Ethereum Staking: Build Wealth by Earning Passive Income
ETH staking provides passive income along with growth potential. This post is a practical guide on staking Ethereum to earn rewards, and why you should safeguard your ETH wealth in multi-signature wallets.
- What is staking?
- Why staking ETH?
- Build wealth or retire adding ETH staking to investment portfolio
- Four ways to stake Ethereum
- Where to stake ETH and store assets for long-term crypto wealth protection?
- What is coming next for Ethereum staking and ETH stakers?
- Conclusion
What is staking?
Since November 2020, when the Ethereum protocol allowed Ether (ETH) to start securing the network en route to its Proof of Stake (PoS) algorithm transition, I have been excited about having a native crypto passive income that earns a variable rewards rate. This activity is also known as staking. Below I outline why adding ETH staking to your investment portfolio may be a good idea to earn passive income.
What is staking and Ethereum staking anyway? Staking means running a computer program to validate data by pledging capital — ETH, and computing resources. In return for this work, honest stakers who validate data according to the predefined rules earn rewards, and dishonest stakers have some of their staked ETH slashed. The amount of rewards stakers receive varies, and there are no guarantees. As of this writing, ETH staking yield is ~4.5% annualized as of mid April 2023. It is also essential to understand that staking is data validation, not investing or lending with a third party.
No equivalent activity that resembles staking in traditional financial markets exists. Hence there is a massive opportunity to be at the forefront of new investment opportunities. Some may say,” Why own ETH?” Owning ETH is a bet on Ethereum. Ethereum is a global, decentralized, open-source, distributed network for decentralized applications. By introducing programmable networks, Ethereum has revolutionized the technology and established a novel application layer on the internet. As a hub for digital assets, global payments, and various applications, Ethereum has fostered a thriving digital economy and innovative earning opportunities for creators. Ether (ETH), the network’s native currency, is utilized for paying transaction fees and as collateral by network validators. Accessible to anyone with an internet connection, Ethereum empowers individuals around the world to engage with this dynamic ecosystem.
Ethereum is the largest decentralized computational platform by market capitalization and assets locked in smart contracts (Total Value Locked). While Bitcoin has a higher market capitalization, it is not a computational platform, and investors view Bitcoin as a sovereign store of value and digital gold.
Where are the staking rewards coming from? Staking rewards come primarily from network inflation when the system issues new ETH as a reward for data validation and transaction fees.
Why staking ETH?
Why am I so excited about Ethereum staking? My excitement comes from the fact that these staking rewards or staking yields are not tied to national economies and solely exist natively in the crypto economies and are paid out by the protocol for data validation. Staking rewards do not correlate with other forms of passive income, such as the yield on U.S. treasuries, corporate bonds, mortgages, real estate rentals, etc. ETH staking exhibits: 1) equity-like growth perspective of the underlying asset ETH, similar to tech stocks, 2) built-in fixed income features similar to variable-interest rate bonds, and 3) opportunity to earn additional yield for the same ETH stake via restaking — this is a novel concept and will be coming to the Ethereum ecosystem at the end of 2023.
ETH staking means generating passive income with a growth-like potential for price appreciation. These features make ETH staking interesting for investment diversification purposes and for those who love passive income streams. Large institutions have always favored investing for yield, so it’s no wonder many of them already participate in Ethereum staking, and more are lining up.
Some may say that ETH is too volatile as presented in the table below. Indeed, like all emerging equities, ETH is volatile, and it is hard for many investors to stomach such volatility. Conducting your research and considering your investment goals and risk tolerance before making any investment decisions is crucial.
Build wealth or retire adding ETH staking to investment portfolio
The prospect of building wealth and retiring investing in staked ETH is intriguing, and this article will explore this idea through a hypothetical scenario. Let’s assume that $1 million in retirement crypto assets is an addition to other retirement assets and income streams that investors may have: stocks, bonds, real estate, state pension plans, etc. This thought experiment of building wealth using staked ETH includes the following assumptions as outlined below.
1) Investors start with staking 32 ETH today — enough to spin up one validator. Validator is a computer program that validates data on the Ethereum network.
2) Contribute $7,000 worth of ETH annually, the equivalent of $584 monthly, and stake it right away.
