For years, Ether has been the #2 cryptocurrency by market cap, but that doesn’t tell the whole story – it’s the top cryptocurrency for users of DeFi via its smart contracts, which BTC doesn’t support. However, Ethereum transaction fees are at all time highs due to network congestion. Competitors like Binance Coin have seized the opportunity to take some market share from ETH by tweaking their networks to offer lower fees. Ethereum still has the upper hand in the NFT and DeFi spaces, but as transaction fees have risen, more platforms have sought out solutions from other blockchains. To combat loss of market share due to congestion, Ethereum developers have put forth a major upgrade called Ethereum 2.0, or Eth2.
Proof of Stake
Eth2’s most significant shift is from Proof of Work, or “mining,” to Proof of Stake. Both Proof of Work (PoW) and Proof of Stake (PoS) are methods for validating transactions on the blockchain, but PoW is the reason many criticize crypto’s energy usage. Essentially, miners use computing power to solve mathematical problems as an arbitrary method of validating transactions. The complexity of these problems increases as the network grows, which in turn requires more power. This is why mining has gotten steadily more expensive, to the point where an average user likely cannot profit from it.
Eventually, it becomes impossible for the average user to become a validator, which inadvertently leads to centralization: larger entities will benefit more from economies of scale, allowing them to acquire hardware and mine cheaper than anyone else. This has become a growing concern for Bitcoin: 65% of BTC hashpower is in China, and if all of those miners coordinated, they could disrupt the blockchain.
On the other hand, PoS actually seems to punish centralization. The larger a validator’s stake is in relation to the rest of the network, the more severely they will be penalized for downtime – more on that later.
Eth2 has two goals to secure the network: 1) to make it costly to attack blockchain, and 2) in case of attack, to make it easier to coordinate a new chain without attacker’s changes. The concern here is a 51% attack, in which an entity with a majority of hashpower could disrupt the network. Both PoW and PoS are vulnerable if one party holds a majority of validating power, but PoS makes it easier to coordinate against an attack. With PoW, countermeasures would likely include forking the blockchain to prevent the attacker from further corrupting the ledger. However, this is only a short term solution, as the attacker could simply swap to the new blockchain as well.
With PoS, 51% attacks are much more difficult in the first place: an attacker would need to purchase more than 50% of the value already staked by other validators, which would be extremely expensive. Furthermore, if such an attack were to happen, the community could counter by creating a new fork without the attacker’s stake – likely ending the attack immediately, and resulting in drastic losses for malicious validators.
Incentives for Stakers
The idea of locking up ETH for the foreseeable future is unnerving in the face of volatility, especially with DeFi providers offering their own rewards, but there are various incentives to encourage people to stake. For instance, LiquidStake will let you use your staked ETH as collateral to borrow USDC, which you can then continue to use on the current network.
Another incentive is staking derivatives: services will let you deposit ETH to stake, and in exchange they will give you an Ethereum derivative (“dETH”) which you can continue to use on dexes. By default, if fewer people stake, the rewards are higher – and with more stakers, the rewards decrease. As such, staking on Eth2 is responsive to market conditions and incentives from other dApps, so validators will have multiple options to earn rewards from their ETH.
Currently, ETH supports up to 15 transactions per second. After shifting to Proof of Stake, Eth2 aims for 1,000 transactions per second. While the upgrade likely won’t finalize before the end of 2021, ETH holders can still get involved. At the moment, if you move any ETH to the new network, you will not be able to withdraw or spend it for the foreseeable future. Staking on Eth2 should be considered a long-term investment requiring faith in Ethereum. If you’re still interested, you can stake on Eth2 in one of three ways:
Do-it-yourself
Via the DIY method, a validator runs their own node. The individual is in full control of their profits from staking. However, an individual validator must have 32 ETH – if you have less, you can join a pool.
Centralized pools
Alternatively, individuals can stake through centralized providers, like exchanges or purpose-built staking pools. This method is much more convenient, and makes validation accessible to prospective stakers with less than 32 ETH. Stakers won’t have to worry about downtime, but the pooling services will likely collect a fee in exchange for this peace of mind. However, staking through a centralized entity likely goes against the core ethos of Ethereum, and requires putting all of your faith in that single provider. All things considered, Eth2 is a long way from deployment, so this might be the safest option rather than contributing your own hardware and electricity until the upgrade finalizes.
Decentralized pools
Similar to AMMs, there are projects under development allowing validators to stake without relying on a single centralized entity. An example is LiquidStake, as mentioned above, which distributes deposits across a network of decentralized nodes.
You could combine Methods 1 and 2 by pooling ETH with friends for a single node – of course, do so at your own risk.
