Ethereum: Birth of the Digital Bond
Ether Capital is primarily invested in Ether (“ETH”) and the Ethereum ecosystem. Later this year, the Ethereum blockchain will transition from “Proof of Work” to “Proof of Stake”. Proof of Stake is a hugely significant milestone for Ethereum and an exciting financial opportunity for Ether Capital investors.
So what is Proof of Stake and why is it so important? In this post we will describe Proof of Stake, show how it creates a digital bond and provide context on yields investors might expect.
Proof of Work vs. Proof of Stake
Before we can understand Proof of Stake, we need to understand its precursor: Proof of Work.
Blockchains like Bitcoin and Ethereum use Proof of Work to make sure that everyone who modifies the ledger has mathematically proven to the network that they have ‘skin-in-the-game’.
To achieve this skin-in-the-game and be allowed to update the ledger, they must invest in mining hardware and related infrastructure. Hence, they are called miners. Their reward for this investment is in the form of an algorithmic “block reward” which is how the cryptocurrencies Bitcoin and Ether are created.
But, Proof of Work has a serious problem. The blockchain validators, or miners, who invested in hardware and infrastructure end up selling their tokens to “holders” to finance their mining operations. Over time, the token-holders and miners become two distinct groups of people, sometimes with competing interests.
Proof of Stake is a well researched solution to this problem. Under Proof of Stake, the mining resources are invested in the cryptocurrency tokens themselves. What this means is that the token-holders are the miners. If this is difficult to imagine, just think of it like each Ether token as giving you the right to operate your own virtual miner.
Token-holders “stake” their tokens, which is just like powering up a Proof of Work miner. As a reward for participating in this process, Ether stakers will earn a yield on their staked Ether. What does this mean for holders of Ether? In late 2020, Ether will become a yield instrument like a bond.
Ether — Birth of the Digital Bond
A popular narrative around bitcoin is that it’s a form of digital gold. For Ether, a popular narrative is as a form of digital oil, in that Ether is used as fuel to run applications on the Ethereum platform. If bitcoin is digital gold and Ether is digital oil, then staked Ether is a digital bond.
“If bitcoin is digital gold and Ether is digital oil, then staked Ether is a digital bond.”
When staked, the Ether you hold isn’t a virtual commodity anymore. It is more like a financial asset on which you’re paid dividends or interest.
Yields on Staked ETH
We get asked all the time by Ether Capital shareholders: if staked Ether is a digital bond, what type of yields can we expect?
The answer depends on the amount of Ether that is staked. The higher the number staked, the lower the yield (and vice versa). Below is an illustration.
Source: Consensys’ ETH2.0 Calculator
In the early days of Proof of Stake, when there is a perception of “higher risk” in the new system, yields might be high. Conversely, when Proof of Stake becomes more mature and battle-tested, a lower risk profile could lead to lower yields.
This is an extremely exciting time to be holding Ether and witnessing the birth of Ethereum’s digital bond. Look out for Ethereum’s upgrade to Proof of Stake — it could end up paying generous dividends.
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At Ether Capital, we are deeply committed to the Ethereum ecosystem and believe that staking presents one of the best opportunities to get exposure to cryptocurrency.
If you’re interested in learning more, please reach out!