3) Long-term ETH staking rewards are 2.5% per year. Keep in mind the more ETH is staked by the network participants, the fewer rewards are received per staked ETH if transaction fees stay the same. If transaction fees increase, they would partially offset the drop in staking rewards.
4) Honest data validation and no slashing events occur.
5) The annual price appreciation of ETH is 10%, which is a reasonable assumption if you consider that the S&P 500 annual return (including dividends) is ~9%.
As you can see from the table above, in 20 years, someone who contributes $7,000 annually (the equivalent of $584 monthly) and has a 32 ETH stack today can hypothetically reach over $1.2 million worth of staked ETH to retire. Of course, some of my assumptions may not materialize. Still, it gives readers a framework and basic idea of how to approach investing in staked ETH if they believe in the long-term potential of crypto and Ethereum in particular. Before making any investments, prospective investors should assess their risk tolerance and consult their financial and tax advisors. It is important to note that investing in staked ETH is not mutually exclusive from other forms of investing, such as investing in the stock market, bonds, real estate, and other asset classes.
I have been investing in ETH using my self-directed IRA and 401K retirement accounts. Both are Roth, meaning that taxes have already been paid on my contributions to these retirement accounts, and earnings and distributions will be tax-free once I reach 59.5 years of age. One of the other benefits of Roth retirement accounts is that withdrawals of my contributions are always tax-free even before I reach 59.5 years of age, as I have already paid taxes on them. Please consult your accountant if you are investing using your self-directed retirement accounts, as they have strict IRS rules that investors must follow.
I have not done ETH staking from my retirement accounts yet, but I am looking at exploring it soon. There is a caveat for ETH staking using retirement accounts — the IRS, most likely, will deem staking not as passive investing activity but as a business activity, and it will want to tax such income. It is called unrelated business taxable income (UBTI). The tax rate is 10–37% on it, with the first $1,000 of such income being excluded. Capital gains are not taxed in Roth retirement accounts, though. Again, please consult your tax advisor to understand crypto and staking taxes. If there is enough interest, I will write a separate post on how to stake ETH from retirement accounts and acquire assets for your retirement accounts that are not readily available on exchanges.
Four ways to stake Ethereum
You may be wondering by now, “How to stake Ethereum and earn rewards?” There are four ways to stake your ETH.
Option 1: Do-it-Yourself at home staking. One of the ways to stake ETH is to spin up your own validator with 32 ETH. 32 ETH is the amount required by the Ethereum protocol for each validator to stake. Spinning up your validator involves a lot of upfront capital (~$57,000 at today’s ETH prices of ~$1,800) and know-how. I am not tech-savvy enough to spin up my own validator. Still, some people enjoy running validators as this is as close to contributing to decentralization as possible, and this activity provides complete control over staked ETH and earned rewards.
Option 2: Staking-as-a-Service. Same as option one above, but instead of running your own validator, you contract a third party, and a third party operates your Ethereum validator. You still need the minimum stake of 32 ETH to get started. Stakers control their 32 ETH stake, but rewards are sent to a validator operator, and your validator operator usually takes a cut from your earned rewards (not from your initial stake). Operator fees range 10–20% of earned rewards.
Option 3: Stake any amount of ETH on an exchange. This option is easy, but I don’t particularly appreciate storing assets on exchanges as exchanges get hacked or may halt withdrawals. For example, my ETH was stolen from one of my retirement accounts in 2022 during the $36 million hack at the Gemini exchange via my retirement plan administrator, IRA Financial Trust. There is an ongoing lawsuit, and I’m not sure if I’ll ever get my ETH back. Exchanges also usually take a cut of the ETH staking rewards and can be up to 30% of earned rewards.
