Ethereum Completes Second Merger Rehearsal. Why is ETH's Daily Staking Volume Declining?

On July 7, the blockchain network Ethereum completed the second test of the merger (transition from PoW to PoS mechanism). This merger "rehearsal" was conducted on the test network Sepolia. So far, Ethereum's merger test has completed two rounds. According to the plan, there is only one last test left on the Goerli test network before the merger.

The completion of the Sepolia test means that Ethereum is one step closer to the final merger. Although there is no more precise timetable for the final merger, judging from the public statements of Ethereum founder Vitalik Buterin and developers, the merger will come within the year.

Ethereum no longer intends to rely on the Proof of Work (PoW) mechanism of mining machines. It will gradually iterate to the "2.0 version" of the network, which is more environmentally friendly and scalable, replacing PoW with the Proof of Stake (PoS) consensus mechanism, and realizing network upgrades in three steps: beacon chain, merger, and shard chain.

Throughout the process, the launch of the beacon chain at the end of 2020 is the foundation. It provides a voting channel for those who are willing to reach a PoS consensus - staking at least 32 Ethereum native assets ETH, serving as a validator of the 2.0 network, ensuring the network's block operation and security while obtaining node rewards.

Judging from the data, consensus has been getting stronger. As of July 7, the Ethereum Beacon Chain browser showed that there are currently about 405,782 active validators, with more than 12.94 million ETH staked, accounting for 10.5% of the total circulation, setting a new record high.

While building consensus on the beacon chain, Ethereum developers are also simultaneously carrying out the second step of consensus switching, "The Merge", which is planned to be officially launched after completing three rounds of testing, and two rounds have been completed so far.

An interesting indicator is that while Ethereum is in full swing to promote the upgrade plan, the daily staking volume of ETH on the beacon chain has declined in the past two months. Does this mean that people's interest in Ethereum 2.0 is waning? Or are people no longer optimistic about the impact of Ethereum's "merger"? How do ordinary users express their thoughts on Ethereum upgrades? This issue of DeFi Honeycomb will bring its own observations.

Ethereum upgrade "trilogy" is halfway through

It is not an exaggeration to regard Ethereum as the "most successful network" in the field of public blockchain, because it always takes the lead in terms of the degree of decentralization, market value, and scale of on-chain applications.

This year, the number of Ethereum network nodes under the PoW mechanism has remained above 5,000, with 4,929 active nodes. At its peak last year (in February), the number of nodes reached 12,569. These network nodes, which can be joined or exited at any time, are distributed in more than 70 countries around the world, maintaining the operation of the network.

In terms of market value, ETH has become the second largest crypto asset after BTC since last year, currently valued at $141.6 billion. There are more than 550,000 token smart contracts running on the Ethereum network, and two major US dollar stablecoins, USDT and USDC, are issued on the network. Tens of thousands of DeFi, NFT and other application markets require this network to provide underlying support.

Ethereum, which is the leader in various indicators, is not without flaws. When there are many applications and frequent transactions on the chain, network congestion and slowness are its biggest problems. When this problem is manifested at the user level (application developers and application users), the application is not smooth, the transaction is slow to arrive, and the network fee (Gas) is high. Once the network is highly congested, if a transaction user wants to transfer a blockchain asset in the Ethereum network, the Gas fee may be over a hundred dollars per transaction.

This is incredible for 5G Internet users who can get dozens of GB of traffic for mobile applications for just a dozen yuan. The blockchain network is still far from the scalability of the current Internet, but the advanced Ethereum does not intend to give up exploration. It wants to expand capacity, increase speed, and reduce fees. Even if it cannot reach the level of the Internet, it will continue to dominate the small field of blockchain. Because in the eyes of blockchain developers, activities that allow people to be transparent but not lose privacy on a decentralized network are a dimensional attack on the Internet and the supreme honor of true blockchain people.

After years of exploration, Ethereum decided to abandon PoW, a consumption-based consensus that relies on miners to maintain low-speed network operation, and instead use the more scalable PoS consensus to build a sharded, high-speed blockchain network.

