Explaining staking rewards to someone new can be tough. An easy analogy could be stock dividends, except it’s not really accurate. Stock dividends originate from excess cash generated by a business which is then distributed to shareholders. There’s an approval step in there as well, where management and boards have to approve of the distribution.

Protocols (L1’s for the purpose of this article, not L2’s), on the other hand, have it “coded in” where staking rewards come from. Since protocols don’t really have much or any activity early on, the only way to generate staking rewards for token holders who have locked up their tokens (delegation) is inflating the token supply and distribute the rewards for helping to secure the Proof of Stake network. They hope that network activity picks up and becomes a more substantial portion of the staking reward. They can then possibly propose a change to the protocol around the amount of token inflation, kind of like “turning a corner” in terms of subsidizing until adoption/usage occurs.

Most networks, even to this day, are still in the “token inflation” boat. However, Ethereum has lots of activity occurring and staking rewards are generated via several avenues. Let’s break it down so it’s easy to understand.

Consensus Layer & Execution Layer

Ethereum's ‘Consensus Layer’ is what ensures that blocks are secured and the network is running appropriately. This is the fundamental part of a “Proof of Stake” networking operating. Specifically, consensus layer rewards come from protocol operations like block proposals, attestations, and sync committee participation. These all ensure network security and consensus.

Then we’ve got what is referred to as the ‘Execution Layer’ rewards, which have to do with activity occurring on the network. These are driven by transaction processing and include Transaction ‘Priority Tips’ and ‘MEV Tips’ to incentivize validators. While Consensus Layer rewards are more predictable and protocol-defined, Execution Layer rewards fluctuate with network activity and user incentives. The Consensus Layer is essential for network agreement, while the Execution Layer facilitates transaction processing and offers additional earning opportunities for validators.

Here’s a breakdown of each reward type:

For the Execution Layer:

So there you have it, five possible sources of rewards. This is important to understand as staking is offered in more investment vehicles such as ETFs. Investors will want to understand the source, and it will also be important to grasp as regulation and tax reporting continue to evolve. Hope you enjoyed!

Explaining staking rewards to someone new can be tough. An easy analogy could be stock dividends, except it’s not really accurate. Stock dividends originate from excess cash generated by a business which is then distributed to shareholders. There’s an approval step in there as well, where management and boards have to approve of the distribution.

Protocols (L1’s for the purpose of this article, not L2’s), on the other hand, have it “coded in” where staking rewards come from. Since protocols don’t really have much or any activity early on, the only way to generate staking rewards for token holders who have locked up their tokens (delegation) is inflating the token supply and distribute the rewards for helping to secure the Proof of Stake network. They hope that network activity picks up and becomes a more substantial portion of the staking reward. They can then possibly propose a change to the protocol around the amount of token inflation, kind of like “turning a corner” in terms of subsidizing until adoption/usage occurs.

Most networks, even to this day, are still in the “token inflation” boat. However, Ethereum has lots of activity occurring and staking rewards are generated via several avenues. Let’s break it down so it’s easy to understand.

Consensus Layer & Execution Layer

Ethereum's ‘Consensus Layer’ is what ensures that blocks are secured and the network is running appropriately. This is the fundamental part of a “Proof of Stake” networking operating. Specifically, consensus layer rewards come from protocol operations like block proposals, attestations, and sync committee participation. These all ensure network security and consensus.

Then we’ve got what is referred to as the ‘Execution Layer’ rewards, which have to do with activity occurring on the network. These are driven by transaction processing and include Transaction ‘Priority Tips’ and ‘MEV Tips’ to incentivize validators. While Consensus Layer rewards are more predictable and protocol-defined, Execution Layer rewards fluctuate with network activity and user incentives. The Consensus Layer is essential for network agreement, while the Execution Layer facilitates transaction processing and offers additional earning opportunities for validators.

Here’s a breakdown of each reward type:

For the Execution Layer:

So there you have it, five possible sources of rewards. This is important to understand as staking is offered in more investment vehicles such as ETFs. Investors will want to understand the source, and it will also be important to grasp as regulation and tax reporting continue to evolve. Hope you enjoyed!