What is Ethereum Staking? How does it work? – Forbes Advisor INDIA

September marks the arrival of The Merge, the long-awaited upgrade of the Ethereum (ETH) network to a proof-of-stake consensus mechanism.

Ethereum currently runs on a proof-of-work model similar to Bitcoin (BTC), which consumes large amounts of electricity. It has also led to problems with scalability and high transaction fees.

Experts say that by adopting Proof of Stake, the Ethereum merger will reduce network energy consumption by 99.95% and increase transaction speeds.

But what exactly is Proof of Stake? How can regular investors get involved in Ethereum staking?

What is Ethereum Staking?

You’ve probably heard of cryptocurrency miners validating transactions on Proof-of-Work blockchains like Bitcoin.

Crypto miners solve complicated mathematical puzzles using high-performance computers that consume large amounts of electricity.

Some leading cryptocurrencies using proof-of-work models – notably Bitcoin – have drawn widespread criticism for their rapidly growing energy consumption.

Staking is the main alternative to Proof of Work. Once Ethereum accepts Proof of Stake, there will still be legions of volunteers validating transactions on the blockchain.

Rather than using high-performance computers to solve math puzzles, Ethereum staking involves locking ETH on the blockchain — staking it, so to speak — for the ability to validate transactions and receive more ETH as a reward.

How does Ethereum staking work?

To become a validator — also known as a staker — network participants must lock 32 ETH on the blockchain. That’s a tidy sum worth more than 39 lakh INR at today’s ETH prices.

Validators are then randomly tasked with the responsibility of validating transactions, building new blocks, and maintaining the overall functionality of the blockchain. In exchange for locking their ETH, stakers receive a return paid in ETH.

Yield drops if a validator fails to validate a block after being assigned responsibility.

Validators can also be penalized as part of “slashing” – when the network seizes some or all of a validator’s staked ETH – for malicious activities, such as B. Collusion to falsely validate blocks.

In theory, these incentives encourage validators to behave appropriately in order to earn passive income and avoid cutbacks.

In fact, Ethereum validators have been using staking for a few months now. The Beacon Chain, the updated proof-of-stake network that will “merge” into Ethereum’s main network around September 15, was originally launched on December 1, 2020.

Since then, investors have been able to participate in staking the network. Your ETH has been locked after staking until the newly upgraded blockchain is up and running.

Ethereum staking pools

Given current prices, 32 ETH is a very high threshold to get involved in Ethereum staking. Most ordinary investors are unable to lock up this amount of ETH to become validators.

This is where staking pools come in. They offer individuals the opportunity to work together to achieve the minimum grade of 32 ETH required to become a validator. Corresponding premiums are then divided proportionately among the pool participants.

Ethereum lacks a native protocol that supports staking pools. Many major cryptocurrency exchanges such as CoinDCX and Binance, as well as third-party providers, offer Ethereum pooling capabilities.

For example, CoinDCX users can stake their Ethereum for 5% – 20% annualized return percentage (APY).

Staking pools, including those offered through crypto exchanges, are allowing more ETH holders to participate and generate passive income.

The chart below shows that there are currently more than 13 million ETH locked up in staking contracts, much of it through third-party mining pools. This equates to $22 billion around INR 1 trillion ETH, almost 11% of the total supply.

It is important to note that the merger will not allow current validators to withdraw their staked ETH. A payout is only possible after the completion of the Shanghai upgrade at a later date.

Lido DAO and Ethereum Staking

Current Ethereum validators have options to get liquidity before the next upgrade.

Lido DAO is a liquid staking solution. Here’s how it works: In exchange for stakers locking their tokens, they receive liquid tokens called stETH, or staking ETH.

This solution was rolled out in December 2020, a few weeks after Ethereum’s Beacon Chain enabled staking. It has since become the dominant leader in Ethereum liquid staking, capturing over 80% market share earlier this year. It’s also decentralized, unlike many liquid staking options.

With Lido, stakers receive the ETH staking rewards, but can also use the stETH tokens they receive to earn additional income or trade across the decentralized finance ecosystem.

While the stETH/ETH relationship should theoretically be 1-to-1, this has not always been the case. Amid the contagion crisis that eventually led to centralized crypto lender Celsius filing for bankruptcy in June, stETH has been trading at a discount of up to 8% to ETH.

This reflected the extreme fear in the market and the knowledge that Celsius was holding a lot of stETH on its balance sheet and was desperate for liquidity when it had suspended customer withdrawals.

How Much Can You Earn By Wagering ETH?

There is no set rate for how much ETH staking pays out. Instead, it varies based on the number of validators participating at any given time. When there are fewer validators, the protocol increases rewards to encourage more stakers to join.

Currently, stakers earn around 5% to 20% annually. However, some analysts are predicting that this could rise to 8% or more post-merger before turning back down.

In terms of dollar gains, the percentage of return earned depends not only on this gross rate, but also on the Ethereum price, which has shown extreme volatility. ETH has lost more than 54% of its value this year alone.

Is Ethereum Staking a Good Idea?

If you plan to hold Ethereum for the long term, staking might be worth it. The excess return generated increases the total ETH you hold.

There are situations where staking may not be appropriate. For one, you sacrifice liquidity as ETH will be locked for several months.

While protocols like the Lido mentioned above can help, there is no guarantee that market sentiment will not suddenly shift and change the stETH/ETH price from a 1-to-1 ratio. The collapse of the stablecoin market in May 2022 offers a cautionary tale.

The most important consideration here is your time horizon and your willingness to stick with ETH.

Ethereum, like other cryptocurrencies, is a volatile, high-risk investment that can quickly change direction. Before investing in Ethereum or any other cryptocurrency, you should do your due diligence and be prepared for the volatility of this type of investment.

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