Staking on Ethereum offers market participants the opportunity to earn yields on what could become crypto's first major deflationary asset.
Key Takeaways
- Ethereum is about to transition from Proof-of-Work to Proof-of-Stake.
- ETH holders can already stake their assets to earn yield.
- Liquid staking protocols, centralized exchanges, independent staking pools, and solo staking are the four major ways to earn yield by staking ETH.
“The Merge” is approaching, and ETH holders have the option to stake their assets through solo staking, independent staking pools, liquid staking protocols, and centralized exchanges. While each method slightly differs from the others, they have different benefits and risks.
Ethereum Prepares for the Merge
Ethereum is about to complete “the Merge” to Proof-of-Stake, and ETH holders have a chance to capitalize.
The Merge will see the world’s second-biggest blockchain switch off its Proof-of-Work consensus mechanism and turn to Proof-of-Stake. In moving away from Proof-of-Work, Ethereum will rely on validators rather than miners to verify transactions. ETH holders can validate the network by staking their assets. In return for their services, they can receive yield.
The Merge is expected to land sometime between September 13 and 15, but multiple staking options are already available for ETH holders. Ahead of Ethereum’s landmark event, this feature details the main ways ETH holders can use to stake their assets.
Liquid Staking Protocols
One of the most popular ways to stake ETH is through liquid staking protocols. The biggest on the market today are Lido and Rocket Pool (NASDAQ:POOL). Users can lock up their ETH and get rewarded with staked ETH tokens (stETH on Lido, rETH on Rocket Pool) representing their deposited assets.
Delegating ETH to liquid staking protocols is easy; all you need is an Ethereum wallet. Lido currently offers 3.8% APR, Rocket Pool offers 3.61% APR for staking, and 4.84% to those who want to stake their ETH and run their node. For comparison, solo staking on Ethereum currently earns about 4.1% APR.
The main benefit of liquid staking comes from receiving a liquid token. When users receive a staked ETH token representing their deposit, they can put it to work in DeFi protocols, increasing their yield. For example, depositing Lido’s stETH in the yield strategy protocol Yearn Finance currently earns roughly 7% APR, bringing the overall yield to almost 11%.
Liquid staking protocols like Lido and Rocket Pool carefully select validators to work with. Lido has a whitelist of industry-leading staking providers and keeps a community-owned scorecard to track the protocol’s staking performance. Rocket Pool, meanwhile, operates a policy that specifies that any losses incurred due to unreliable validators are shared across the Rocket Pool network to minimize the impact on single users.
While Lido and Rocket Pool are the most prominent players in the liquid staking game with $7.5 billion and $589.2 million in value, respectively locked, other prominent providers include Stakewise, StakeHound, Stader, Shared Stake, pStake, Claystack, and Tenderize.
With Lido dominating the space, some Ethereum community members have become concerned that it has decreased the network’s decentralization. According to Dune data compiled by hildobby, the protocol currently processes 30.4% of all staked ETH.
One risk of ETH staking is slashing—when the network punishes validator malfunction or misbehavior by burning the validator’s ETH stake. Lido and Rocket Pool has implemented measures to limit slashing, but other risks come with using them to stake.
The protocols could suffer from bugs or exploits, and their governance processes can be captured. Lido’s stETH also briefly lost its 1:1 parity with ETH in June by more than 5%, indicating that stETH and rETH should not be considered equivalents to ETH—they are derivatives.
Staking on Exchanges
Centralized exchanges offer convenient ways to stake ETH and earn yield. Most major crypto exchanges, including Coinbase (NASDAQ:COIN), Binance, and Kraken, offer staking services and plan to support Proof-of-Stake Ethereum following the Merge. Coinbase currently offers around 3.28% APR, Kraken offers between 4% and 7%, and Binance offers “up to 5.2%.”
Staking on centralized exchanges is arguably the easiest way to earn a yield on ETH. However, most exchanges require users to pass KYC (Know-Your-Customer) identification checks to open an account. Furthermore, these exchanges are custodial, meaning users entrust their funds to a third party. Crypto has seen several cases of users losing everything after entrusting companies with their assets in the past—ask Mt. Gox and Celsius customers.
Nevertheless, major exchanges provide a convenient and relatively secure conduit for staking ETH. A widespread assumption is that exchange-operated validators are unlikely to suffer from slashing. Coinbase has indicated that users may be compensated for slashed stakes even when the cause lies outside the exchange’s control.
