ETH 2.0 staking, explained
Creating yield with cryptocurrency today is as simple as buying dividend income from stocks and shares. That’s the real thing that has pushed cryptocurrency investment adoption to the masses, both retail and institutional.
Consider investments in top FTSE 100 shares in the UK, for example. Companies like this rarely have stable yields of more than around 3% year on year. So say I have a net worth of a couple of million dollars, and liquid capital to invest of around $150,000.
Why would I invest my hard-earned cash in AstraZeneca or Unilever where I can expect glacial share price growth and pitiful yields?
When I could buy ETH instead and stake it to get 12% a year?
Do you know how much compound interest you can make with 12% instead of 3% per year? It’s quite a lot. Take my $150,000 and set it to work gaining reinvested dividend income for 10 years at 3%. In a decade my original stake will be worth $201,587.
At 12%? That same capital sum set aside for a decade would be worth a whopping $465,877.
The new Proof of Stake Ethereum 2.0 chain essentially replaces miners with ‘validators’, who bet or stake their coins in order to verify blocks of transactions.
When validators verify blocks, they get rewards in the form of passive income. And it’s entirely possible to run your own validator node for Ethereum’s new chain. So what does it take?
Running a validator node for ETH requires a 365-day lockup and a minimum balance of 32ETH, worth around $20,000 at today’s prices. The process is pretty complex, comes with a whole host of risks, and would take far longer than we have in this article to explain fully.
One way to do it is to use DappNode, and there’s a really good outline by Raymond Durk on Medium here, if you’re interested.
In a nutshell, you need a really fast PC that is online 100% of the time. If your internet connection fails then you could lose your staked deposit. If your validator is online and chosen, you earn some level of ETH as a reward. But if your validator is offline at the time you are chosen, you’ll be penalised for missing it.
And you will need to have enough hard drive space to contain the growth of the chain. As Durk writes: “At the time of writing, the size of the blockchain for Geth is 467GB while it is 304GB for Parity to run a full node.” As the popularity of ETH2 increases and the size of the chain grows, space will become a premium.
In six months in 2017 crypto underwent its first breakout bull market, and the size of the Ethereum blockchain tripled from 10GB to 31GB, Durk notes. Then it increased in size another fivefold in a bull market that lasted two years.
Another, much simpler, way to leverage crypto for passive income rewards is via staking pools.
The staking model is attractive to a far wider range of users because it dispenses with the need for highly specialised technical skills.
It’s the same concept as a Bitcoin mining pool, really. Just as not all of us have the economies of scale available to us to run a factory full of high-end ASIC-chip Bitcoin mining rigs, so not all of us want the hassle of setting up incredibly complex and fragile computer systems.
I’d wager that for investors who require a more hands-off approach — and whether we are retail or institutional investors, that will be the vast majority — we would prefer to use a middleman like an ETH staking pool.
We take our crypto holdings, which can be as little as a fraction of an ETH, like 0.1ETH, and stake it with a provider like Cream Finance, Lido, or Rocketpool.
Most staking pools require you to link up an online wallet like Metamask in order to transfer your ETH to them. This is a pretty simple process. Just download the Metamask Chrome browser client, grab your online wallet address, head over to wherever you are keeping your crypto holdings and type in the Metamask address to transfer your crypto. Link Metamask to the staking pool and start earning passive crypto.
Cryptoexchanges can themselves run this staking-as-a-service and are likely to attract more interest from institutional investors seeking trustworthy, stable partners.
As attractive as a Rocketpool or Lido service may be, they remain fairly new, lacking in transparency and without the business bona fides to capture significant amounts of capital.
Regulated cryptoexchanges, by contrast, are far more visible and embedded in known financial architecture.
Coinbase announced on ETH2.0’s launch date in December that it would offer staking rewards. As per a blog post by chief product officer Surojit Chatterjee: “Coinbase intends to support ETH2 through staking an trading. Coinbase customers will be able to convery ETH in their Coinbase accounts to ETH2 and earn staking rewards. While staked ETH2 tokens remain locked on the beacon chain, Coinbase will also enable trading between ETH2, ETH and all other supported currencies providing liquidity for our customers.”
And San Francisco cryptoexchange Kraken reported on 8 December 2020 that its clients had put forward 100,000ETH (~$60m) for its new ETH 2.0 staking service.
The rewards for staking via a pool or through an exchange are hardly any smaller than running your own validator node.
Compare the percentage returns available: running a validator node offers an average annualised return of around 14.2%. Staking ETH through a third-party pooled service like a staking pool can earn an average of 13%, while through an exchange is more likely to earn in the region of 12%.
Early adopters, developers and the technically minded may want more control, and the incremental gains of running a validator node, but to most investors it will be unnecessarily complex. We know which method we’d choose.