An Ethereum Staking Industry Overview: Liquid Staking, DeFi Integration, MEV capture, and DVT
Establishing Use Cases for SafeStake
In this article, we will look at the most important updates surrounding the fledgling industry that is Ethereum Staking.
Introduction
Ethereum Staking allows people to earn rewards by putting their Ethereum, also known as ETH, at ‘stake’ to secure the Ethereum 2.0 network. In September of 2022, Ethereum transitioned from Proof-of-Work mining to Proof-of-Stake consensus, reducing the blockchain network’s energy usage by over 99% and allowing validators to secure the network as opposed to miners. Therefore, staking is an important part of the Ethereum ecosystem, not only securing the network, but incentivizing users to hold their ETH over the long term.
After Ethereum transitioned from PoW to PoS successfully (an event known as ‘The Merge’), users that deposit 32 ETH on their own or as part of a ‘staking pool’ can run validators on the Ethereum network. These ‘stakers’ will be able to ‘unstake’ (withdraw) their ETH deposits after the next planned upgrade (known as ‘Shanghai’) which is expected to happen sometime around the end of Q1 2023.
Currently, Ethereum has a lower staking ratio as compared to other PoS blockchains. With only 14.47% of the circulating supply of ETH staked, it sits significantly below the industry average of 59%. At SafeStake, we believe a clear trend has already been established for Ethereum to reach similar levels, representing an ETH staking market cap of just over $30 billion (USD).
As Ethereum continues its climb toward the PoS industry average staking ratio, the opportunities are immense, with the potential to be a trillion-dollar industry in the not so distant future.
ParaState is keenly aware of this amazing opportunity, deploying our SafeStake non-custodial ETH solution (currently in Stage 1 of Galileo Incentivized Testnet) to capitalize on it while helping to decentralize the Ethereum validator base with the use of cutting-edge DVT (Distributed Validator Technology).
ParaState expects that at minimum, SafeStake will acquire a 10% market share which will generate around 40,000 ETH annually in protocol fees. At the current price of ETH, that’s over $60 million (USD) per year.
Ethereum Post-Shanghai
The recent Shanghai update has improved Ethereum’s fundamentals, but it has also led to concerns that it could cause selling pressure from ETH holders who participated in ‘illiquid’ staking on the Beacon Chain since it became available in December 2020.
However, recent data from Dune Analytics shows that the current price of ETH may discourage many stakers from selling their holdings even after the Shanghai update. In the infographic below, you can see that 59% of stakers are below their original stake value (underwater) and not ‘in the money.’ Additionally, the withdrawal process is slow due to daily withdrawal limits put in place by the Ethereum foundation. As a result, abrupt selling pressure is not only unlikely, but made impossible at the protocol level, ensuring that this update doesn’t lead to a severe drop in the price of ETH.
Alongside ‘traditional’ staking, the additional options new liquid staking protocols offer stakers is expected to lead the charge in the expansion of the decentralized finance (DeFi) sector and grow exponentially over the next few years.
Ethereum’s adoption is undoubtedly expanding after The Merge and its transition from PoW to PoS, increasing the amount of ETH staked and the likelihood that Ethereum staking becoming a trillion-dollar industry after the Shanghai update.
The chart above shows that investors are becoming increasingly confident in ETH staking, with a massive 38.55% growth as compared to its market cap.
The surging interest in running Ethereum validators is also highly evident with SafeStake’s Incentivized Testnet, dubbed ‘Galileo,’ which has recently garnered significant interest from solo stakers and staking institutions alike.
What about regulation?
The SEC’s recent scrutiny of ETH2 staking has highlighted the need for alternative staking options that do not fall under the guidelines of ‘securities’ as defined by the SEC, and therefore, not subject to their regulations.
However, it is worth noting that while Kraken’s recent issues with the SEC put ETH staking on their radar as something to regulate in 2023, we feel that Staking Rewards likely says it best — “While this looks like the SEC is against staking, it appears to be a Kraken-specific problem rather than an industry-wide staking problem.”
If this proves to be true, the light at the end of the tunnel could be a push for greater regulatory clarity for the industry, ultimately benefiting both institutional and retail investors to participate in and adopt the post-Shanghai Ethereum staking ecosystem with lower risks.
We’d also like to point out that SafeStake’s implementation of DVT also offers a potential solution to this problem by providing a staking mechanism that may not be classified as a security.
Users in SafeStake never lose control of their assets and generate rewards directly in the protocol without the need for intermediaries or third parties to hold these assets to generate a return. So, it seems the standard applied to assets to determine whether or not they’re a security, known as ‘Howey’s Test,’ would not apply to SafeStake’s implementation of pooled staking.
Liquid Staking
Liquid Staking has become an important sector of the crypto industry due to its ability to allow ETH holders to leverage the performance of their holdings by receiving a receipt token for staking ETH with a Liquid Staking provider.
LSD tokens are fungible, transferable, fractional, and most importantly, make an otherwise illiquid asset, like staked ETH, liquid. With Liquid Staking, staked funds are no longer unusable and can be invested elsewhere, like DeFi, to earn compounding interest.
After the implementation of Shanghai, ETH LSDs are expected to become even more popular, reducing the risks and hassles of staking ETH and generating more revenue for their protocols.
However, crucial to the sector’s growth are the proper management of liquidity, yield, credit, and technological risks.
Currently, Lido is the dominant player in the Liquid Staking market with 73.3% of the market share and representing 29.36% of the entire circulating supply of ETH staked.