Ethereum has decided to upgrade, but changing the consensus is equivalent to rebuilding a bottom layer. In order not to affect the operation of the current PoW chain, Ethereum developers decided to take a "three-step approach" to first solve the consensus switch and then solve the scalability problem. Specifically, it is divided into "three steps":

Beacon Chain - a new proof-of-stake (PoS) consensus mechanism blockchain, was launched in December 2020. Users can stake at least 32 ETH to the Beacon Chain to become a network validator and receive block rewards.

The Merge - the process of switching Ethereum from PoW to PoS, that is, the current Ethereum PoW mainnet group will merge with the beacon chain at a certain time, at which time Ethereum will implement the PoS consensus and stop the PoW chain mining.

Shard Chain - The main purpose is to solve the scalability problem of Ethereum. Sharding technology enables multi-chain parallel operation to improve performance, just like dividing multiple lanes on a congested road.

Regarding the above three steps, the official said that they are "developed in parallel", but there is a step-by-step relationship between them. The launch and normal operation of the beacon chain are the prerequisites for the merger. After the merger, the idea of ​​​​sharding chain can be realized.

Ethereum upgrade trilogy

Judging from the current progress, two of the three originally planned merger tests have been completed, the "trilogy" is already halfway through, and the merger is expected to be completed within the year.

Before the merger is officially implemented, the existing proof-of-work chain (ETH 1) will eventually be abandoned through a difficulty bomb, and users and applications will gradually migrate to the new proof-of-stake chain (ETH 2).

In order to reduce user confusion about the concepts of ETH 1.0 and ETH 2.0, at the end of 2021, the Ethereum Foundation abandoned this name and used the names "execution layer" and "consensus layer" to replace 1.0 and 2.0 respectively. After the name change, ETH1.0 is called the "execution layer", which refers to the original Ethereum chain under the PoW mechanism; ETH 2.0 is renamed the "consensus layer", which refers to the beacon chain later built by Ethereum with PoS consensus.

At present, the Ethereum "execution layer" carries all smart contracts and network rules, and is also responsible for processing block generation and reward rules; in the future, the "consensus layer" will be responsible for processing the consensus of proof of stake and formulating reward and punishment mechanisms for the network. The two layers will be "merged" after testing, and after the merger, the focus will be on the next step of "sharding".

The merger is considered the most important step in the Ethereum upgrade process, because the impact of the change in consensus mechanism on Ethereum is still unknown, such as whether it is safe? Are the nodes decentralized enough? Is the merger beneficial to ordinary users? These questions can only be answered after the merger. Of course, for developers, safe mergers are the top priority, which is why merger tests are repeatedly conducted so that Ethereum developers can understand the potential risks of mergers.

Currently, Ethereum is running in parallel with the mainnet and beacon chain. For users, the current interactive activities are still on the mainnet, and the beacon chain will only be touched when "staking ETH to become a validator", which has no impact on the user experience. Once merged, the interaction with smart contracts and the transfer of assets will be carried out on Ethereum under the PoS consensus.

Use value incentives to retain users waiting for upgrades

The Ethereum upgrade period is also the era when the public chain enters the second round of major competition. Compared with the wave of conceptualists around 2017, this round of public chain competition is more industry-driven, because the applications are truly implemented on the chain, and the DeFi scenario has taken the lead. Of course, this trend also started from the Ethereum chain.

Various decentralized trading applications, decentralized lending applications, and stablecoin applications began to emerge on the Ethereum chain. The wealth effect generated quickly prompted public chain developers to follow suit, and they launched so-called high-speed, low-fee chains in a way that was compatible with Ethereum. The trick is to reduce the number of verification nodes, which more or less loses the decentralization of the blockchain.

In the competitive landscape, Ethereum upgrade is a slow process. How to avoid losing users in this process? Ethereum's "big brother" status in the market capitalization market has come into play, and the appreciation of ETH has become an important topic of discussion throughout the Ethereum upgrade process.

During the Ethereum upgrade process, changes such as staking ETH to become a validator and adjustments to the network's basic fee burning mechanism are all pushing up the market's expectations for ETH's value.