Option 4: Staking pool or liquid staking. In my view, the easiest way to stake ETH is participating in staking pools or liquid staking — this is my preferred way of staking Ethereum. Numerous professional staking operators provide liquid staking services. Stakers can deposit ETH with an operator and receive a liquid staked token (LST) or they can acquire LST on exchanges like Uniswap or in some self-custodial wallets. LSTs represent staked ETH and accrued staking rewards/right to receive staking rewards. The most well-known LSTs are Lido’s stETH, Coinbase’s cbETH, Rocket Pool’s rETH, StakeWise’s sETH, ANKR’s ankrETH, and Frax’s sfrxETH. We at Linen Wallet have integrated Lido’s stETH to provide our users easy access to ETH staking rewards. stETH can be acquired in Linen Wallet under the Investments tab. Users can always sell their stETH for ETH or USDC or withdraw their stETH at any time. Additionally, users can acquire cbETH issued by Coinbase and rETH issued by Rocket Pool using the swap assets option in Linen Wallet.
Where to stake ETH and store assets for long-term crypto wealth protection?
Now that you are familiar with Ethereum staking and liquid staked tokens (LSTs), next, you should know where to stake your ETH and where to store your assets long-term to earn passive income from ETH staking rewards or just to hold your ETH. To stake your ETH, you need to have an Ethereum wallet, or you can stake it on an exchange. In the spirit of self-sovereignty, separation of assets from the state, and asset protection, I will focus on staking ETH and storing LSTs or ETH using self-custodial multi-signature wallets. This method is the only secure way of storing crypto wealth long-term and having unstoppable control over your crypto assets.
A multi-signature wallet, also known as a Smart Account or Smart Contract Account, is a highly customizable and more secure alternative to traditional self-custodial crypto wallets. Traditional self-custody wallets, including hardware wallets, use a single key (Secret Phrase) to secure access to your assets. Anyone with that key can transfer ETH or other tokens from your wallet. The challenge with this wallet configuration is that securely storing the key proves to be immensely difficult. Most people end up saving their keys in cloud storage or emails which is not secure as Secret Phrases get compromised by malicious actors using malware and other techniques. This is where multi-signature wallets come into play.
A multi- signature’s fully customizable nature allows you to create any rule you desire. A popular rule is a multi-signature account, which requires multiple authorized signers instead of a single private key. For instance, you can designate two trusted individuals as additional signers for your account. To execute transactions, at least two of the signers must approve.
Transforming the fundamental concept of an account from merely using a password or private key to approve transactions to a fully customizable system unlocks limitless possibilities for multi-signature wallets. Some of them are:
- Enhanced access control.
- Advanced wallet recovery options.
- Reduced single points of failure.
- Ability to pay transaction fees in stablecoins and not in ETH.
Most battle-tested multi-signature wallets are based on the Safe technology that secures over $35 billion in crypto assets as of mid April 2023. We at Linen Wallet have been building our mobile multi-signature wallet using Safe since 2020. Iterating on Linen Wallet, my co-founder Alex and I realized that self-custody wallets that rely only on a single key (Seed Phrase) are not secure as most people store their private keys in cloud drives or emails. This storage method is prone to hacks and phishing attacks. Hundreds of millions of dollars worth of crypto has gone due to stolen or missing private keys. Single-key wallets are essentially a ticking bomb, as investors may only know if their keys have been compromised once assets are stolen or become inaccessible.
What about hardware wallets? Hardware wallets are generally better than software wallets that rely only on a single private key in the sense that private keys are not exposed to the online environment. However, hardware wallets have the same single point of failure problem related to having only one key. If that private key is lost or stolen, assets become inaccessible to the owner. A hardware wallet can be one of the signatories of a multi-signature wallet, which adds an additional layer of security to a multi-signature wallet.
Which wallet to use to stake your ETH? We like the Safe official interface for more advanced users who are confident that they can properly set up a multi-signature wallet on a desktop and the Web. Linen Wallet powered by Safe on mobile is for those crypto holders who want multi-signature security, streamlined onboarding, excellent user support, and a user-friendly interface. We at Linen Wallet provide a pre-set key distribution, such as a three-key multi-signature wallet; two keys are required to make a transaction and recover your wallet. In the future, we will add additional wallets as signatories for the multi-signature wallet.
In summary, the self-custody of ETH is vital because it provides unrestricted ownership, control, security, and reduced counterparty risk. Multi-signature wallets enhance self-custody security by requiring multiple private keys for transactions, providing better access control and recovery options, and reducing single points of failure.
What is coming next for Ethereum staking and ETH stakers?
