Galaxy: Detailing the risks and model adjustments of Ethereum’s staking economy

Written by: Christine Kim, Vice President of Galaxy Research

Compiled by: Luffy, Foresight News

This report provides a comprehensive overview of staking, how staking works on Ethereum, and important matters for stakeholders when participating in staking. This is the first of a three-part staking report series that will delve into the risks and rewards of various staking activities, including re-staking and liquidity re-staking. The second report will provide an overview of restaking, how staking works on Ethereum and Cosmos, and the important risks associated with restaking.

Introduction

Ethereum is the largest Proof-of-Stake (PoS) blockchain by total staking value. As of July 15, 2024, ETH holders have staked more than $111 billion worth of ETH, accounting for 28% of the total ETH supply. The amount of ETH staked is also known as Ethereum's "security budget" because stakers may be punished by the network in the event of double-spend attacks and other violations of the protocol rules. In return for maintaining the security of Ethereum, stakers are rewarded through protocol issuance, priority fees, and Maximum Extractable Value (MEV). Users can easily stake ETH through liquid staking pools without sacrificing the liquidity of the asset, which has created more demand for staking than Ethereum developers anticipated. Based on the current staking status, developers expect ETH’s staking rate to grow further in the coming years. To mitigate this trend, developers are considering significant changes to the protocol’s issuance policy.

This report will provide an overview of staking on Ethereum, including the types of staking users on Ethereum, the risks and rewards of staking, and predictions of staking rates. The report will also provide insights into developers’ proposals to change network issuance to curb staking demand.

Stakeholder Types

There are six main types of Ethereum users who can earn rewards by staking. The table below details their respective profiles:

Among these stakers, the largest number are custodial stakers, i.e. those stakers who delegate their ETH to professional staking node operators. Professional operators, although few in number, are the type of staking entity that manages the most staked ETH.

Liquidity staking, re-staking and liquidity re-staking pool protocols are not considered in the analysis here as these entities do not directly run the staking infrastructure or fund its use. However, these entities do receive a percentage of the rewards from stakers who use their platform; they are the middleman entities that facilitate the relationship between custodial stakers and professional (or amateur) stakers, and are therefore important participants in the Ethereum staking ecosystem By. Lido is a liquidity staking protocol that is by far the largest staking pool operator on Ethereum, accounting for 29% of ETH staked volume. Considering the adoption and critical role of liquidity staking pools on Ethereum, it is important to understand the risks of liquidity staking.

The next part of this report will dive into the risks of staking based on the technology and entities used to earn staking rewards.

Staking Risks

The risks associated with staking largely depend on the staking method and technology. Here are the three broad categories that define staking methods and their associated risks:

Direct Staking: Users or entities directly operate their proprietary staking hardware and software. The risks of directly staking ETH include staking penalties and slashing risks. Staking penalties due to long-term machine downtime and other reasons may cause users to lose part of their pledge rewards; in addition, reduction events due to validator software configuration errors and other reasons may cause users to lose part of their pledged ETH balance, up to 1 ETH.

Delegated staking: Users or entities entrust their ETH to professional or amateur pledgers for staking. The risks of entrusted staking include all the risks of direct staking, in addition to counterparty risk, as the entity you entrust to pledge may not fulfill its responsibilities or obligations. ETH holders can delegate their ETH to a trust-minimized staking service provider, such as an entity controlled through smart contract code, but this carries additional technical risks as the code may have vulnerabilities or the system may be hacked.

Liquidity Staking: Users or entities entrust professional or amateur stakers to stake and exchange for liquidity tokens representing their staked ETH. The risks of liquidity pledge include all risks of direct pledge and entrusted pledge. In addition, due to market volatility and delays in validator entry or exit, liquidity risk may lead to decoupling events where the value of liquid staking tokens deviates significantly from the value of the underlying staking assets.