Coinbase, Kraken, and Binance control 14.5%, 8.3%, and 6.6% of the total market share of staked ETH, making them the three biggest staking entities after Lido. This has led to further centralization concerns, especially in light of the Treasury Department’s recent move to sanction Tornado Cash.
The main concern is that U.S. exchanges like Coinbase or Kraken could be asked to censor transactions on the Ethereum base layer (the Ethereum community could respond by slashing their stakes). Coinbase CEO Brian Armstrong has stated that he would rather close Coinbase’s staking services than censor Ethereum if the issue ever arose in the future.
At the same time, Vitalik Buterin said that he would consider censorship an attack on the network. For now, though, the Treasury has not indicated that it plans to attack the Ethereum network.
Staking Pools and SaaS Providers
“Staking pool” is an umbrella term for any staking service provider that lets users contribute small amounts of ETH to a pool. As Ethereum requires users to deposit 32 ETH (over $54,000 at current prices) to become a validator, staking pools are popular options for those with a smaller stake to deposit.
Lido, Rocket Pool, Coinbase, and Kraken run their staking pools. Several “independent” staking pools can be used to stake ETH and earn yield.
Providing ETH to an independent staking pool is, in most cases, just as easy as staking through Lido or Coinbase. The more challenging task is picking the right staking pool. For innovative contract platforms like Ethereum, it’s helpful to ask whether the pool is open-source, audited, and trustless, whether it supports permissionless nodes, whether a bug bounty has been issued, and how diverse its validator set is.
Factors such as the staking service provider’s track record, reputation, security architecture, and asset volume are essential considerations for centralized entities.
Delegating to an independent staking pool helps increase Ethereum’s decentralization. Independent staking pools and solo validators account for less than half of the network’s staking power. They also tend to offer higher yields than other services: stakefish, for example, currently offers 6.67% APR, while Everstake offers 4.05% APR.
ETH holders can also use a Staking-as-a-Service (SaaS) platform to stake their assets. SaaS platforms offer an exceptional staking service by enabling users with sufficient ETH to rent a validator and delegate operations to a third party. SaaS platforms are widely thought to be less risky than independent staking pools, and they usually offer higher yields. However, they are only available to users holding 32 ETH.
It’s important to note that independent staking pools and SaaS platforms can expose users to the same risks as liquid staking providers and centralized exchanges. Exploits, bugs, withdrawal freezes, and slashing are all possible.
Solo Staking
The most apparent option for ETH holders looking to stake their assets is to set up their validator. This usually requires dedicated hardware, technical know-how, a solid Internet connection, and 32 ETH, but it’s arguably easier than running a mining rig. According to the Ethereum website, solo staking currently yields 4.1% APR, though this figure is expected to shoot up past 8% following the Merge.
Solo stakers participate in network consensus and contribute to Ethereum’s security and decentralization. They receive rewards directly from the protocol without paying management fees. The Ethereum Foundation encourages solo validating: according to Dune data compiled by hildobby, Vitalik Buterin has staked 6,976 ETH across 218 of his validators.
There are obvious risks associated with solo staking. Validators can have their funds slashed if their Internet connection goes down. Solo validators must guarantee uninterrupted network uptime, manage their private keys, monitor their node, and regularly update their client software.
Validating, therefore, does not quite qualify as a “passive income” strategy. Moreover, in extreme circumstances, users risk losing 32 ETH if they make a mistake setting up their node. Ethereum transactions are irreversible, so they risk losing their assets forever. For these reasons, solo staking is typically only recommended for more advanced users.
Final Thoughts Ahead of the Merge
Would-be stakers should note that any ETH staked on the network is locked and will be unavailable for retrieval even after the Merge. This applies to all Ethereum staking activity, whether through liquid staking protocols, centralized exchanges, independent staking pools, or solo validating.
Ethereum developers have stated that withdrawals will be enabled about six months after the Merge, meaning sometime in early 2023, but there’s no fixed date. Those who cannot afford to wait to retrieve their assets should consider whether staking ETH is the right option for them.
Finally, ETH holders should note that staking is not mandatory. Many ETH holders opt to hold their ETH in cold storage wallets (arguably the safest way to gain exposure to the asset) or on centralized exchanges. While earning yield has an upside, it comes with risk. Do your research and proceed with caution.