September marked a long-awaited upgrade of the Ethereum (ETH) network to a proof-of-stake consensus mechanism.
Ethereum previously operated on a proof-of-work model similar to Bitcoin (BTC), which uses large amounts of electricity. It also led to scalability issues and high transaction fees.
By adopting proof-of-stake, experts claim that the Ethereum merger will reduce network power consumption by 99.95% and increase transaction speeds.
But what exactly is proof of stake? How can regular investors participate in Ethereum by staking themselves?
What is Ethereum Staking?
You’ve probably heard of cryptocurrency miners validating transactions on proof-of-work blockchains like Bitcoin.
Crypto miners solve complex mathematical puzzles with powerful computers that use large amounts of electricity.
Some prominent cryptocurrencies that use proof-of-work models, particularly Bitcoin, have drawn widespread criticism for their rapidly growing power consumption.
Staking is the main alternative to proof of work.
Rather than using powerful computers to solve mathematical puzzles, however, Ethereum staking involves locking ETH on the blockchain – staking it, so to speak – for the ability to validate transactions and report back. more ETH as a reward.
How does Ethereum staking work?
To become a validator – otherwise known as a staker – network participants must lock 32 ETH on the blockchain. That’s a tidy sum worth over £40,000 at today’s ETH prices.
Validators are then randomly assigned the responsibility of validating transactions, building new blocks, and maintaining the overall functionality of the blockchain. In exchange for locking up their ETH, stakers earn a return paid in ETH.
Yield will drop if a validator fails to validate a block once responsibility is assigned.
Validators can also be penalized under “slashing” (when the network confiscates some or all of a validator’s staked ETH) for engaging in malicious activities, such as colluding to incorrectly validate blocks.
Ethereum Staking Pools
Considering current prices, 32 ETH is a very high threshold to get involved in Ethereum staking. Most ordinary investors are not able to lock this amount of ETH to become validators.
This is where staking pools come in. They allow individuals to collaborate to achieve the minimum rating of 32 ETH required to become a validator. The corresponding rewards are then distributed on a pro-rata basis among the participants in the pool.
Ethereum does not have a native protocol that supports staking pools. Many large cryptocurrency exchanges, such as Kraken, and third parties offer Ethereum pooling features.
For example, Binance users can stake their Ethereum for an annual percentage yield (APY) of 6%.
Staking pools, including those offered through crypto exchanges, allow more ETH holders to participate and earn passive income.
How much can you earn by staking ETH?
There is no fixed rate for the amount of ETH staking. Instead, it will vary depending on the number of validators participating at any given time. When there are fewer validators, the protocol increases the rewards to entice more stakers to join.
Currently, punters earn around 4% to 7% per year.
In terms of sterling gains, the percentage of return you get will depend not only on this raw rate, but also on the Ethereum price, which has shown extreme volatility. ETH lost over 54% of its value in the last year alone.
Is Ethereum staking a good idea?
If you plan to hold Ethereum for the long term, staking might be worth it. The extra yield earned will increase the total ETH you hold.
There are situations where staking may not be suitable. On the one hand, you sacrifice liquidity because ETH will be locked for several months.
The most important consideration here is your time horizon and your willingness to hold on to ETH.
Ethereum, like other cryptocurrencies, is a volatile, high-risk investment that can change direction quickly. Before investing in Ethereum or any crypto, you should do your due diligence and be prepared for the volatile nature of this type of investment.