三种不同方法质押的 ETH 总量

Another risk to be aware of with these three staking methods is regulatory risk. The further away an ETH holder is from their staking assets, the greater the regulatory risk for staking activity. Delegated staking and liquid staking require ETH holders to rely on different types of intermediary entities. In the view of legislators and regulators, these entities may need to comply with certain rules and regulatory frameworks in order to operate, depending on their structure and business model.

In addition to regulatory risks, protocol risks associated with these three types of staking activities also need to be detailed. Protocol risk arises from the fact that the network can initiate penalties against users who intentionally or unintentionally fail to meet the standards and rules in the Ethereum consensus protocol. There are three main types of punishment. Sorting from low to high severity is as follows:

• Offline Penalty: Penalty incurred when a node goes offline and fails to perform its duties (such as proposing blocks or signing block proofs). Typically, validators are only penalized a few dollars per day.
• Initial slash penalty: The penalty a validator receives when its violation of network rules is detected by other validators. The most common example is if a validator proposes two blocks for a slot or signs two proofs for the same block. Penalties range from 0.5 ETH to 1 ETH, depending on the validator’s effective balance, currently up to 32 ETH. Protocol developers are currently considering increasing the maximum valid validator balance to 2048 ETH and reducing the initial slash penalty in the next network-wide upgrade, Pectra.
• Related slashing penalties: After the initial slashing penalty, validators may be subject to a second penalty based on the total amount of stake slashed in the 18 days before and after the slashing event. The motivation for the associated penalty reduction is to measure the penalty based on the amount of stake managed by a validator who violates the network rules. The associated penalty is calculated based on the malicious validator’s effective balance, total balance, and proportional slash multiplier.

In addition to the above three penalties, special penalties can also be imposed on validators if the network fails to achieve finality. (For a detailed overview of Ethereum finality, see this Galaxy Research report) When the network fails to achieve finality, it imposes more severe penalties on offline validators. By gradually burning the staked shares of validators who have not contributed to the network consensus, the network can rebalance the validator set and thereby achieve finality. The longer the network fails to achieve finality, the greater the penalty.

Staking Rewards

Of course, while taking risks, stakers can also earn approximately 4% annualized return from the pledged ETH. These rewards come from new ETH issuance, priority fees that Ethereum users attach to their transactions, and MEV.

ETH 质押名义收益率

Please note that staker rewards have been steadily declining over the past 2 years, for two main reasons. First, the total amount of ETH staked and the number of validators increased. When the value of the stake increases, the validator's issuance reward is diluted, as shown below:

仅 ETH 发行支付的质押收益率

While the issuance reward can be calculated based on the total number of active validators and the amount of staked ETH on Ethereum, the validator The other two revenue streams are difficult to predict because they rely on online transaction activity.

Over the past two years, transaction activity has decreased, resulting in a decrease in validator base fees, priority fees, and MEV. Typically, the higher the value of assets being transferred on-chain, the higher the willingness of users to tip in order to prioritize those transactions in the next block, and the higher the MEV that seekers can profit from the reordering within the block. As shown in the chart below, the dollar value of Ethereum’s daily transfers correlates with transaction priority fees:

According to Galaxy’s calculations, MEV increases validator yields by approximately 1.2%. Validator rewards from MEV account for approximately 20% compared to other types of validator revenue, including new ETH issuance and priority fees. Some attribute MEV to additional value given to block proposers that does not come from priority fees or ETH issuance. However, others believe that a priority fee can itself represent MEV profit if it is funded through a successful front-running or reverse trade. To account for the fact that priority fees themselves may contain MEV, other methods compare the value of blocks built with MEV-Boost software to blocks built without MEV-Boost software.

The above chart shows that the size of MEV may be much larger than 20% of the validator reward. According to an analysis by Ethereum Foundation researcher Toni Wahrstätter in October 2023, the median block reward would increase by 400% if validators received blocks via MEV-Boost instead of building blocks locally.

