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Staking, all you need to know

Uncategorized Apr 19, 2021

Dear Crypto Enthusiasts,

In our previous article, we analyzed the fundamentals of staking and defined it as a digital work agreement that provides people all over the world exposure to the new, digital, web 3 economy. Anyone, in every corner corner of the world, can provide value to a crypto network and receive rewards for it, without asking for permission from anybody (aka permissionless). We will now further analyze blockchain staking at the blockchain protocol layer (also known as layer 1) in blockchains that have or will have Proof-of-Stake as a consensus algorithm, with particular reference to Ethereum.

The basic way staking at layer 1 works is following:

a) First, a user collateralizes value. Remember that in blockchain networks, value is represented virtually as tokens or cryptoassets. Blockchains enabled for the first time in history digital scarcity, key property for managing and storing value. This digital scarcity, not possible in web2 or web1, is embodied in digital tokens that can’t be copied or manipulated. This cryptoasset is then staked or locked in a protocol or network.

b) By locking the cryptoasset, one earns the right to provide digital work for a protocol. The work could be, for example, to run an open source software in a dedicated machine that syncs a digital, decentralized, ledger of transactions (aka running a blockchain node). In the Ethereum blockchain, as in other PoS platforms, the digital work consists specifically in validating transactions and adding new blocks of transactions to the blockchain. Stakers in these blockchains are also known as validators, and fulfill a similar role to miners in Proof-of-Work blockchains.

Syncing this database is crucial for achieving consensus in a decentralized network. Another important aspect is that the more nodes are running, the more secure and resilient the network will be against external attacks. All of these aspects are crucial for the survival and growth of the platform at absence of a central administrator.

c) The right to produce work is represented through a digital bond, which is issued through the protocol. This bond entitles the “digital worker” to periodic payments, as long as the staker provides services to the protocol.

 
Ethereum2 Digital Bonds were launched in December 2020 and currently have annualized yield of 8%. Source: Ethereum Launchpad

Digital, web3 bonds have similarities to bonds in the legacy financial industry, mainly because they entitle the holder to periodic payments. But they also have substantial differences, as they normally don’t have maturity (are perpetual) and don’t have counterparty risk: the protocol that pay out the returns is technically designed to be solvent and can’t default. For this reason, as we saw in the previous article, ETH 2 staking rate can develop into the risk-free rate of the Ethereum economy.

There are however, an important difference to traditional bonds that I want to highlight:

Web3 Internet bondholders are lenders of capital, labor, resources, and simultaneously owners and governors of the network.

We will expand on governance rights on a further article, but the basic idea is that the the earned tokens can be used to vote on future developments of the protocol. This is not true for Ethereum, as Ether the asset doesn’t grant governance rights, but it is true for other blockchain networks and for most of DeFi staking. The great majority of DeFi assets, which can be earned through staking or other forms of liquidity mining, are simultaneously governance tokens.

Be part of the web3 economy

As we saw, staking in Ethereum or other public blockchains is permissionless, which means that anyone can participate, doesn’t require permission from anybody, as long as you have an internet connection and some capital to invest. There are several ways to participate in Ethereum2 staking:

a) run your own node

It is now possible with consumer hardware and basic technical know how to run a full node in your own home. As we mentioned, the more nodes are running, the more decentralized the network is and hence the more resilient and censorship resistant will be.

 
Ethereum node map. Source

 

Ethereum 2 is designed for hundreds of thousands of validators to participate and maximize decentralization. Anyone will be able to run a validator without expensive infrastructure costs or strict maintenance requirements. The main requirement for participating as a full node is to stake 32 ETH.

If you have interest in participating, there are excellent tutorials from the the Bankless community, which you should definitely check out!

b) Delegated staking

There are numerous Staking-as-a-Service platforms which provide you with possibilities to participate in staking without running your own node. In delegated staking, it is possible to start with amount below 32 ETH, which makes them more accessible. Major Crypto Exchanges such as Kraken and Coinbase also offer staking services for all major PoS blockchains. Although more convenient and economically accessible, delegating staking come with an important downside: there is a centralization risk on having to depend and trust on a third party to correctly execute staking. From a network level, there is a risk that major players such as crypto exchanges centralize staking, which in turn makes the network more vulnerable. A good overview of different alternatives is provided by Staking Rewards. One interesting alternative worth to mention is Rocket Pool, which provide decentralized staking services. The product is still in testing but will soon be available for interested stakers.

 
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