The State of Staking Ahead of The Merge
As of this month, staked ETH is at 12,099,684.
While there are four key upgrades coming to the Ethereum network as a result of the Merge, one for the staking community to keep in mind is that the Merge will reduce barriers to entry for validators. To learn why that is the case, and other benefits of the Merge, read on.
One of the most significant outcomes of the move to PoS is that it will make Ethereum energy efficient. By shifting to a mechanism that would reduce energy requirements for Ethereum transactions by 99.95%, Ethereum will become the first major decentralized system to address its carbon footprint.
In addition, PoS will inherently change the network economics– by reducing the number of tokens created to pay validators by 90%, and by burning the tokens collected as transaction fees. By constricting the supply of Ether in circulation, PoS will make it more valuable.
However, the reason that the Merge is important for the staking community is that it will reduce barriers to entry for validators. The PoS mechanism is designed to ensure that every validator – whether they are an individual, or a whale with multiple nodes – gets an equal chance at earning rewards.
While being an independent validator still requires one to lock up at least 32 ETH, a number of staking protocols lower the liquidity requirements to participate in staking by allowing validators to pool their ETH. One such protocol is Rocket Pool DAO; ConsenSys is one of the 14 organizations supporting this decentralized protocol. We take a look at another such protocol, Lido DAO, later in the post.
The developer community has been hard at work, testing the Merge on a number of testnets since December 2021. The latest testnet, called the Kiln merge testnet, launched in March and will be the last one before the actual Merge. It is a good thing that the Core Devs are striving for perfection. No one has ever taken a multi-billion dollar network and transformed it in this way without shutting the whole thing down. It is better that the community spends the time to perfect the shift now rather than risk the ETH later.
Lido and Centralization
Getting users to stake their ETH without a definitive timeline for withdrawals, has been a challenge for the staking community. Of the total supply of Ether, only 9.32% are currently locked in staking, according to data from stakingrewards.com. Lido DAO is trying to address this challenge by incentivizing users to stake their ETH without foregoing liquidity.
Lido hits a sweet spot for the staking community – it allows a user to accrue rewards from staking their ETH, while also earning yield from other DeFi protocols. The way Lido enables this is by issuing a derivative token, stETH, in return for the ETH that a user deposits in its smart contracts. Users are then free to use the stETH to participate in other DeFi applications.
The success of Lido can be gauged from the fact that the protocol currently has ETH worth $10.6B locked in. It is the dominant player in Ethereum liquid staking, with nearly 86% share of the market.
However, when a player begins to gain monopoly, it runs the risk of becoming a threat to Ethereum’s core principle of decentralization. Lido addressed some of those concerns in its ‘roadmap to decentralization’, and reiterated its commitment to democratize network participation.
One thing Lido has in its favor is that it isn’t running the ~100K validators itself – it has 21 peer-reviewed node operators, each with less than 2% of the staked Ether. Its algorithm deliberately prioritizes operators that have the least number of validators so as to balance the distribution of validators between its numerous node operators.
More decentralization will make the Ethereum network more attractive for stakers, as well as more secure. As mentioned earlier, the PoS mechanism will provide each validator with an equal chance at earning staking rewards. As against the Proof of Work mechanism, which favors miners with the highest computing power, the PoS mechanism will randomly choose validators to verify transaction blocks.
Democratized participation in staking will also dramatically increase the cost of attacking the network. A staker will require at least 51% of the total staked ETH, worth tens of billions of dollars, to attack the network. In addition, once the miscreant is identified, their stake will be slashed, and they will be required to make a further investment to maintain the attack. Therefore, the high cost of maintaining an attack on the chain is designed to be a deterrent for stakers to sabotage the network.
The real focus for the ecosystem should rather be on how Lido is going to implement withdrawals and, furthermore, how the maximal extractable value (MEV) is going to be handled in the post-merge environment. MEV is the maximum economic value apart from the validating reward and gas fee that can be extracted from validating a block by including, excluding, or changing the order of transactions to be included in a block.
Withdrawals and Liquidity
If the Merge date gets pushed, so do withdrawals. This is because withdrawals will be enabled in the fork that will come after the Merge. The inability to withdraw ETH before the Merge will make liquidity (usually in the form of derivative tokens like stETH and rETH from protocols like Lido and RocketPool) even more of a focus.
We passed our Systems and Organization Control (SOC)2 Type 1 with no issues found. As mentioned in an earlier post, we will now begin the Type 2 rolling assessment with the aim to finish by the end of the year. While a SOC2 Type 1 assessment looks at how security processes are designed, the Type 2 assessment analyzes how robust these processes are over a period of time.
We have also been hard at work, re-engineering and improving our data gathering and reporting capabilities. Within the next few weeks we hope to release to production the ability to see individual rewards and penalties for every validator for every epoch — all callable via API with custom queries crafted by customers or us using GraphQL. If you want to know more, don’t hesitate to contact us.
There are so many great places to get detailed information on what’s happening with the Ethereum roadmap. A good place to start is Ben’s fortnightly update. Anthony Sassano’s Daily Gwei is also a fun daily update on all things Ethereum.