BiZai Research Institute: Research on ETH2.0 Staking Derivatives Track_

1. Overview

According to the latest news from the developers of ETH2.0, the Deposit Contract of ETH2.0 Phase 0 has been launched on November 4, which means that the highly anticipated ETH2.0 in the industry will be available on December 1. Now users can participate in ETH Staking and enjoy the staking income of ETH by paying 32 ETH to the Deposit contract.

However, all this is not as simple as it seems. In the design concept of ETH 2.0 Staking, there is only the concept of Validators, but no concept of Stakers, that is, users cannot entrust ETH to nodes like other PoS projects, and then the nodes run the client to earn Staking income and the nodes earn commissions. Therefore, if users want to participate in ETH Staking, they must also learn how to become a validator, run a node client, etc., which undoubtedly blocks a large number of ordinary users from the door.

In addition to the high threshold for participation, ETH2.0 Phase 0 and Phase 1 do not support operations such as transfers and redemptions, which means that Stakers can only get back the staked ETH and the corresponding staked income when ETH2.0 Phase 2 is launched. It is extremely uncertain when Phase 2 will be launched, or even whether it will be launched. According to official statements, it will take at least 1 to 2 years for Phase 2 to be launched.

The existence of the above problems has discouraged a large number of ETH loyal users from ETH Staking. At this time, whoever can lower the participation threshold for ordinary users and solve the liquidity after Staking can get the greatest "vote with feet" from users and enjoy the greatest dividends. Therefore, this article attempts to analyze the ETH2.0 Staking derivatives track from three aspects: ETH2.0's Staking mechanism, existing problems, and existing solutions, to see who can capture the industry's biggest dividends.

2. ETH 2.0 Staking Mechanism

2.1 Introduction to ETH 2.0

ETH 2.0 specifically refers to Ethereum. Ethereum will begin to switch from the original PoW consensus protocol to the Casper FFG PoS consensus mechanism at the end of 2020. According to the Ethereum 2.0 roadmap, ETH 2.0 will be implemented in stages and will eventually merge with the PoS chain and the original PoW chain:

Phase 0:

In Phase 0, ETH 2.0 will launch the beacon chain. The beacon chain is the core of the ETH 2.0 architecture and is very similar to the relay chain in the Polkdot architecture. It performs intelligent functions such as coordinating 64 shard chains, storing transaction status indexes on shard chains, and coordinating and managing validators. It is the "brain" in the ETH2.0 architecture.

However, the beacon chain in Phase 0 is still a low-profile “brain” that only supports the validator’s staking function, and does not support smart contracts, transfers, redemptions, and other functions.

Image source: ethos.dev

Phase 1:

In Phase 1, the most important task is to launch the shard chain, but the shard chain at this stage has no accounts or assets, which means that it cannot perform transaction operations such as transfers, and it does not support smart contracts. In Phase 1, the state of ETH2.0 is more like a transition stage to the shard chain.

Phase 2:

In Phase 2, ETH 2.0 will launch virtual machine functions, support smart contract operations of shard chains, and also perform operations such as transfers and redemptions. At the same time, starting from Phase 2, ETH2.0 will be integrated with the original PoW chain (ie ETH1.0). Phase 2 is the most technically difficult update, and the official final design has not yet been determined.

Image source: Consensys

2.2 Introduction to Staking Mechanism

In the ETH 2.0 Phase 0 stage, an important function is for validators to participate in node operation and enable the Staking function. That is, each node needs to run the beacon chain client and the validator client, and at the same time, it needs to pledge 32 ETH to the Deposit contract of the ETH PoW chain.

In general, the requirements and costs for validators of ETH2.0 are relatively low, so the number of validators participating in ETH2.0 Staking may reach hundreds of thousands or even millions, which can ensure the decentralization of the ETH2.0 network to the greatest extent.

According to data from EthHub, the annualized rate of return for ETH Staking can reach up to 18.10% (based on ETH), which has attracted the attention of a large number of PoS mining pools, node service providers, wallets, exchanges and other institutions, who have expressed their willingness to actively participate in ETH 2.0 Staking.

Image source: EthHub

In addition to Staking benefits, validators may also face two types of penalties:

1) Penalty for disconnection.

