The Reality of ETH Staking: Ethereum Proof of Stake Is a Regressive Capital Tax

Ethereum recently merged its original chain with a new Proof-of-Stake (PoS) chain. The PoS blockchain was fashioned after the original chain began recording massive costs and scalability problems. Developers intended to bring a better chain that lowers costs and increases speed. 

Controversy; The PoS Regressive Capital Tax System

However, the merger has faced a lot of criticism from investors. Even before the merger, there were questions about Ethereum PoS. Some experts claim that the new chain is a regressive capital tax system. 

The regressive capital tax claims have been backed by multiple critics, including a former Chinese Ethereum community leader and a Redditor. The Redditor, SenatusSPQR, actually said; 

“Proof of Stake is a regressive capital tax system. It leads to the rich getting richer, subsidized by the poor. The post below explains why this is the case and why this is worrying from a security perspective as this leads to ever less security and decentralization over time.”

A regressive capital tax system allows large capital holders to get richer at the expense of small capital holders. This system deters equality for Ethereum stakers. It means that lower-tier stakers earn minimal rewards. Ethereum PoS stakers are classified into four different tiers as follows; 

• Tier 1. Requirements include 32 ETH or 16 ETH when using a Rocket Pool. You get the utmost rewards ranging from 4% to 17%. 
• Tier 2 – Minimum requirements are 16/32ETH. You outsource a node, staking as a service tool. There are costs for outsourcing nodes that lower the rewards. 
• Tier 3 – No minimum stake. You add tokens to a staking pool. Rewards are calculated after deducting pool fees.
• Tier 4 – The lowest tier involves locking tokens to exchanges. The fees are super high, and the process is way less profitable. 

There’s a colossal difference in the earnings between tiers 1 and 2 compared to the bottom two tiers. That difference encourages larger stakers to continue staking, while smaller staker suffer the most costs. 

The Absurdity of Lower Tier Investors Paying High Staking Charges

Well, it’s absurd for small Ethereum stakers to carry the burden of paying super high fees. In Ethereum, staking and unstaking are blockchain transactions that require fee payments. 

Smaller stakers pay 0.05 ETH for staking and the same for unstaking. Moreover, the staking protocols and exchanges charge extra staking fees ranging from 10%-15% of the profits. Realize the smallholder is paying multiple fees for staking, unstaking, and pool.

Contrarily, large stakers who run their own nodes are required to pay a one-time 0.5 ETH staking charge. As such, stakers in tiers 3 and 4 generally incur higher costs. Now, considering their small capital, smaller stakers may opt to sell or hold the tokens in wallets since the costs of staking are incredibly high. 

Network Fees Controversy: Taking from the Poor, Giving to the Rich

As mentioned, Ethereum has a standard 4-tier system for staking and rewarding investors. However, not all Ethereum holders stake their coins.

Small stakers in the network chose not to stake because of the colossal requirements. However, they are charged transaction fees since they hold or use their tokens via the Ethereum network. The fee payment is a year-round occurrence. That means as long as you use ETH, you pay the fees.

How does ETH PoS generate staking rewards? Staking is not akin to mining where new miners earn mostly from newly produced tokens. In staking, the validators earn mainly from the network fees. The fees paid by traders to use the Ethereum network are collected together to pay staking rewards. 

Even when charging fees/gas, the Ethereum blockchain doesn’t care about the number of tokens investors hold in their wallets or transact. Persons/transactions paying higher gasses get priority over those paying lower gasses. For instance, a person who owns 100 ETH and pays 0.1 ETH as fees will be prioritized over a person holding 1 ETH and pays over 0.09 ETH. 

Small token holders must either force themselves to pay massive transaction fees or pay low fees and get inadequate services. This is unrealistic as it discourages small Ethereum holders, who are the majority (over 80%), from transacting.

Remember, small holders don’t stake because of high requirements. Therefore, the fees generated mainly by small traders are then used to reward more prominent traders. Larger investors will continue staking to gain even more rewards from staking fees. In the long run, the smaller traders’ holding reduces, while the wealthy investor gets richer. ETH PoS redistributes value from the poor to the rich. 

Ethereum PoS Poses a Centralization Risk

While it’s already a problem to steal from the poor and give to the rich, Ethereum’s problems worsen. How now?

Remember, large investors gain money at the expense of small investors. In the long term, large investors continue to accumulate more and more Ethereum network tokens. Most Ethereum tokens are gradually moving to the hands of a few whales or large investors. This creates a centralization problem where few people control most of the Ethereum network.

The first 2 tiers consist of node validators. According to reports, following the merger the number of node validators increased to over 435 thousand. These top validators earn way more than the average stakers. Furthermore, a few large sized companies Lido, Binance, Coinbase and Kraken run most (59%) Ethereum staking pools. This fosters centralization. 

Centralization in the crypto sphere is a threat to financial security. Every day the Ethereum network is on, it becomes more centralized, hence more insecure. 

In Conclusion

While Ethereum’s PoS move was good for gas fees and scalability of the network, there’s a dark side to the move. The Ethereum network creates more wealth for a few large-scale investors. The rich get richer while the poor lose out. The staking fees discourage holders of small capital from participating in the activity. Moreover, the staking mechanism continuously takes funds from the poor to the rich through network fees. As such, Ethereum PoS will increasingly become centralized in the long run.