In the PoW era of Ethereum, miners need to consume electricity and graphics card energy to participate in mining. After receiving ETH rewards, miners often sell them directly to pay for the cost of maintaining mining machines. Currently, miner rewards include a fixed reward of 2 ETH for creating a block and all gas fees included in the block. Under the PoS mechanism, mining will lose node qualifications and be replaced by staking validators. Validators obtain block qualifications by staking ETH and obtain additional ETH.

To become a validator on the beacon chain, you only need to stake 32 ETH (or its multiples). In order to attract more users to participate in staking, the beacon chain links the annual yield of the validator to the amount of ETH pledged, and the yield will decrease as the number of stakers increases.

As of July 5, according to the beacon chain browser BeaconScan, there are currently more than 12.94 million ETH involved in staking, accounting for 10.5% of the total circulation, setting a historical high.

In addition to staking ETH to reduce market circulation, the Ethereum upgrade process also added a basic fee burning mechanism. In August last year, the Ethereum London upgrade passed the EIP-1559 proposal - each on-chain transaction will burn a certain amount of basic gas fees, which will automatically reduce the circulation supply of Ethereum.

As of July 5, Watch the Burn shows that since the implementation of the EIP-1559 proposal, a total of 2.51 million ETH has been burned and 4.45 million block rewards have been produced.

Ethereum Burn Data

It can be said that the upgrade of Ethereum has turned ETH from an inflationary asset into a deflationary asset.

There are two main mechanisms that make ETH a deflationary asset: one is that every on-chain transaction will burn ETH after the EIP-1559 proposal is implemented; the other is that after the Ethereum PoS consensus mechanism is switched, ETH production will decrease. However, it is still unknown how much ETH production will decrease after the merger.

Will the deflation of ETH after the Ethereum merger trigger a surge in prices like the halving of BTC? This needs to be seen after the Ethereum merger is actually launched. Some users have begun to show a rational attitude and believe that the impact of the Ethereum merger on the ETH price can be ignored.

This rationality has been reflected in the daily staking of ETH. Although the total staking of ETH on the beacon chain has been on an upward trend, the daily staking of ETH has begun to decline since May this year, with the highest being 121,648 ETH on May 2 and the lowest being 32 ETH, which has occurred many times.

Daily ETH staked on the beacon chain

Analysts believe that the increase in the total amount of ETH staked indicates that the PoS consensus is still being consolidated, but as the current crypto asset market is in a bear market, users will naturally prefer to abandon risks, and the rewards for staking assets need to be redeemed after the Ethereum upgrade is completed, so users' enthusiasm for staking will be discounted. In addition, with the merger imminent, the security of the beacon chain still needs to be verified. In the face of the unknown, a large number of users will definitely choose to wait and see. "The market is still the main and biggest uncertainty factor."

Liquidity staking platform helps users participate in verification

Indeed, becoming an Ethereum validator does not mean there is no risk. The risk of a validator mainly comes from the liquidity and opportunity cost of ETH. After staking ETH on the beacon chain, it cannot be redeemed immediately. It needs to be merged and upgraded by Ethereum before redemption can be performed, which limits the liquidity and utilization of users' assets. In other words, during the staking period, there may be opportunities to obtain higher returns than locking positions.

In addition to the uncertainty of the unlocking time, if users want to become validators, they also need to set up their own node servers, which requires a certain technical threshold. If the operation is not done properly, the staked ETH may be lost or confiscated.

In order to address these concerns, some ETH liquidity staking platforms have emerged, aiming to help users obtain liquidity while staking ETH. On these platforms, users stake a certain token (often referring to the network native token under the PoS mechanism) on the platform, and the platform participates in the staking of a PoS blockchain on behalf of the user and mints staking certificates at a 1:1 ratio. These certificates can be used to mine income in the DeFi market.

At present, many developers have already laid out in this track, including:

Lido Finance, the leader in liquid staking protocols

Lido Finance is built on the Ethereum beacon chain, and the platform's locked TVL (US$4.95 billion) ranks first among similar competitors.

After users stake any amount of ETH (not necessarily 32 ETH) to the Lido protocol, all staked ETH will be divided into 32 ETH and allocated to node operators, who are responsible for verifying the use of these staked deposits. Node operators are verified and approved by LidoDAO and selected through voting governance. Lido does not require node operators to deposit an equal amount of staked positions, but only requires staking experience. The risks are covered by insurance invested by Lido.