Being offline when the vast majority (2/3) of validators are still online will result in a relatively small penalty, because in this case there are still enough online validators on the ETH2.0 beacon chain so that they can fulfill their validator responsibilities.

In general, as long as the validator’s normal online time is greater than 50%, the penalties received are relatively minor, and the Staking rewards are generally not that high, which will not affect the 32 ETH principal.

2) Confiscation income, also known as Slash.

The main purpose of the slash system is to make the cost of attacking Eth2 very high. If the validator adopts malicious and destructive methods, such as double signing, the system will deduct a certain amount of ETH. Once the amount in the validator's account is reduced to 16 ETH, the system will forcibly remove the validator sequence.

2.3 Staking Dilemma

However, the current design of ETH2.0 is not friendly to users who want to participate in ETH Staking:

1) Sakers must master a lot of knowledge about running nodes in order to become Stakes and obtain staking benefits by running the validator client. This is too high a threshold for participation for those who simply want to obtain Staking rewards;

2) Each node can stake up to 32 ETH. If the amount of ETH you want to stake is too much, you will need to run multiple validator clients at the same time, which will greatly increase the operating cost and difficulty of the node;

3) If the user wishes to stake less than 32 ETH, he/she will not be able to successfully participate in ETH2.0 Staking;

In addition to the high participation threshold mentioned above, Stakers will also face the problem of redemption after participation: after participating in ETH Staking, they can only redeem their assets into the original ETH after ETH2.0 Phase 2. It is estimated that it may take 1 to 2 years for ETH2.0 Phase 2 to go online, which means that Stakers' assets may not be redeemed for circulation within 1 to 2 years, which is unbearable for most Stakers.

Although the design of the ETH 2.0 Staking mechanism is to ensure the decentralization of nodes, it also blocks many ordinary investors who hold ETH and just want to participate in ETH staking to obtain staking rewards without running the validator client and becoming nodes. How to solve this mismatch between demand and supply, lower the participation threshold for ordinary users, and propose a set of safe and feasible liquidity solutions to solve the short-term non-redeemable [top priority] that is difficult for both Stakers and nodes to accept, is bound to become an important issue and development trend in the industry.

3. Analysis of ETH Staking derivatives projects

At present, there are many projects in the industry that focus on providing ETH Staking derivatives and solving liquidity problems. Most of them are conceptual and have not yet announced specific executable solutions. The projects that have announced detailed solutions are mainly: Rocket Pool and Ankr. The basic information of the two projects is briefly summarized as follows:

3.1 Rocket Pool

Rocket Pool is a mining pool project that has been running since February 2017 and focuses on ETH2.0 Staking. It has been the most focused and longest-lasting in the field of ETH Staking. The product design has also been revised many times, and the Beta version has been launched. Users can participate in staking ETH and mint or redeem rETH.

According to Rocket Pool's latest plan, users can participate in any amount of ETH Staking without being subject to 32ETH staking, nor do they 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. If the user chooses Rocket Pool to stake, after successfully staking ETH, he will immediately receive the rETH Token issued by Rocket Pool as a certificate for participating in ETH 2.0 Staking. rETH can be circulated and traded on the official website or DEX, and exchanged for ETH, etc.

It should be noted that the amount of rETH a user receives is not a 1:1 exchange with the amount of ETH staked, but is calculated based on a floating exchange rate. For example, if a user stakes 110 ETH, and the current rETH/ETH exchange rate is 1.1, then the user can only receive 100 rETH.

The increase in the rETH/ETH exchange rate is mainly due to the staking income generated by users' ETH staked in Rocket Pool, which will increase the rETH/ETH exchange rate, that is, users holding 1 rETH will be able to exchange more ETH.

In addition to user pledges, in order to prevent user funds from being lost due to nodes receiving Slash penalties, Rocket Pool requires each node to pledge 16 ETH. In this way, when a Slash penalty occurs, the system will automatically deduct the corresponding fine amount from the 16 ETH pledged by the node to compensate user funds, thereby ensuring that user-side funds will not be affected by Slash penalties.

In general, Rocket Pool has set higher requirements for validator funds in order to protect user funds from Slash. Such a design will require a higher capital threshold for validator operators. At the same time, in order to solve the liquidity of the 16ETH staked by the node, Rocket Pool has also designed an ERC 20 Token: nETH. Different from the floating exchange rate of rETH, the exchange rate of nETH/ETH will maintain a 1:1 relationship.

