Ethereum: An Introduction to Mergers and the ETH Staking Ecosystem

Ethereum plans to start implementing the merger this quarter. What opportunities and challenges will the merger bring to Ethereum? Let’s see Figment analyst J.Mason Bump briefly introduce Ethereum’s merger and ETH staking ecosystem, and learn what services Figment can provide in the “post-Ethereum era”.

What is Ethereum and how do you use its token ( ETH )?

Ethereum is a Layer-1 blockchain designed to provide cryptocurrency transactions and value storage properties, as well as the additional functionality of smart contracts. Smart contracts are a concept established by Nick Szabo in 1994 and further developed in 1996. They have been used to deploy DeFi solutions, DAO (decentralized autonomous organization) frameworks, and many other platforms for decentralized, permissionless coordination between parties around the world. Ethereum is by far the most dominant platform for developers to build decentralized protocols.

Ether (ETH) is the native token of Ethereum and is the native unit of account for interacting with the network and transacting with other users. The Ethereum whitepaper was published by Vitalik Buterin in 2014. Ethereum has led the paradigm shift of Web3 by combining the innovation of blockchain with the Ethereum Virtual Machine (EVM). Many consider it one of the few true "blue chip" cryptocurrencies, considered less vulnerable to market downturns and more resistant to shocks in the cryptocurrency ecosystem. ETH has no issuance cap, but will experience deflation after the merger because the destruction rate of ETH far exceeds the rewards received by validators, leading some to call it "ultrasound money".

Timeline before the merger

The above diagram shows a general timeline leading up to the Ethereum merge. Currently the Ethereum Mainnet (Proof of Work) and Beacon Chain (Proof of Stake) run in parallel, and while regular transactions are processed on the Mainnet, the Beacon Chain is forming consensus on its own state, which is generally of little use to Ethereum users. The "merge", expected to be implemented in Q3 2022, will bring the two together, with the execution layer (what we call the Mainnet today) focusing on processing transactions, and the consensus layer (what we call the Beacon Chain today) reaching consensus on the state of the network and blocks.

Merger Roadmap​

In terms of timing, the latest news seems to indicate that the merger will take place in the third quarter of 2022 (1), but this is not certain. The prospect of launching Ethereum’s proof-of-stake functionality pales in comparison to the prospect of doing so in a way that ensures minimal risk. In terms of Ethereum’s future development, the merger is the earliest stage in the following roadmap:

• Phase 0 (current) — Beacon Chain : The Beacon Chain (PoS) runs in parallel with the Ethereum mainnet (PoW) and generates blocks related to the Beacon Chain, but most Ethereum users are largely uninterested in these blocks. Currently, neither smart contracts nor transactions can be executed on the Beacon Chain, but those who wish to deposit 32ETH can become validators. Funds cannot be withdrawn until this feature is enabled after the merger.

• Phase 1 — Merge: The merge is when the beacon chain is combined with the execution layer (what we currently know as mainnet), changing the consensus from proof-of-work to proof-of-stake.

• Phase 2 — Post-merge cleanup: Several changes will occur after the Ethereum merge, including enabling withdrawals and some “technical cleanup.”

• Future Phases — Scalability / Sharding: After the merger, Ethereum will attempt to increase capacity by splitting the network into multiple chains (called “shards”) to spread the processing load across multiple validators without increasing their size. This is expected to solve the scalability problem.

Token Economics Before and After the Merger

Currently, approximately 15,000 ETH is issued daily to miners (~13,500 ETH/day) and validators (~1,500 ETH/day). In addition to this, approximately 8,100 ETH is destroyed daily(2), meaning that Ethereum will become “deflationary” after the merger. In other words, stakers will still receive an estimated 7-9% annualized staking reward, but this will be paid out in an asset with a decreasing supply.

Currently, automatic reward compounding is not enabled, and rewards to validators are distributed by performing one of three activities. These three activities are described below (references to the architecture are minimized as a lot of technical explanation is required to fully describe them):

1. Issue new blocks;

2. Proof (i.e. vote in favor with staked ETH)
a. Beacon chain head (i.e. "LMD GHOST")
b. The source (i.e., “FFG Voting”), and
c. Target (i.e. “FFG Voting”); or

3. Participate in the "Sync Committee" (a group of 512 validators are selected every 256 epochs or about 1 day) - this group of validators continuously signs block headers per slot.

