What the Ethereum union means for cryptocurrency staking rewards

  • Ethereum recently renewed its protocol from proof-of-work model to proof-of-stake model.
  • Industry analysts have predicted that this update could triple Ethereum’s current staking yields.
  • Here’s how staking will change in light of the Ethereum merger and what it means for returns.
  • This article is part of “Master Your Crypto”, an Insider Series that helps investors improve their cryptocurrency skills and knowledge.

The long-awaited Ethereum merger on Thursday, Sept. 15, in which the blockchain shifted its protocol from a proof-of-work consensus model to a much more energy-efficient proof-of-stake consensus model, will surely be immortalized as one of the most important events in the history of cryptocurrencies. It represents the next evolution of digital assets and future growth in space, according to Thomas Perfumo, head of strategy at Kraken, which is currently the fourth largest cryptocurrency exchange in the world.

There is another reason why the merge was so important, Perfumo told Insider: Eventually, it will all by itself increase the total market cap of staking cryptocurrencies from 25% to 30% to over 50%. .

For context, proof-of-work protocols like Bitcoin verify blockchain transactions by having miners solve computational puzzles, while proof-of-stake systems like those employed by Solana, Cardano, and Polkadot choose random validators that have wagered or blocked their crypto assets – for up to two to three weeks. Although validators are chosen randomly, they are more likely to be selected if they have a higher stake and have held the stake for a longer period of time than others.

How investors make money from staking

Similar to holding a stock dividend, investors who bet on their own cryptocurrencies are theoretically able to benefit in two ways: from the appreciation of the price of the underlying asset and the additional reward they earn each time they verify a transaction, known as a percentage rate. annual, or April.

Since Ethereum validators also earn commission on gas, higher transaction volumes mean a higher return. And since each block only has a fixed number of rewards, the reward rate decreases as the total number of staking validators and cryptocurrencies vying for those rewards increases.

As validators take risks through their exposure to the underlying asset, investors shouldn’t buy cryptocurrency solely for its April potential, Perfumo said. “But if you have a belief in Ethereum in your time horizon and believe that staking offers you a way to increase rewards on the asset while holding it, it seems like a good idea,” he added.

Prior to the merger, Ethereum holders could bet on its Beacon Chain, with one big caveat: they could not withdraw their assets, which means that the percentage of Ethereum staked has only grown over time. But withdrawals are expected to be allowed once the Shanghai fork of the merger is completed within the next six to nine months, Perfumo estimates.

While in theory, every cryptocurrency holder can bet on their own instead of betting on an exchange, in practice it is much more difficult to bet alone because validators have to constantly monitor the software or risk paying a penalty for inactivity. Ethereum also requires all solo validators to contain at least 32 ether before they can be staking, and node and server costs can add up quickly, Perfumo said.

On the other hand, exchanges like Kraken and Lido, which accept a performance fee, allow users to contribute an amount of their choice and can also minimize the cut penalties through redundancy mechanisms. Since Lido offers users a derived ETH token for each ether they bet, users are even able to cancel the stake of their coins simply by swapping the two currencies. But as these exchanges effectively manage the custody of a user’s assets, Perfumo stressed the importance of choosing a reliable exchange to minimize counterparty risk.

Lido currently lists its Ethereum APR at 3.8%, while Kraken advertises its annual Ethereum rewards rate of between 4% and 7% due to the variability between the transaction demand and the offer of validators, Perfumo explained. He added that rewards differ between blockchain protocols as newer ones might offer higher base returns for circulating the currency supply, while more mature networks with large validation networks like Ethereum offer a smaller percentage of new tokens than to the total offer.

Stakers will now earn all rewards after merging

One of the biggest post-merge benefits is that the rewards pool for validators has now significantly increased, said AD, a pseudonym used by Lido’s head of marketing and community.

“Yields are expected to rise as the fees that flowed to the miners will now go to the stakers,” he told Insider. “You are moving from a return that is currently around 3.8% – it varies slightly – but our modeling shows that it will potentially double or even triple.” Lido’s estimates are in line with estimates made earlier this year by other cryptocurrency analysts that post-merge staking returns could rise between 7% to 15%.

However, Perfumo says the exact percentages of post-union rewards are difficult to predict, especially as the aether becomes more liquid within months.

“If people can cancel staking, the reward rate will be more variable, meaning it can rise and fall, depending on how many people are staking. It is possible that over time the reward rate may skew to disadvantage because the resulting liquidity the possibility of unstake encourages people to bet, “he explained.

Additionally, platforms could reduce reward rates to compensate for the fact that mining is much higher in power consumption than staking. “You don’t need to have such a large incentive model to encourage validators to work on the platform,” said Perfumo.

Since he believes that Ethereum’s rewards may not necessarily increase after the merge, Perfumo stressed that investors should still keep their personal time horizons in mind when it comes to Ethereum staking and only consider staking if they are on their own. comfortable with blocking their resources for at least another six months.

This article is intended to provide generalized information designed to educate a large segment of the public; does not provide personalized investment, legal or other commercial and professional advice. Before taking any action, you should always consult your financial, legal, tax, investment or other professional for advice on matters that affect you and / or your business.

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