质押率预测

假设以太坊上的质押需求像过去两年一样呈线性增长，那么预计 2024 年的质押率将超过 30%。如本报告前面所述，更高的质押率将减少新 ETH 发行带来的回报。以太坊上的流动质押服务使用户可以轻松质押并绕过入场队列等质押限制。用户只需购买 stETH 即可获得质押回报。大量购买 stETH 会导致公开市场上 stETH 的价值与基础质押资产的价值失衡，进而导致 stETH 溢价，直到以太坊上质押更多 ETH。与购买 stETH 不同，以太坊上的质押活动会有所延迟。每个 epoch（即 6.4 分钟）只能向以太坊添加 8 个新验证者或最多 256 ETH 的有效余额。因此，假设从现在到 2025 年底每个 epoch 的验证者数量都达到最大值，那么以太坊将需要一年多的时间（准确地说是 466 天）才能达到 50％的质押率。

从历史来看，进入以太坊质押队列的需求高于退出的需求。尽管最近几天验证者进入队列的活动有所减少，但由于各种原因，质押需求预计将再次飙升，包括但不限于通过再质押获得额外收益、DeFi 活动复苏带来的 MEV 增加，以及 ETF 等传统金融产品中支持质押活动的监管变化。

出入口队列验证者

开发人员知道，质押率再次走高和质押者收益下降只是时间问题，因此他们正在考虑几种改变网络发行以抑制质押需求的方案。

新 ETH 发行变更讨论

ETH 持有者应该知道，未来质押收益率将发生巨大变化。以太坊开发人员正在权衡多种选择，以确保以太坊的质押率趋向于目标阈值，例如 25% 或 12.5%。以太坊基金会研究员 Caspar Schwarz Schilling 解释称，维持低质押率的主要理由包括：

• 流动性质押代币 (LST) 主导地位：如果质押率增加，那么集中在一个质押池（如 Lido）中的 ETH 数量可能会增加，从而造成一个实体或智能合约应用程序的中心化风险，以及对以太坊安全性产生过大影响的风险。
• 削减的可信度：与对 LST 主导地位的担忧相关，高发行量流入到的单个实体或智能合约应用程序可能会降低以太坊上大规模削减事件的可信度。例如，如果发生影响大多数质押者的削减事件，该协议可能会面临来自 ETH 持有者的压力，这些持有者可能希望进行状态变更以恢复被处罚的质押 ETH 余额。以太坊在历史上仅进行过一次不定期的状态变更，那是在 2016 年臭名昭著的 The DAO 黑客事件之后。虽然可能性不大，但为响应大规模削减事件而进行不定期的状态变更并非不可能。事实上，一些以太坊研究人员认为，在高发行量的情况下，这种结果出现的可能性更高。
• ETH 才是无需信任的基础货币：高发行量可能导致流通中的原生 ETH 不足，以及第三方实体发行的流动性质押代币激增。以太坊研究人员表示，他们倾向于推广使用原生 ETH 进行质押以外的活动，而不是使用不那么去中心化的流动性质押代币。
• 最小可行发行量 (MVI)：尽管与挖矿成本相比，质押成本微不足道，但也不容忽视。专业质押提供商需要运行验证器所需的硬件和软件，因此需要支付运营成本。要通过这些提供商进行质押，用户必须向这些提供商支付费用。此外，即使用户通过质押原生 ETH 获得了流动质押代币，如果质押操作出现故障，他们也会因通过第三方进行质押而承担额外风险。因此，将质押成本保持在最低水平符合网络的利益，因为支持质押活动的额外成本意味着更高的发行量，从而导致 ETH 供应量膨胀。

