Author: Glaze & Fundamental Labs Research
Editor: Philip
TL;DR
We break up PoS staking into three parts: node providers, liquid staking pools, finance derivatives
The big players have already dominated the market
New players can enter the market by supporting long-tail assets, and better UX
There are the following opportunities:
Data analysis tool
Toolkits for bootstrapping your node provider business
Long-term fix rate staking derivatives
Better tokenomics design
Intro
Ethereum is turning from Proof-of-Work (PoW) to Proof-of-Stake (PoS) for higher transactions-per-second (TPS) and efficiency. Most of the major blockchains that support smart contracts use PoS, such as Solana, Cardano and Avalanche.
Source: Staking Ecosystem Report 2021
Most blockchains turn to PoS because PoS empower them to embrace high performance, faster finality, environmental sustainability, scalability, low cost of security, and flexibility in architecture compared to PoW approach.
Source: Staking Ecosystem Report 2021
PoS gives users a new way to earn stable yields. Delegate the native assets to the staking node, users can earn 10%-20% yields. This is like the treasury bond of countries. It is stable and low-risk and it is much more profitable than stablecoin farming on popular DEXs and lending platforms.
Hopefully, these crypto treasuries can help investors overcome fiat currency inflation. The following chart illustrates the inflation rate around the world. The fiat currency inflation is around 3% to 6%.
Source: Staking Ecosystem Report 2021
Staking mechanism
Different blockchains have different staking mechanisms, differing in withdrawal period and slashing rules.
Ethereum
Ethereum is turning from PoW to PoS for sustainability and scalability.
Source: Delphi Digital
Ethereum describes staking on Ethereum as “Staking is the act of depositing 32 ETH to activate validator software. As a validator, you’ll be responsible for storing data, processing transactions, and adding new blocks to the blockchain. This will keep Ethereum secure for everyone and earn you new ETH in the process. This process, known as proof-of-stake, is being introduced by the Beacon Chain.”
In short, the user needs to stake 32 ETH and run a validator node to become a staker. Users can withdraw staked ETH at least after the merge.
Currently, users will get around 4.2% APR, not deducting the server cost. After the merge, Kraken expects the APR to increase to 8.5% - 11.5% in the report “The State of Staking Q1 2022”.
Source: The State of Staking Q1 2022
The Ethereum node doesn’t require high-end hardware. The server cost is relatively low. The recommended specifications are:
4+ cores CPU
16 GB+ RAM
SSD with at least 500 GB of free space
25+ MBit/s bandwidth
Based on the node type, the disk space requirements varies from 400GB to 6TB.
In the ETH2 network, a proposer mints the new block, and the attester vote for this block to be part of the canonical chain.
Slashing means the validator violates rules and is forced to exit. There are three slashing conditions:
As a proposer, the node sign more than one beacon block for one slot
As an attester, the node signs more than one attestation on the same target
As an attester, the node sign an attestation conflict with the history
If any of these behaviors is caught, the node is forced to exit the beacon chain around 36 days in the future. The penalties will continue to incur for around 36 days until the node can exit. The penalty number varies based on the network condition.
Slashing forces validators to exit the network, but penalties don’t. Penalties conditions can be put into the following categories:
Attester penalties
Inactive leak penalty
There are a total of 13,310,531 ETH staked and 396,982 total validators. The following charts illustrate the ETH 2.0 staking rate and staked ETH.
Source: CryptoQuant
Source: CryptoQuant
The inflow chart reveals some peak inflow time points. Some big inflow happened in Dec. 2020 and March 2022.
Source: CryptoQuant
Kraken is the 1st staker in ETH 2.0. CEXs still has an advantage in the market. They can turn their existing users into ETH 2.0 stakers.
For liquid staking, Lido dominates the market. Liquid staking derivatives help user liquid their staking assets and improve capital efficiency.
Source: Delphi Digital
ALT
Lots of smart-contract-enabled chains use PoS considering TPS and sustainability.
They have different rules. Some chains allow users to delegate their staking to active validators. These validators run the node and charge commission fees from delegation staking. To withdraw their staking, users need to wait a period of time before undelegating.
Currently, Ethereum 2.0 has the lowest staking ratio.
Source: Staking Rewards
Node providers
Running own staking nodes has lots of risks and needs a large amount of money to start. It is hard for individuals to maintain a 24/7 online server and not do anything wrong causing penalties. To help individuals easier to stake and earn rewards, there appears staking-as-a-service. Node providers will take care of the infrastructure and users only need to stake their funds.
Node providers provide node operation services. They provide service to individuals and liquid staking derivatives. To individuals, node providers charge a monthly node operation fee or commission fee. To liquid staking derivatives, node providers usually get a percentage of the staking rewards. Lido explains how they choose node operators.