In addition to Ethereum, it currently supports Solana, Polygon and other blockchain networks. In simple terms, Lido allows users to stake network tokens under the PoS mechanism without losing the liquidity of the tokens. However, Lido charges a 10% fee on all staked profits.

Operational Mechanism

Taking ETH2.0 staking as an example, when a user stakes ETH through Lido, the user will receive a stETH staking certificate at a 1:1 ratio. Users holding stETH can redeem it back to ETH on DEX and receive staking rewards.

stETH can be held, traded or sold, and the balance of stETH of the pledger = total locked ETH + total staking rewards - service fee. In addition, stETH certificates can also participate in on-chain lending, staking, and liquidity contribution rewards in other DeFi protocols to increase income.

For example, deposit stETH as collateral in Aave, borrow ETH, and then deposit ETH in Lido to obtain stETH, so as to carry out circular lending. This method releases the pledge liquidity of ETH, but also amplifies the leverage risk. The previous price decoupling of stETH and ETH is a manifestation of risk.

Fully decentralized staking RocketPool

Rocket Pool was first built in 2017 and is the earliest liquidity staking protocol on Ethereum, but the product was actually launched in November 2021, aiming to build a truly decentralized liquidity staking platform.

Operational Mechanism

Rocket Pool focuses solely on the Ethereum network and primarily serves two user groups: stakers and node operators.

For staking users, they only need to deposit more than 0.01 ETH to participate in Ethereum staking. Users do not need to worry about how to run node services, etc. The system will automatically assign the ETH deposited by the user to the validator in Rocket Pool. Users who deposit ETH will obtain the staking certificate rETH at a 1:1 ratio. rETH can be circulated on the official website or DEX, and traded for ETH, etc.

For node operators, anyone can become a node operator by depositing 16 ETH, plus 16 deposited non-validators' ETH to create a "Mini Pool" to form a new validator. The creation, rewards, and withdrawals of the Minipool are all automatically run by the Rocket Pool smart contract, so it is completely decentralized.

However, before becoming a node, users need to stake RocketPool's platform token RPL. The amount of staked RPL must be worth at least 1.6 ETH. The more RPL staked, the more RPL token rewards they will receive.

The difference between Rocket Pool and Lido lies in the process of selecting validators. Instead of giving the decision to token holders, anyone can become a node operator in the network by creating a Minipool. However, node operators need to deposit 16 ETH, and the remaining 16 ETH comes from other users' locks. In addition, operators also need to pledge RPL worth 1.6 ETH for protection in the event of a major accident.

Dual Token Staking Platform Stakewise

Stakewise is also a liquidity staking service platform on the Ethereum beacon chain, supporting anyone to stake any amount of ETH to obtain staking rewards.

Unlike other staking platforms, Stakewise tokenizes users' staking and rewards. After users deposit ETH, they will receive sETH2 (staking ETH) and rETH2 (staking rewards) at a 1:1 ratio. The former represents the ETH staked by the user, and the latter represents the ETH rewards that users can get by staking. As long as the user holds sETH2 in the wallet address, the amount of rETH2 staking rewards will increase.

In addition, the Stakewise platform supports users to put the staking rewards rETH2 obtained as original collateral into the protocol for compound interest. It also supports users to provide liquidity for sETH2-ETH and rETH2-sETH2 pools to obtain platform token SWISE rewards.

On June 6, StakeWise announced that it and blockchain infrastructure provider Blockdaemon will jointly launch Harbour, a liquidity staking platform for institutional clients, which supports B-side clients to stake ETH on the platform to obtain staking certificates. Institutions can use staking certificates on other licensed DeFi protocols to obtain returns while maintaining their staked ETH to obtain staking rewards.

It should be noted that when participating in third-party ETH2.0 liquidity staking and derivative DeFi, users need to carefully consider the collateral liquidation risk brought about by the downward trend of ETH. That is, when the pledged certificates are sold, they may be decoupled from ETH, and they are likely to be liquidated as collateral.