Ethereum Staking is for Everyone
The Merge is coming soon, and if you want to capitalize on it and its ETH-denominated staking rewards, then it is imperative to understand the various options for staking. Even if you don’t have a lot of ether, there is still a way for you to collect rewards! Ethereum has been trying to transition from Proof of Work to Proof of Stake for the past few years. This is an incredibly difficult process, equivalent to replacing the engine of a plane while it’s in the air without having any of the passengers notice. Several test merges have been conducted to catch as many bugs as possible. With the recent announcement of the final testnet (Goerli) Merge occurring somewhere between August 10th and 11th at a difficulty level of 107,900,000, we can expect the mainnet Merge to occur around September 19th. To run a solo validator node, a minimum deposit of 32 ETH is required, which is equivalent to $53,408 as of August 2nd. This is no insignificant sum of money, and some may believe that they are priced out of earning staking rewards. However, there are many staking as a service (SaaS) options that run staking pools, allowing for individual investors to earn staking rewards with as little as a 0.01 ETH deposit. Two of the biggest decentralized staking pool protocols are Rocket Pool and Lido.
Rocket Pool
Rocket Pool is a decentralized, permissionless staking protocol which is designed to be aligned with Ethereum’s ethos. It is designed for two types of people: those who have at least 16 ETH and want to run a node for a higher return, and those with smaller amounts of ether that want to earn staking rewards. Rocket Pool allows for anyone with 16 or more ETH to contribute to the protocol as a SaaS provider by operating a node, whether they’re a professional or a hobbyist, to achieve a greater return than running a solo validator by receiving commissions. Once one deposits 16 ETH along with 10–150% of that value being backed by an RPL stake, they are assigned the remaining 16 ETH required to run a validator from a pool of smaller ether depositors. RPL is Rocket Pool’s insurance and governance token which ensures honest node behavior and protects users against slashing punishments/node downtime by acting as a buffer. These SaaS providers run a node for themselves and the smaller depositors, collecting a validator and commission reward for staking ether upon the pool’s behalf. Thus, small pool participants earn a lesser return than solo validators in exchange for not having to run their own node, something that requires hardware, computer uptime, and significant technical knowledge. Users’ smaller deposits are completely managed via smart contracts to ensure the protocol’s non-custodial and decentralized properties.
When a smaller user deposits a minimum of 0.01 ETH into the Rocket Pool front end, they receive a slightly smaller amount of rETH, a derivative token which is a liquid wrapper for staked ether. Unlike solo stakers, a staking pool participant’s ether is not locked up, meaning they are free to continue trading rETH and using it as collateral in DeFi after 24 hours of owning it. Once rETH is obtained, it does not rebase, meaning the quantity of rETH that you own does not change. “How do you accrue staking rewards, then?”, you might ask. Over time, as node operators accrue staking rewards, this data is relayed from the Beacon Chain to the protocol via oracles within Rocket Pool’s OracleDAO, while governance ensures the integrity of this data. The value of rETH relative to ETH increases based on the performance of the validators. This exchange rate is determined by the protocol and its oracles, and it is displayed on the front-end of rocketpool.net via the “unstake” function. This method of staking reward accrual allows for the avoidance of tax issues for smaller stakers concerning the rebasing of a liquid token, meaning that the rewards get treated as capital gains instead of income tax. The rETH:ETH ratio is calculated via the following formula: (total ETH staked + Beacon Chain rewards)/(total rETH supply). This is especially advantageous if you live in a country that distinguishes between short-term and long-term capital gains taxes. As an ERC-20, rETH can be used as a swapping pair on DEXs, meaning that secondary markets exist. However, since the primary exchange rate is determined by the Rocket Pool protocol, any secondary markets create an arbitrage opportunity.
According to rocketpool.net, you can currently stake your ether for a reward of about 4.03% APR, but this rate is subject to change since the validator reward rate is variable depending on the amount of total ether staked to secure Ethereum. Smaller users are not assigned to a specific validator, and instead are just depositors in the protocol. This means there is no risk of being assigned to a “bad validator”. All slashing and downtime penalties are socialized across the network. If penalties are incurred by a SaaS provider, they are paid out by the operator’s RPL buffer stake, so losses don’t fall upon the pool participants. A higher RPL stake results in greater insurance, and if the penalties are greater than the validator’s RPL stake, losses are taken from the node operator’s 16 ETH deposit before the protocol touches pool participants’ deposits. This structure helps formulate a less scalable, yet lower risk staking pool infrastructure.
Lido
Another popular decentralized staking protocol is called Lido. It works in a very similar fashion to Rocket Pool, in that you receive the liquid staking token stETH in exchange for staking ether. stETH is backed 1:1 by staked ether, and you can still use it as collateral to earn yield in DeFi, meaning you don’t need to lock up your capital while staking. However, stETH is a rebasing token, meaning that the amount you own does not remain constant. You can view exactly how much stETH you’ve earned in staking rewards on lido.fi, which is updated daily. Some DeFi protocols, such as Uniswap, require tokens to be constantly balanced, and to interact with them you need to wrap your stETH to wstETH so that it behaves like rETH, a non-rebasing token. Once you wish to unstake your stETH, you can burn it on lido.fi for it to be redeemed 1:1 for ETH.
