Ethereum is finally set to shift from a proof-of-work infrastructure to proof-of-stake. The end result of this upgrade will effectively take ETH out of circulation, replaced by a tokenized version of itself.
In almost every instance that you can imagine people wanting to hold ETH, it will be preferable to hold a staked version rather than the original real asset. This tokenized version of ETH will perform all the same functions of ETH, but it will also be more valuable because it will earn staking rewards and can simultaneously do other things. For example, it could be used as collateral in Compound or supplied to a Uniswap liquidity pool.
This makes perfect sense. Decentralized finance (DeFi) is, after all, Ethereum’s killer app, so it would actually be unthinkable to keep staked ETH from the DeFi world. Rather than remain on its own, separate island, staked ETH will inevitably be tokenized and form the bridge that will bring Ethereum 2.0 across to its killer app.
We have seen this staked tokenization play out with other cryptocurrencies such as DAI – the first important token in the DeFi space. cDAI is a tokenized representation of DAI that has been deposited into Compound. Staked ETH will be far more significant because there is so much more of it and it represents way more value.
Ethereum 2.0 is a big deal. A blockchain with the size and value of Ethereum has never transitioned users and assets to a completely new network while the previous version continues running. The notion, therefore, of replacing ETH may sound foreboding.
But, in fact, it is positive in three key ways: Now users will be able to secure the Ethereum network by staking, earn yield for doing so, and have the ability to use that ETH as yield-generating collateral elsewhere.
Ethereum advocates may chafe at the idea due to a preference for users only to stake. But the outcome is the proverbial win-win. The security ramifications are significant for Ethereum because staked ETH creates additional incentives to stake ETH and simultaneously participate in DeFi activity. That’s a good thing. In the end, securing a network is what proof-of-stake is all about.
There has been a proliferation of PoS networks, such as Polkadot, Cosmos and Tezos, among others, but none come close to the significance of Ethereum. It is no wonder there is increasing attention on the approaching day Ethereum 2.0 goes live. Although there have been delays and progress hasn’t always gone smoothly, the testing has now been robust and the results raise the confidence that the new network will be ready within only a few weeks.
At Staked, we run 25 other proof-of-stake networks. But the size and complexity of running Ethereum 2.0 staking infrastructure is like none other. That said, every indication is Ethereum 2.0, phase 0, is now ready for prime time, starting with the deposit contract. Once testing for Ethereum 2.0 is complete, a validator deposit contract will be created on Ethereum.
This deposit contract is where all users interested in being a validator for phase 0 can lock in their ETH.
Many in the space will be attracted to the staking rewards. Ethereum 2.0 uses a sliding scale for staking rewards. We estimate yields will be between 8%-15% annually. That’s not as eye-popping as YOLO-ing into the latest DeFi craze, but offers lower risks and predictable returns that will appeal to larger institutions.
In it for the long haul
So, faced with compelling rewards, a word of caution is required. Staking, at least initially, may not be for everyone. Ethereum 2.0 requires a complicated technical setup (at least one beacon node with a full copy of the blockchain and individual validator clients for each 32 ETH you stake), significant technical resources to ensure the entire setup is always available and secure, and funds that will not be liquid until Ethereum 2.0 reaches phase 1, which could be years away.
It is a simple but important fact: Once ETH is transferred to the Ethereum 2.0 network, it cannot be transferred back to the original Ethereum blockchain. This one-way trip means your funds are not liquid, so the only direct activity available is to participate in staking.
This is why we should expect tokenized staked ETH. Staked ETH indeed does have to remain locked away until further Ethereum 2.0 developments. But the world of DeFi won’t wait. Staked ETH will be tokenized and will replace ETH. It is not a case of if, but when.
UPDATED: The section covering the technical requirements of staking has been updated with greater detail.