Generally, the annualized return (APY) of rewards is calculated based on the total amount of ETH staked, as shown in the following figure:

Currently, once a user deposits their ETH into the beacon chain, the lockup period for staked ETH is indefinite. In all likelihood, the first upgrade after the merge will likely support withdrawals (see Shanghai and Capella). It is worth noting that it is possible for ETH to voluntarily exit the validator set, or exit due to a slashing event. In both cases, ETH remains locked in the beacon chain until there is an upgrade after the merge that supports withdrawals. These two events can generally be understood as:

• Voluntary exit from validator set: Similar to entering the queue, the maximum number of validators allowed to exit in any given epoch; if the queue is empty, exit takes at least 5 epochs (about 32 minutes); please note that exited ETH will not be withdrawn until merged.

• Slashing : Applies to (1) double voting, or (2) wraparound voting. When slashing occurs, the penalty is the same (assuming 32 ETH):
  - 0.5ETH will be deducted immediately;
  - 0.15 ETH is deducted when a validator is waiting to be removed from the validator set; and
  - The amount of tokens deducted from the stake is proportional to the number of other validators slashing at the same time

The Current State of the Ethereum Staking Ecosystem

Ethereum has proven to be one of the best blockchain networks in terms of security, flexibility, and reliability, processing over $2 billion in transaction volume per day. Due to the staggering amount of demand for this reliability and security information for many interoperable applications, the cost of block space on Ethereum has skyrocketed. This has created an opportunity for layer-2 (“L2”) networks, which aggregate transactions on their own sidechains before a single transaction is added to the Ethereum blockchain, thereby spreading the cost of expensive ETH transactions across all L2 participants.

ETH is the native token on Ethereum, but it also manifests itself in these different L2 solutions as wETH, axlETH, and stETH, among others. These L2 solutions allow the network to scale and provide greater efficiency to users outside of the base protocol layer, with the benefits of lower transaction fees (e.g. Polygon, Arbitrum) and access to liquid staking before withdrawals are enabled on Ethereum itself (e.g. Alluvial, Lido). Lido is an L2 network for permissionless liquid staking, allowing anyone to deposit ETH and receive stETH in return, thereby generating staking yield, which can also be freely traded or deposited into compatible derivative smart contracts. Alluvial, on the other hand, is liquidity staking for institutions, which have different needs (e.g. AML and KYC). Alluvial aims to not only provide this higher level of service to institutions, but also plans to convert into a decentralized autonomous organization (DAO) and hand over governance to its community to retain the principles of decentralization.

With the pivot to Proof of Stake, Ethereum will continue to have scalability issues for the foreseeable future. This means that L2 solutions will remain important to the overall success of the network and participants in the Ethereum ecosystem. Even with withdrawals enabled after the merger, liquid staking solutions like Alluvial and Lido will continue to account for the majority of the Ethereum staking market as they not only allow stakers to continue to earn yield on liquid assets, but also enable more powerful yield-generating strategies by allowing them to deposit their assets into other utility-based smart contract platforms. The merger is an important step in the evolution of Ethereum, but importantly, it is only the beginning of what we are going to build together. ‍

Staking Ethereum with Figment

If you are interested in more than 32 ETH, we offer a range of services designed to provide safe and reliable staking returns for your assets. Not only do we provide some of the highest quality staking infrastructure in-house, we also provide many auxiliary data processing services for you to use. ‍

Here’s a quick overview of what Figment has to offer:

• A white glove solution that caters to the current technology stack and security needs of token holders.

• A combination of bare metal and cloud infrastructure is optimized for security.

• Custom SLAs: coverage for slashing and missed rewards.

• Rewards reporting and custom portfolio dashboards.

• Private consultation channel available 24 hours a day.

• The Lighthouse client provides unique security coverage and superior performance.

• Security key handling.

• Validators can be configured in specific geographic locations based on preference.

• Automatic validator configuration.

• API for customer self-service.

• Get setup and staked within 5 business days.

We also support Lido, a liquid staking solution that allows ETH holders to stake less than the 32 ETH required to start a validator on the beacon chain. We are also one of several core staking providers for the institutional version of Alluvial, Lido’s liquid staking service.