Lido differs from Rocket Pool in a few key ways: rebasing, permissionlessness, slash protection, and multi-chain operations. The most noticeable to the user is the fact that stETH is a rebasing token and thus can be interpreted as income tax once staking rewards are received. Another difference is that Lido is not a permissionless protocol. To become a Lido validator, you must apply and be voted on by Lido’s ArgonDAO. Once approved, chunks of 32 ETH are distributed to validators for them to begin operating their node. Node operators collect a 10% reward fee in stETH from poolers, which is deducted before being distributed to pool participants. Another key difference between Lido and Rocket Pool is the fact that Lido is currently unprotected from validator penalties. They were insured via a third party, Unslashed Finance, with 5% of their ETH deposits covered for slashing, which cost a quarter of the DAO’s annual revenues. However, after a vote about a year ago, the DAO decided to not renew Unslashed’s plan and instead pursue a self-covering mechanism. They are currently exploring a set of options to protect against slashing but do not have anything set in stone yet. These include:
· Staking LDO as a buffer (a similar mechanism to Rocket Pool)
· Establishing an internal insurance fund from the treasury or DAO earnings
· Staking stETH as a buffer
· Contracting additional 3rd parties to insure risk.
According to a team member on the Lido Discord server, one of the internal insurance fund options is the most likely option to be used, but in the meantime, all slashing and downtime penalties are being socialized throughout the Lido ecosystem, although they have avoided any slashing events thus far. However, this along with the lack of a 16 ETH deposit by node operators makes the protocol simpler and more scalable. Finally, Lido has a multichain strategy when it comes to their SaaS business model. They currently support Ethereum, Terra, Solana, Kusama, and Polygon. While this is great for scalability and a diversification of revenue, it can leave the protocol and DAO exposed to contagion risks outside of a singular ecosystem, in contrast to Rocket Pool, who solely focuses on Ethereum staking.
De-Pegging
During the past couple of months, there was great concern with pegged assets following the Terra/UST implosion. This was evident in stETH/ETH losing its peg along with UST. It turns out that many large players had significantly levered staking positions involving stETH on Aave and Curve, which exposed them to risk of liquidation if stETH lost its peg too much. During the Terra collapse, the stETH pool on Curve lost more than 50% of its TVL, mostly due to Three Arrows Capital and Celsius withdrawing a combined $800M, which caused a pool imbalance and dried up liquidity. CeFi players such as these had also wrapped stETH to bETH on Terra so it could be used to mint UST and purchase more stETH. However, as the UST peg broke, users rushed to bridge their bETH back to mainnet and unwrap it back into stETH. Concern surrounding these derivative assets caused many to sell their stETH for ETH, which caused the stETH peg to decline enough to de-lever Aave and Curve participants. This, amplified by a UST peg defender selling large quantities of stETH for bETH and then UST, caused the peg to sink from 0.98 down to its low of 0.94. Since then, the stETH peg has mostly recovered, but it is still trading at a 2.32% discount to ETH. It is important to note, however, that stETH lost its peg due to risky CeFi positions and the extreme market conditions of the time, not due to a death-spiral effect such as what UST and LUNA were exposed to. Still, rETH is vulnerable to a similar event, and stETH remains backed 1:1 by ETH.
TL;DR
If you believe in the long-term vision of the Ethereum network and want to aide in securing it while earning ether-denominated rewards, then staking might be right for you. The 32 ETH barrier to staking only exists for solo stakers at this point, which means that collecting staking rewards is for everyone. There are many other staking protocols that I did not mention in this article, but everyone considering joining a SaaS pool should do their own research and choose the protocol which aligns best with their values and risk tolerance. If you prefer a more decentralized protocol that denominates rewards in capital gains, has virtually full slashing protection, and only operates within Ethereum, then Rocket Pool might be the solution for you. If you care more about flexibility, scalability, and daily readability of staking rewards while also being able to purchase a wrapped, liquid staking token at a slight discount, then Lido might be a better choice. It is important to note that Lido is the largest Ethereum staking service, hosting 32% of the total ether staked in the ecosystem. This could be a point of centralization in the Ethereum network, especially if client diversification of the individual validators is not encouraged, but this is a discussion for another time. For so long, we’ve asked “wen merge”, and now it’s finally “soon merge”. Please conduct research before making any large decisions, and happy staking, everyone!
Sources
https://medium.com/rocket-pool/rocket-pool-staking-protocol-part-1-8be4859e5fbd
https://medium.com/rocket-pool/rocket-pool-staking-protocol-part-2-e0d346911fe1
https://medium.com/rocket-pool/rocket-pool-staking-protocol-part-3-3029afb57d4c
https://medium.com/rocket-pool/rocket-pool-2-5-tokenised-staking-48601d52d924#92b0
https://docs.rocketpool.net/guides/staking/overview.html#how-to-stake-with-rocket-pool
https://blog.lido.fi/offline-slashing-risks-are-self-cover-options-enough/
https://blog.lido.fi/how-lido-works/
https://coinyuppie.com/comparison-of-lido-and-rocket-pool-how-to-choose/
https://www.nansen.ai/research/on-chain-forensics-demystifying-steth-depeg
