As Ether staking returns decline, protocols will have to seek innovative solutions

summary

• As more ETH is staked to secure the network, the staking yield is falling

• The most recent annual staking yield is 5%, and is expected to drop to 3% by the end of the year. It may then drop below 1%

• To remain attractive, staking protocols will have to find ways to increase returns

Ethereum’s staking craze is only two months old. However, it won’t last for long, and the teams responsible for running staking protocols are already thinking about a future where the safest way to earn money in cryptocurrency could become boring.

Here’s the thing: The more ether you stake, the lower your annual yield. That decline is already underway. After a major Ethereum upgrade last September, the yield on staked ether fluctuated between 5% and 6%. Since then, the share of circulating ether staked has increased from 11% to nearly 20%. This month, its staking yield has hovered between about 4.5% and 5%.

To contribute to the security of Ethereum, users must stake (lock up) their ether. Their compensation is a modest and relatively risk-free return, paid in newly issued ether. Another major upgrade in April, known as Shapella, eliminated the remaining tiny risk, and investors flocked to staking protocols, including Lido and Rocket Pool.

Some researchers predict that eventually most Ethereum will be staked. If that happens, yields could drop below 1%, according to Mike Silagadze, founder of staking protocol ether.fi. “No one is going to stake for 70 basis points.” This will force protocols to find new ways to increase returns.

Re-staking

According to Darren Langley, CEO of liquid staking protocol Rocket Pool, re-staking is the most obvious source of future returns.

Restaking allows users to reinvest their staked ether into other decentralized applications on Ethereum and other blockchains using a liquid staking token similar to Rocket Pool’s rETH. The technology made its debut last week when U.S.-based company EigenLayer launched their eponymous restaking protocol.

“The staking space is full of innovation and the Ethereum blockspace ecosystem is constantly evolving,” Langley said. “EigenLayer is a prime example of how to further increase potential returns for stakers. In that [1%] scenario, what is going to provide the returns for staking? I honestly think re-staking is going to be the most important thing that happens to Ethereum .”

Counterpoint

To be sure, if Ethereum becomes mainstream, stakers can still enjoy attractive annual returns. This is because staking rewards will also increase with the increase in network activity.

“As network activity increases, rewards may increase again, so it’s hard to predict what the annualized yield on Ethereum staking will ultimately be,” said Josh Fraser, co-founder of Origin Protocol, which provides a liquid staking service. For example, in November last year, as the collapse of FTX, one of the world’s largest cryptocurrency exchanges, triggered a trading frenzy, the staking yield temporarily jumped from 5.5% to 8%.

balance

Ethereum founder Vitalik Buterin wrote last year that the inverse relationship between staking ether and its rewards is a design compromise between two options, each of which has flaws. The two options are a fixed reward rate or a fixed total reward. The former option would force Ethereum developers to choose a reward rate, and they could screw it up. If the reward rate is too low, no one will stake, making Ethereum vulnerable to attacks by bad actors; if the reward rate is too high, the blockchain will issue too much ether, diluting the value of the token over time. The latter option would also create an incentive to bully competing stakers to exit, allowing the remaining stakers to get a larger share.

However, if staking returns do plummet, Ethereum may reach an "equilibrium point," Matt Leisinger, co-founder of liquid staking company Alluvial, told DL News. "It will be interesting to see if (falling returns) incentivizes people to unstake at some point." Some say this equilibrium is still a long way off.

“We expect 25% of ETH to be staked by the end of the year; that would equate to a yield of about 3%, which, in my opinion, is still attractive,” said James Butterfill, head of research at crypto data company CoinShares. And according to Langley, the security of staking means that yields can drop very low until investors start looking for other investment opportunities.

Ethereum staking is considered one of the safest ways to earn yield, so even if the reward rate drops significantly, people are still willing to stake their ETH. It all comes down to stable and secure income.