Cryptocurrency’s second biggest player, Ethereum, underwent a major transition known as the Merge in September, when its consensus mechanism switched from a proof-of-work protocol to one that uses proof of stake.
While developers — including Ethereum founder Vitalik Buterin himself — describe the overhaul as a given, chalking it all up to timing, the outcome is anything but known. As the aftermath of this historic shift plays out, crypto enthusiasts have two choices: wait and watch, or buy into the action, staking their Ether as the network expands.
What Is Ethereum Staking?
Ethereum staking refers to participation in Ethereum’s transaction validation process following its move to a proof-of-stake consensus protocol. When staking, users lock in, or “stake,” tokens on the blockchain in order to earn transaction validation opportunities that secure the network in exchange for rewards.
What Is Ethereum Staking?
Ethereum staking refers to the process of transaction validation on the Ethereum blockchain network. This method sees users lock in, or “stake,” the platform’s native coin, Ether, to qualify for validation privileges in order to earn rewards and help secure the network.
“Once tokens are staked, they’re on hold for an extended period to provide liquidity [respective to the amount of] staked Ether,” said Arie Trouw, software engineer and co-founder at XYO Network, a geospatial blockchain protocol.
Staking is quite different from more familiar concepts like investing, he explained: While investing in Ethereum is as simple as buying Ether and letting it sit in a wallet as the price fluctuates, staking, on the other hand, allows a user to earn tokens with interest, participate in liquidity pools, lending, yield farming and derivatives.
The reward for validating blocks is no longer fixed, as rewards once were under the prior proof-of-work consensus mechanism. A block’s value now depends on the number of active validators in a network and the total amount of staked funds paid into Ethereum’s protocol.
Validators can get paid in a few ways, according to Eugene Zomchak, product owner at CoinLoan, a crypto marketplace and lending platform where users can earn, borrow and trade digital assets.
The Perks of Being a Validator
- Developers can tip as an incentive to speed up block production.
- Validators can reorganize queued transactions, ordering them in a way that maximizes their profit from block production.
- Validators yield an annual return rate between 2 percent and 20 percent in passive income, according to Ethereum’s website.
Decentralized application, or dApp, developers may “tip” validators as an incentive to speed up transaction processing and prioritize their operations in the queue by including them in the next available block. Another method, known as maximum extractable value, is a way validators gain additional revenue by reorganizing the order of transactions on standby from the common memory pool before they are included in a new block.
“Because there are more validators, the Ethereum network has become more decentralized after the Merge.”
Like any type of financial investment, there are risks. If a user stakes a node that generates invalid blocks, Trouw said, then the stake is slashed and that user loses a portion of the stake. This ‘“slashing insurance” is there to keep validators accountable, and can be utilized to punish validators for inactivity or malicious actions.
“Because there are more validators, the Ethereum network has become more decentralized after the Merge,” he said. “This allows more dApps to function and more users to access the network.”
How Does Ethereum Staking Work?
To become a validator — essentially, authenticating transactions in order to form blocks on the blockchain — users need to deposit 32 Ether or join a collective staking pool, where users stake only a portion and receive rewards respective to their contribution. As for tools, these users must download software that enables transaction validation on devices required to run 24/7, with more than 900 terabytes in memory to spare.
“Any extra funds [beyond 32 Ether] will not give you any profit,” Zomchak said. “So it makes sense to leave them to form another validator.”
To kick off the validation process, a user stakes 32 Ether, then acquires validation privileges and must program their node accordingly. Once set up, a validator must wait to be selected to authenticate a transaction in part of the block production process. These are completed in time slots — a fixed time interval of 12 seconds during which a block is formed.
As time slots accumulate, they accrue into epochs, which are groups of 32 separate time slots that are each respectively 12 seconds. This totals 384 seconds, or 6.4 minutes, to form one epoch, he calculated.
The first block of an epoch is known as a checkpoint, which is followed by 31 regular blocks. Like the lid of a sandwich, Zomchak said, the next checkpoint block closes the sequence. This process is important to understand algorithmically, since the hash encoding the regular blocks from 2 to 32 refer to the first checkpoint block as its key base, creating a single chain that holds the epoch together.
To complete the validation process, each block within a time slot is voted for by one committee of validators, each having a minimum of 128 members. The maximum number of members is 2,048, however, anything more than that is considered redundant, Zomchak indicated. These 128 (or more) members are automatically and randomly elected to the committee from the general pool of Ethereum validators, fixed for the epoch duration.
“So, if we multiply 32 by 128, we get 4,096,” he said, “This serves as the minimum amount of collateral staking per committee.”
Furthermore, each committee is distributed over one time slot, forming 32 committees per each epoch. While one of the committee members validates a block, the remaining members can vote for this initiative. This kind of voting is called block attestation, Zomchak said. If approved, the block will become part of the main chain. At the end of an epoch, validators from the common pool are shuffled to form new committees for the next epoch. In total, there are at least 4,096 members per committee across 32 committees, equaling 131,072 Ether per epoch, Zomchak estimated.
The process rinses and repeats in entirety, ranging from a few seconds to several hours depending on network congestion.
Why Stake Ethereum?
“Validators are providing a public good for the network and getting paid for it,” said Habeeb Syed, a senior associate attorney at Vicente Sederberg LLP who specializes in advising startups in the cryptocurrency and blockchain space.
“Staking Ether is a low-risk way to put your tokens to work,” Syed added. “If you don’t want to go through the trouble of setting up your own validator, you can always use a centralized exchange or other platform which offer easier alternatives.”
“Ultimately, proof of stake does allow more people to participate in a more meaningful way on the network, and it makes usage of Ethereum more palatable without the energy waste controversy ... But it does not in and of itself make Ethereum more accessible for users.”
Sustainability and accessibility are reasons why users flock to Ethereum, according to Syed.
“Ultimately, proof of stake does allow more people to participate in a more meaningful way on the network, and it makes usage of Ethereum more palatable without the energy waste controversy,” Syed said. “But it does not in and of itself make Ethereum more accessible for users.”
The biggest barriers to accessibility that remain are gas fees and transaction speeds. A common misconception of Ethereum 2.0 is that the network would be faster and cheaper. Syed said that’s not the case.
“People purchasing Ether or transacting on the network for the first time may be confused by having to pay several dollars for a simple transaction,” Syed said, in a post-Merge market. While proof of stake significantly reduced Ethereum’s energy usage, gas fees have generally stayed the same. Though historic, the latest update has left room for improvement, potentially to be seen with additional upgrades down the line.
“We will need to wait and see what Ethereum has in store,” Syed said, “Or look to Layer 2 blockchains who build on top of Ethereum.”