以太坊开发人员和研究人员正在权衡各种降低以太坊质押率的提案。这些提案包括但不限于：

• In the short term, reduce staking rewards: In February 2024, Ethereum Foundation researchers Ansgar Dietrichs and Caspar Schwarz-Schilling once again proposed a one-time reduction in staking yields. The idea was originally proposed by Ethereum Foundation researcher Anders Elowsson. In Dietrichs and Schilling’s latest article, the researchers recommend cutting staking yields by 30%. However, this number specifically depends on Ethereum’s staking ratio. Given the rising staking ratio since February, researchers believe that the theoretically suggested yield cut should be higher. The proposal would require a simple code change to be implemented and would disincentivize the economic incentives of staking by reducing issuance rewards in the short term. The proposal is intended as an interim measure to pave the way for long-term solutions, such as targeted policies.
• Long term, staking ratio target: Implementing a new ETH issuance curve, the higher the staking rate exceeds the target ratio (e.g. 25% of the total ETH supply staked), the higher the cost for validators to stake and receive rewards. This idea is based on research by Elowsson, Dietrichs, and Schwartz-Schilling. There are several mechanisms for achieving the target ratio, each varying in terms of issuance schedules and the extent to which issuance declines. For more details on the issuance curve under the collateralization target model, read this Ethereum research article.

None of the above proposals will be included in the next Ethereum hard fork, Pectra. However, it is very likely that Ethereum developers will push for proposals to make changes to ETH issuance in subsequent upgrades. Discussions about issuance changes within the Ethereum community have so far been highly contentious and without broad consensus. Key objections to the issuance changes include concerns that reduced staking revenue will hurt the profitability of large staking providers operating on Ethereum as well as individual stakers; proposals affecting the issuance to date lack sufficient research and data-driven analysis. It is unclear what the exact target staking rate should be to achieve MVI, and whether achieving this through issuance changes will reduce concerns about centralization of staking distribution, or if it will exacerbate the problem as independent stakers prosper and bleed away. To address some concerns about the long-term profitability of independent stakers on Ethereum, Ethereum co-founder Vitalik Buterin shared preliminary research in March 2024 on adding new anti-correlated rewards and penalties, which would Benefiting node operators who control fewer validators.

The monetary policy of Ethereum’s proof-of-stake blockchain Beacon Chain has not changed since its birth in December 2020. However, before merging with the Beacon Chain, Ethereum’s monetary policy had gone through several revisions in its roughly seven-year history. Ethereum’s initial block reward is set at 5 ETH/block. In the Metropolitan upgrade in September 2017, it was dropped to 3 ETH. Then in the Constantinople upgrade in February 2019, it dropped back to 2 ETH. Then, in the London upgrade in August 2021, the rewards miners received from transaction fees were burned, and then in the merged upgrade in September 2022, mining rewards were completely abolished on the network.

Under the proof-of-stake consensus mechanism, changes to Ethereum’s monetary policy are likely to be more controversial than previous changes issued by the network under proof-of-work, because the user base affected by the changes is much wider. Unlike miners, issuance changes affect a growing number of ETH holders, staking service providers, liquidity staking token issuers, and restaking token issuers. As the base of stakeholders involved in protecting Ethereum continues to expand, Ethereum developers are unlikely to change Ethereum’s monetary policy as frequently as in the past. The contentious nature of this discussion may result in staking-related policies and rewards becoming increasingly rigid over time. Therefore, as the staking industry built on Ethereum grows and matures, the window of opportunity for changes to the Ethereum codebase is shrinking and is unlikely to last long.

Conclusion

The staking economy built on Ethereum is still in its infancy. When the Beacon Chain first launched in 2020, users staking ETH were not guaranteed to be able to withdraw ETH or transfer funds back to Ethereum. When the Beacon Chain merges with Ethereum in 2022, users will receive additional rewards for staking through transaction priority fees and MEV. When staking ETH withdrawals are enabled in 2023, users will finally be able to exit validators and profit from staking operations. There are a series of other changes coming on the Ethereum development roadmap that will impact the staking business and individual stakers. While most of these changes will not affect the economic incentives of staking, such as the increase in a validator’s maximum effective balance in the Pectra upgrade, some will.

So as Ethereum’s development roadmap continues to evolve and be implemented through hard forks, it is important to carefully evaluate the risks and rewards of staking on Ethereum. Because Ethereum’s staking economy encompasses many more stakeholders than in the Ethereum PoW era, changes that impact staking dynamics may become harder to enforce over time. However, Ethereum is still a relatively new proof-of-stake blockchain and is expected to undergo major changes in the coming months and years, and one needs to carefully consider the impact of changing staking dynamics on all relevant stakeholders.

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