearn Finance’s governance token that didn’t exist a year ago – is up 2,300%, per Messari. Overall, the DeFi asset class is up 456% year-to-date against the dollar.

But not all were lucky: Lending protocol Compound’s token COMP dropped off a cliff after a very productive summer, down 55% year-to-date. 

Hits and misses with Ethereum tokens, and DeFi in general, may have some investors looking for more stable returns, particularly ones with less software risk. Which takes us to Ethereum 2.0 also known as Serenity, a proof-of-stake (PoS) blockchain promising stable returns on ETH deposits.

Stake it, baby

The proximity of “DeFi Summer” and Eth 2.0’s launch makes the pair a relatively straightforward comparison: If you have a DeFi coin sitting around, you’re more than likely to have some ether. Luckily for DeFi traders, the niche industry’s first bear market coincided with Ethereum’s relaunch and subsequent reward distribution. 

A PoS network, Eth 2.0’s rewards are denominated in ether and adhere to a distribution curve dependent on participation and average percent of stakers. A lot of Ethereum developers like to compare it to a bond, although this bond’s expiry relies more on GitHub pull requests merging on time than a corporate clerk mailing out checks.

When annualized, rewards per epoch (a period of time during which transactions are proposed and validated by token deposits) are competitive against some DeFi project rewards. 

Indeed, Eth 2.0 staking rewards start at some 20% for early stakers. They will continue to drop as more validators join the network to between 7% and 4.5% annually. 

For comparison, a snapshot of DeFi yields from more trusted projects shows yields sitting around 5%–7%, according to DeFi Rate. That’s not to say you can’t still find higher yield, but you do take on software risk which has determined the fate of many a DeFi project this year.

Eth 2.0: Risk and reward

Staking is risky as well, complete with different tradeoffs from DeFi. Not only can your initial deposit be slashed for failing to keep up with the network, but hidden software risks still exist.

Each Eth 2.0 validator has to choose its own specification to work with from five different teams that programmed Eth 2.0 in various languages. Those specifications could have exploitable flaws, regardless of how smoothly testing went throughout the second half of 2020. That’s one reason staking rewards are set so high by developers.

Some clients, moreover, were late to join the deposit contract party, leading to investors missing out on early high-yield opportunities. For example, Prysmatic Labs had breaking changes in its final implementation of the Eth 2.0 spec. Unfortunately, the client was not ready until after the deposit contract was filled up. Eager validators, including CoinDesk, are in queue for validation but will miss out on at least the first week’s juicy rewards.

Staking in Eth 2.0 also means your ether is locked up for months to years. You can look at it, but you can’t touch it. 

Secondary markets might be able to address concerns around the lock-up period, however. For example, Coinbase chief product officer Surojit Chatterjee announced yesterday the intention to create a market for staked ether, also known as Beacon Chain ETH (BETH) in a blog post. It’ll be interesting to see how liquid a BETH market becomes compared to other tokens, given the inherent counterparty risk associated with staking.

Thanks for reading. If you haven’t already, you can sign-up for our Valid Points newsletter here.

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