Imagine if you could not only stake your ETH to validate data on the Ethereum network and earn ETH staking rewards but also opt-in to validate data for other projects. That’s what the upcoming project EigenLayer aims to enable ETH stakers to do. It is called ETH restaking. Restaking allows staked ETH or LST to be used as crypto-economic security for protocols other than Ethereum. In exchange, those third parties that require data validation pay fees to ETH and ETH LST stakers. As an ETH staker or liquid ETH staker, I can take on the additional risk of slashing if I behave dishonestly. In return, I earn fees in addition to my ETH staking rewards. ETH stakers will be able to opt into multiple restaking opportunities. From an investor perspective, this is yield stacking — the ability to configure yield based on my risk appetite while using the same asset, ETH or ETH LST. EigenLayer is expected to be launched at the end of 2023. If ETH restaking by EigenLayer works, this will significantly juice up ETH staking rewards and create additional utility for ETH.
Let’s say an ETH staker opts into validating data on four additional projects with the help of EigenLayer — restaking using the same ETH used to validate the Ethereum blockchain. Two projects involve lower risk and pay an equivalent of 0.4% per year each per the 32 ETH staked. The other two are deemed riskier or more computationally resource-intensive and deliver an equivalent of 0.6% per year each per the 32 ETH staked. Four projects are projected to earn an incremental 2% yield per year (2×0.4%+2×0.6%) on my staked 32 ETH.
We are going back to our hypothetical example of someone who wants to build wealth by staking ETH. I have modeled this incremental annual restaking yield of 2%. Opting into ETH restaking via EigenLayer will help ETH investors grow their assets by almost 40% ($1.7 million vs $1.22 million) over 20 years compared to no ETH restaking. All contributions remain the same with restaking and without restaking. This calculation below assumes that no ETH slashing would occur.
Conclusion
To conclude, ETH staking provides a new form of earning passive income, not tied to any national economy. It is a bet on the decentralization of a computational layer and an opportunity to earn a variable rewards rate and diversify your investment portfolio. While staking is not investing or lending, it is a unique opportunity to be at the forefront of these new investment opportunities. Staking rewards come from network inflation, transaction, and other fees. ETH staking exhibits equity-like growth potential and built-in passive income, making it interesting for investment diversification purposes. Investors who are thinking about adding crypto to their portfolio may want to look not only for growth but also for passive income, as ETH staking offers it.
When EigenLayer launches and if the project is successful, it allows for ETH restaking; it could open an opportunity for Ethereum stakers to validate data for third-party projects and earn extra rewards for incremental risk-taking. ETH restaking, if it works, is set to create additional demand for ETH as ETH utility would expand to securing other projects.
Finally, self-custody of ETH and other crypto assets using multi-signature wallets like Safe and Linen Wallet powered by Safe allow for a much more secure way of protecting your wealth as those wallets will enable you to replace keys if some of them are lost or compromised. ETH staking from Linen Wallet is very easy, even for those new to crypto.
If you have been staking ETH using Linen Wallet or any other third-party apps and wallets and have noticed that certain features need to be included in those wallets, please hit me up on Twitter @srndptme or email hello@linen.app with your request or feedback. I will forward your feedback to our product team.
Special thanks to Alex Bazhanau, co-founder of Linen Wallet, for the feedback.
Disclaimer
This publication does not constitute investment advice, recommendations, offers or solicitations to purchase or sell any securities or any other instruments by anyone in any jurisdiction; nor should they be used by others in connection with any sale, offer for sale or solicitation of an offer to buy interests in a fund, securities, or any other instruments. Linen Mobile, Inc. and the other authors (collectively, the “Authors”) of this report have obtained all information contained herein from public sources believed to be accurate and reliable, but do not make any representation about or endorse the accuracy, completeness, timeliness, or reliability of any of the information, materials, advice, statements, or opinions contained herein or with regard to the results to be obtained from its use, and do not endorse or recommend any presenter, promoter, investment advisor or other professional. Any projections, forecasts, and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice and the Authors do not undertake to update or supplement this article or any of the information contained herein.
Disclosures
At the time of publication, Linen Mobile, Inc and/or authors of this report own directly or indirectly Ether (ETH) and do not own equity or tokens in the EigenLayer project.
