What does Ethereum consolidation mean for Crypto staking rewards
- Ethereum recently revamped its protocol from Proof of Work to Proof of Stake model.
- Industry analysts predicted that this upgrade could triple Ethereum’s current revenue.
- Here’s how staking will change in light of the Ethereum consolidation – and what that means for the proceeds.
- This article is part of “Mastering Your Cryptocurrency,” an Insider series that helps investors improve their skills and knowledge of cryptocurrency.
The long-awaited merger of Ethereum on Thursday, September 15 – as the blockchain moved its protocol from Proof of Work to the more energy-efficient Proof of Stake consensus model – will surely be one of the most important events in crypto history. It marks the next evolution of digital assets and future growth in the space, according to Thomas Perfumo, head of strategy at Kraken, which is currently the fourth largest cryptocurrency exchange in the world.
Perfumo told Insider that there was another reason the merger was so important — ultimately, it would alone increase the overall market value of the crypto-assets stacked from 25% to 30% to more than 50%.
For context, Proof-of-Work protocols like Bitcoin validate blockchain transactions by having miners solve algorithmic puzzles, while Proof-of-Stake systems like those used by Solana, Cardano, and Polkadot randomly select validators who have bet – or closed off their crypto-assets – for a period of time. More than two to three weeks. While auditors are chosen at random, they are more likely to be selected if they have a larger stake and have held their stakes longer than others.
How do investors make money from taking risks?
Similar to holding dividend stocks, investors who participate in their cryptocurrency are theoretically able to benefit in two ways – from the rise in the price of the underlying asset, and from the additional bonus they earn each time they check out a transaction, known as the annual percentage, or APR.
Since Ethereum validators also earn gas fees, higher transaction volumes mean a higher return. And since each block only contains a fixed number of rewards, the reward rate decreases as the total number of validators and cryptocurrencies competing for those rewards increases.
Perfumo said that since auditors are taking risks with their exposure to the underlying asset, investors should not buy cryptocurrencies solely for a potential APR. “But if you have conviction in Ethereum over your time horizon and feel that staking offers you a way to increase the rewards on the asset while holding it, it seems like a good idea,” he added.
Prior to the merger, Ethereum owners were able to participate in their Beacon chain, with a big caveat – they were unable to withdraw their assets, which means that the percentage of Ethereum will grow over time. But withdrawals should be allowed once the Shanghai fork of the merger is complete within the next six to nine months, Perfumo estimates.
Although, in theory, each cryptocurrency holder can participate on their own rather than going into the exchange, in practice, it is very difficult to participate alone because the auditors have to constantly monitor the program or risk being fined for inactivity. Perfumo said that Ethereum also requires all single validators to hold at least 32 Ether before they can participate, and contract and server costs can increase rapidly.
On the other hand, exchanges like Kraken and Lido – which take a fee on the return – allow users to contribute an amount of their choice, and can also reduce mitigating penalties through redundancy mechanisms. Since Lido gives users one ETH derivative token for every Ether they share, users are able to redeem their coins simply by re-trading the two coins. But since these exchanges effectively manage the custody of user assets, Perfumo emphasized the importance of choosing a reliable exchange to reduce counterparty risk.
Perfumo explains that Lido is currently listing Ethereum’s annual percentage rate as 3.8%, while Kraken is reporting an annual Ethereum reward rate that ranges from 4% to 7% due to the discrepancy between transaction demand and audited supply. He added that the rewards differ between blockchain protocols because newer ones may offer higher base returns for a circulating supply of coins, while more mature networks with large verification networks such as Ethereum offer a lower percentage of new tokens relative to the total supply.
Criminals will now get all the rewards after merging
A.D., a pseudonym used by Lido’s head of marketing and community, said one of the biggest takeaways after the merger was that the pool of rewards for auditors had now increased dramatically.
“Revenues are expected to rise because the fees that used to flow to miners are now coming to stakeholders,” he explained to Insider. “You’re going from a yield that’s currently around 3.8% – slightly different – but our models show it’s likely to double or triple.” Lido’s estimate is in line with estimates made earlier this year by other crypto-analysts that post-merger returns may be inflated to between 7% to me 15th%.
However, Perfumo says that it is difficult to predict exact post-merger reward rates, especially as ether becomes more liquid within a few months.
“If people are allowed not to participate, the bonus rate will be more diverse, meaning it can go up and down, depending on how many people are betting. It is possible that over time, the bonus rate may shift to the downside because the liquidity generated by being able to buy encourages people to participate.”
Additionally, platforms may lower reward rates to compensate for the fact that mining is much higher in energy consumption than mining. “You don’t have to have such a huge incentive model to encourage auditors to work on the platform,” Perfumo said.
Since he believes that Ethereum’s rewards may not necessarily increase after the merger, Perfumo emphasized that investors should keep their personal time horizons in mind when it comes to at least another six months.
This article aims to provide general information designed to educate a broad cross-section of the public; It does not provide personal, legal or other professional investment advice. Before taking any action, you should always consult a financial, legal, tax, investment or other professional for advice on matters affecting you and/or your business.