How Does Ethereum Staking Work? A Beginner’s Guide

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How Does Ethereum Staking Work? A Beginner’s Guide

Ethereum staking potentially presents an opportunity for investors to earn crypto investment income denominated in the crypto asset ETH. This guide will explain what Ethereum staking is and how it works. Also, you will learn about what could happen post-Merge.

What Is Ethereum Staking?

Ethereum staking is the act of locking up your ETH for a specific period of time to help keep the network secure. People that participate in Ethereum staking are called validators or stakers.

By staking their ETH tokens, validators are responsible for processing transactions and adding new blocks to the blockchain, thus maintaining and securing the Ethereum network. In return for their contribution to the Ethereum network, they earn newly minted ETH. 

Staking was introduced to Ethereum through the inception of the Beacon Chain, a proof of stake (PoS) consensus layer that, as of now, exists separate from the mainnet.

The Beacon Chain shipped in December 2020, but it doesn’t process transactions or manage smart contracts like the mainnet yet. Instead, it conducts and coordinates a network of stakers. 

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Ethereum’s Move From Proof of Work to Proof of Stake Explained

Ethereum has been running on a proof of work (PoW) consensus mechanism since it was launched. PoW blockchains require the use of energy-intensive machines, which are an environmental concern to many people in and outside the crypto space.

For this reason, Ethereum is shifting from PoW to PoS through an upgrade called The Merge. This upcoming Ethereum upgrade will ship in Q3 or Q4 2022. The project has also issued a soft deadline of September 19, 2022, but this could change.

Its implementation means the mainnet and the Beacon Chain will merge to form a single PoS blockchain. This will reduce the energy consumption of Ethereum by approximately 99.95%.

Once Ethereum has fully transitioned to PoS, mining will no longer be used to produce blocks.

But Where Will the Current Ethereum Miners Go?

Vitalik Buterin recently advised PoW enthusiasts to join Ethereum Classic, an Ethereum fork that runs on the original Ethereum code. Furthermore, analysts at Galois Capital predict that a fork could occur to maintain the current system since Ethereum has a large network of miners. If this happens, it could mean The Merge will be somewhat unsuccessful because rather than creating a single blockchain, it will lead to two parallel chains.

Having said that, the anticipation of the upcoming Ethereum network upgrade has led to the ETH price rallying. Nevertheless, only time will tell whether ETH will sustain the upward trend in the coming weeks and after The Merge.

How Does Ethereum Staking Work? 

Anyone interested in staking ether has to lock up their ETH to activate the validator client, a software that acts on behalf of the validator.

Stakers are required to stake their own funds because this way,  malicious actions can be discouraged on the part of stakers. The Ethereum protocol uses the stake to enforce financial consequences for dishonest behavior, something referred to as slashing.

The Ethereum network becomes stronger as more ETH is staked. For an attacker to gain control over the network, they would need to command a majority of the validators, which means controlling most of the ETH in circulation. That’s a lot of ETH to control, making an attack an expensive venture. 

Requirements

You need to stake at least 32 ETH to take part in the staking process. However, you can stake less (below 1 ETH) via cryptocurrency exchanges or pooled staking solutions (liquid staking). Investors that stake more ether earn more rewards. 

Stakers also need hardware and a reliable internet connection. If a staker doesn’t want the hassle of running and maintaining their own hardware, they can use staking-as-a-service (SaaS) solutions like Everstake, Kiln, and Launchnodes that take care of the hardware part.

Staking Options

The easiest way to stake Ethereum may be through registering an account with a crypto exchange like Binance. All you have to do is complete identity verification, deposit ETH to your exchange account, activate staking by locking some of your coins for a specified duration, and then wait to receive your rewards.

Crypto exchanges consolidate ETH from their users to run several validators, whose role is securing the Ethereum network and verifying transactions. 

Pooled staking is also an easy alternative. You can stake less than 1 ETH on staking pool solutions like Lido, RocketPool, stakefish, StaFi, and StakeWise. These pools allow many users to “pool” their funds to reach the 32ETH threshold required to activate a validator client.

Some pools may use smart contracts to facilitate staking. Users lock their funds in these smart contracts, which then issue them a liquidity token that represents the value of their stake. They can hold the liquidity token, use it as collateral on a DeFi lending protocol, or sell it. Users have to connect a DeFi wallet to stake through a staking pool. 

How It Works

On the Beacon Chain, a staker is randomly assigned the duty of proposing a new block and verifying the transactions within it. The remaining stakers then participate in a consensus finding process where they vote to add the new block of Ethereum transactions to the chain. 

Stakers will only receive their ETH rewards after the block has been added to the blockchain. A block is a data structure that holds the permanent record of transaction data. All blocks are linked (also called hashed) to each other, creating a virtually unbreakable chain. This means that to alter the transaction of one block, you have to change the data in the previous blocks too. This task is nearly impossible to execute in large crypto networks.

Staking will still run similarly on the single PoS Ethereum blockchain after The Merge. If a hard fork occurs, those that remain on the current PoW mainnet will not have access to Ethereum staking. 

Ethereum Staking APY: How Much Will Validators Earn? 

The question on everyone’s lips is: will stakers earn more post-Merge?

Probably yes, but not as much as anticipated. 

According to insights from IntoTheBlock, Ethereum staking yields will probably be lower than expected since people are staking more ETH, resulting in a drop in the rewards validators receive. That means the previously projected 12-15% annual percentage yield (APY) was probably too optimistic. 

IntoTheBlock forecasts the returns may fall within a range of 6-8% if The Merge ships in September 2022. This means the yield could double post-Merge since the yields at the time of writing for staking pools and running your own validator were 4.06% and 4.56%, respectively.

Crypto derivatives traders are reportedly also betting on yields doubling to 8% post-Merge. The current earnings from staking via an exchange or SaaS provider are currently below 4%. That could mean staking rewards on these platforms will rise to about 6-7%.  

FAQs

Can I withdraw staking rewards post-Merge?

Staked ETH will only be available for withdrawal after the Shanghai update, which comes after The Merge.

Why should I stake my ETH?

Firstly, staking ETH secures the network from attacks. The success of Ethereum rides on the network’s security. Secondly, staking rewards incentivize people to earn a passive income for their contribution to the Ethereum network. Lastly, staking is more environmentally-friendly than mining and doesn’t require power-intensive equipment.

Is ETH staking the same as mining Ethereum?

Staking is somewhat similar to mining ETH, but it’s not the same. Staking doesn’t necessitate buying expensive energy-intensive mining equipment that requires a high amount of energy to run. Conversely, mining doesn’t require participants to lock up their coins as collateral, making it difficult to punish malicious actors.

Will Ethereum staking rewards drop when more validators join?

When less ETH is staked, rewards are likely to be high to attract more validators to stake their ether and enhance network security. On the contrary, the staking reward drops as the amount of staked ETH increases. At the time of writing, the amount of staked ETH was over 13 million.