There are lots of node providers in the market. They differ in the following aspects:
Fee
Supporting assets
Reliability and safety
Source: Staking Rewards
Big players have already established large user groups, good reputations, and safe operation records. It is hard for new players to take a large market share. Big market players believe the opportunities for small players are the following:
Better UX
Supporting long-tailed assets
Providing services besides staking, like ecosystem updates, simple financial engineer tools, information websites, and data analysis tools
Though small players are hard to compete with large players, large players do face some challenges:
Risk of centralization
Compliance
Security and operation risk
Decentralization is the key to a network. If several node providers have a major stake in the network, these node providers are a stratum for cartelization. @djrtwo questions this in his passage “The Risks of LSD”.
To build a decentralized and permissionless product, compliance is a big problem. Stake.fish believes that “due to how staking looks like fixed income in some sense, this could invite regulators to consider validators closer to financial entities than miners. If this occurs, then there would be no way for validators to stay compliant without becoming a fully licensed custodian and guarding delegator access (which again, may technically be impossible to enforce)” in the “2021 staking ecosystem report”.
Node operators put safety first because the safety incident can cause asset loss. In Jan 2021, ETH2 validators got slashed due to a bug. Here is the recent slashing history for ETH2 validators.
Source: beaconcha.in
Node providers are trying to increase the stability of the infrastructure with new tech like SSV. The secret shared validator network is a tech that can reach active-active redundancy. All validators in the network actively produce new blocks. The mechanism is like a multi-sig wallet.
Source: OBOL
Other techs used for slashing prevention are the local slashing protection database which records messages causing slashing, and remote slasher which records all attestations and blocks received.
From the Staking Rewards survey, users do care more about reputation than cost, and node providers are trying to improve their reliability in order to build their reputations.
Source: Stake Rewards
Liquid staking pool
After choosing the best staking node providers, the next problem is capital efficiency. Users need to lock assets in the staking node but only yield 10% annually. In the crypto world, there are opportunities everywhere. The opportunity cost of locking assets in the staking pool is huge. Thus users are trying to increase capital efficiency. A liquid staking pool helps users get their liquidity almost instantly.
The liquid staking pool has two functions:
Lower the staking requirement for users
Greatly increase the liquidity of staked assets
To increase the liquidity of staked assets, the staking pool mint a new token for users. For example, after staking ETH in Lido, Lido mints stETH for users. Users can exchange stETH with ETH on DEX. Below is the pricing chart for stETH.
Source: Dex Screener
stETH is like a bond. 1 stETH can redeem 1 ETH in the unpredictable future. We are not sure when Ethereum will release staked assets in the staking node because releasing the staked assets needs a hard fork update after the ETH2.0 merge.
The next few charts show that Lido dominates the ETH staking market and secures a large portion of the market share.
Source: Delphi Digital
Source: Delphi Digital
However, Marinade dominates the Solana liquid staking market instead of Lido.
Source: Delphi Digital
Here is a fee breakup for liquid staking on Solana.
Source: Delphi Digital
Besides fee and reputation, utility is another major point. More partnerships mean deeper liquidity for liquid assets in DEXs and lending platforms. Marinade has the most partnership with DeFi projects.
Source: Delphi Digital
Source: Delphi Digital
Finance
Most DeFi users are APY addicted. Is there any way to push our staking yields, but still enjoy a low risk? Yes. Leverage farming can do this.
Most leveraged yield farms use 2x - 3x leverages and offer around 7% APY. They do have liquidation risks.
Basically, they deposit stETH on Aave and borrow WETH through Aave. Then they swap WETH for more stETH and repeat the steps above.
Another interesting project is SR20 by Staking Rewards. SR20 is an index containing the top 20 PoS assets weighted by total staked value. The index also accrues staking rewards on a continuous basis. The following charts demonstrate the allocation:
Source: Staking Rewards
The current index price is $304.41 and the reward rate is 6.54%. The staking returns YOY is 9.44%. Below is the price chart of SR20.
Source: Staking Rewards
To avoid slashing risk, there are also insurance products for validators. Lido partnered with Unslashed Finance to cover approximately $200M worth of staked ether from slashing in Feb 2021.
Source: Lido Medium
What’s next
The ecosystem of staking is established. Big players have already gained a strong position in the market. The total staking market will continue to grow because the ETH staking ratio is still low compared to other PoS assets. We are optimistic about the future of the staking market.
Staking assets is similar to buying treasury. Institutions and big whales are willing to buy these assets. One big difference between treasury and staking is that staking reward is not fixed. Staking rewards vary upon network conditions. To make the APR more stable, we anticipate fixed APR and long-term staking assets.
Source: Staking Rewards
Current tokenomics for liquid staking protocols cannot catch the true value. With rising revenue and TVL, the token price drops. We need a better tokenomics design to support the staking protocol. Currently, the protocol revenue does not share with the token holder. This makes the token a pure governance token.
Two opportunities for new players are better UX and long-tail assets support. Spinning up a node is easy with the help of an official document. The hard part is operation and customer management. To better support these new players, some toolkits are necessary. This is similar to the VPN market. Lost of small players entering the market with lower fees and better UX.
A specific data analysis tool is also necessary. For stakers, they care about the liveness history, staked ratio history, slashing history, etc. These data are different from the common dataset we use. The common dataset we use focuses on transactions. To better support stakers, a new data analysis tool is necessary.