Source: Rocket Pool White Paper

3.2 Ankr

As a project established in 2019, Ankr’s main focus is not on ETH2.0 Staking derivatives, but on the node service platform of Web 3. That is, it provides node deployment tools and platforms for various PoS projects, reducing the cost of deploying PoS nodes for individuals, enterprises or developers, so that they can easily and quickly create PoS nodes and become validators of a PoS project.

Ankr released Stkr, the ETH2.0 Staking liquidity solution, on October 22 this year. The protocol will issue aETH to ETH2.0 Staking users as an asset certificate for participating in Staking. Users can participate in the three trading pairs of ANKR/aETH, ETH/aETH, and ANKR/ETH on Uniswap to exchange and obtain liquidity. At present, the Stkr platform has not been officially launched and is still in the internal testing stage.

According to Stkr’s plan, there are four major participants on the platform:

¡ETH Staker: Also called Requesters, it is called Requesters because Stakers need to initiate the ETH2.0 Staking Project on the Ankr platform. Their main purpose is to stake ETH to nodes to obtain ETH staking income. A mechanism called Micropool was created to support users with a minimum staking amount of 0.5ETH, with no upper limit. After users stake, the system will automatically allocate funds to the best Provider, but they can also select manually.

¡Node Provider: It is the one who runs ETH2.0 POS nodes on the ANKR platform and earns node income (mainly from staking rewards and platform fees). A minimum deposit is required as insurance to deal with slashing situations. Stkr will establish a reputation evaluation system for Providers, with the main factors being the performance of the validator and the staked amount. Once a slashing situation occurs, the Provider’s funds will be deducted, and the user’s staked funds will be automatically allocated to other nodes.

¡ANKR staker: People who stake ANKR may be participants in the ANKR staking program, or they may be nodes that pay the Issue Fee (income comes from platform fees). There will be an ANKR staking program. Whether nodes want to stake to improve their ranking or ordinary ANKR holders, they can all participate in staking. The source of all staking rewards is the platform fee in the Stkr product (ANKR is collected).

¡ Governor: A person who participates in Node Provider governance to ensure the decentralization of the Stkr platform. Stkr will invite professionals in the industry to serve as Governors to assist in the governance of the Stkr platform.

Source: Stkr Whitepaper

3.3 Comparative Analysis

At present, according to public information, only Rocket Pool and Ankr have disclosed in detail the solutions for ETH2.0 Staking derivatives. If we compare the main situations of the two projects, we can find that there are still big differences between the solutions. For example, the exchange rate mechanism of derivative tokens and ETH is different, and the staking requirements for nodes are also not the same.

The comparison of each latitude is listed below:

Source: BitZ Research Institute

Comprehensive comparative analysis shows that Rocket Pool wins in terms of first-mover advantage and its solution has been completed. If ETH2.0 is launched in the near future, Rocket Pool will undoubtedly be officially available to users immediately, but Stkr will still need to wait for a while. Stkr also has a competitive advantage in node resources, because the Ankr platform has a deep accumulation of PoS nodes, and can compete with Rocket Pool with its abundant node resources.

4. Conclusion

The launch of ETH 2.0 Phase 0, as a major event in the industry at the end of 2020, is bound to trigger discussions and demands for ETH Staking verification products in the industry. Currently, in addition to Rocket Pool and Ankr, other PoS mining pools and node service providers in the industry have announced that they are designing solutions for ETH Staking derivatives to provide liquidity for Stakers.

However, judging from the maturity of the current solutions, Rocket Pool and Ankr are undoubtedly the two most complete projects with the highest brand recognition, and are expected to be the first to enjoy the industry dividends. However, there are still uncertainties in the design of ETH2.0, especially when BETH will start the transfer function, which is the biggest uncertainty factor. This also means that most platforms that provide ETH Staking derivatives will not be able to make any profits for a long time, and can only get [BETH] similar to accounts receivable.

Therefore, how the future will develop, whether there will be new industry players entering the industry, and whether there will be new solutions that fit the market, all need to be observed. But at least for now, Rocket Pool and Ankr are undoubtedly ready, just waiting for the ETH2.0 trend to blow towards them.