However, Liquid ETH staked on Ethereum’s Beacon Chain represents only a small fraction of the total supply of ETH in circulation, and approximately 96% of it is staked through three centralized entities: Lido, Coinbase, and RocketPool.
How SafeStake Can Help
ParaState has developed SafeStake, a DVT-based protocol that aims to make staking safe and easy while mitigating the risks centralization poses in the growing LSD market. SafeStake is a trust-minimized middle layer for secure, decentralized ETH staking that will allow users to stake ETH and receive an LSD (sfETH) in return.
We are currently in Stage 1 of our testnet, only supporting 32 ETH deposits. However, Stage 2 will introduce pooled staking functionality to the network and lower the staking threshold to 8 ETH. Later, in Stage 3, one of the significant advantages of Liquid Staking with SafeStake will be the ability to stake with deposits as low as 0.1 ETH, further expanding the base of validators needed to achieve greater decentralization, security, and censorship-resistance for Ethereum.
It’s also worth mentioning that SafeStake’s Liquid Staking is fully decentralized and non-custodial, preventing deposits from ever touching third-party vaults.
The LSD sector has expanded rapidly over the past twelve months, with year-over-year growth of 90.47%. It has risen from 21% of all ETH staked on the Beacon Chain in January 2022 to over 40% of all ETH staked on Beacon Chain twelve months later.
DeFi Integration
Decentralized Finance (DeFi) has revolutionized the financial landscape by offering affordable and highly attractive yield-generating opportunities through blockchain technology and dApps (decentralized apps).
At its peak in November 2021, DeFi had grown to over $240 billion in several thriving ecosystems, and currently stands at around $50 billion. Liquid Staking is one of the most valuable propositions, contributing significantly to DeFi growth and making cryptocurrency staking more attractive.
Liquid staking allows users to start by staking their crypto assets on their PoS blockchain of choice, then incentivizes them to participate in the respective blockchain’s DeFi ecosystem. This makes it possible for them to earn on-chain staking rewards and DeFi rewards simultaneously.
Bringing it all together, Liquid Staking options allow DeFi and PoS blockchains to grow mutually, providing benefits for everyone along with the value proposition of cryptocurrency staking.
The Liquid Staking sector is poised to be a major catalyst for accelerating DeFi’s growth by leveraging the current $89 billion in global staked asset value, offering users increased opportunities and rewards, and increasing activity and liquidity from new and existing users.
However, DeFi integration with protocols based on the nascent Liquid Staking sector still faces significant challenges. A recent Coinbase report notes that only half of the supply of stETH (Lido’s LST) leverages current DeFi structures for additional yield by reinvesting the token in DeFi dApps.
It is likely the industry will likely see an increase in adoption as the implementation of ETH takes root.
Moreover, as protocols for ETH2 staking emerge in the ecosystem with a better focus on security, liquidity, and decentralization, some or many of these challenges may be overcome. Of course, SafeStake is addressing these concerns with the use of DVT.
Maximum Extractable Value (MEV) vs. Decentralization
The emergence of Maximum Extractable Value (MEV) has presented a challenge for Ethereum’s mantra of decentralization. While the MEV-Boost software has been effective in providing MEV gains to validators, it has also resulted in increased censorship and centralization.
The MEV extraction can distort Ethereum’s decentralization by concentrating the resources needed to achieve this activity profitably in the hands of only a few institutions and large players in the Ethereum ecosystem.
While proposed solutions are expected to generate a more socialized average MEV, the centralization of validators due to the MEV effect remains a latent threat until said solutions are fully vetted and implemented.
MEV earnings for validators have declined, with the average gross earnings dropping from ~510 ETH per day in 2021 to ~350 ETH in 2022 YTD. However, if DeFi manages to reach November 2021 levels again in terms of LTV, MEV gains could skyrocket.
MEV earnings for validators are estimated to have added 0.9% to the total staking and transaction fee rewards APR, but the problem of centralization and censorship in Ethereum due to the monopolization by MEV-Boost block relays from Flashbots remains a latent threat until the network as whole manages to incorporate DVT technology.
DVT-based solutions, like SafeStake, are building state-of-the-art infrastructures to mitigate the problems of centralization and censorship in Ethereum exacerbated by running validators on single nodes.
SafeStake integrates DVT at the protocol-level to avoid concentrating too much ETH in a single validator by decentralizing and distributing validator duties and activities to multiple operators (nodes).
In addition, SafeStake plans to enable a new ‘Validator Extracted Value’ (VEV) protocol and a distributed validator oracle to achieve diversification in the MEV market and avoid single points of failure, like censorship, that come along with centralized companies like Flashbots.
The incorporation of DVT technology and the use of solutions like SafeStake are expected to mitigate this and other issues and provide a more decentralized Ethereum ecosystem.
Final Thoughts
There is no doubt that the Ethereum staking industry has a bright future. It will become even brighter when the challenges of both regulation and centralization that continue to concern users, and especially institutional investors, are resolved.
The use and deployment of DVT technology in decentralized protocols to facilitate ETH2 staking will undoubtedly allow it to capitalize on the opportunities offered by the staking industry in line with the utopia of a fully decentralized Ethereum.
About ParaState
ParaState is participating in ETH2.0 PoS Staking with a new tech stack called SafeStake, a trust-minimized middle layer fostering the decentralization of ETH2.0 staking. SafeStake is a non-custodial, DVT-based infrastructure and protocol written in Rust and implementing HotStuff consensus and a Threshold Signature architecture to provide robust security, reliability, and decentralization for ETH validators.
