We talked about Ethereum 2.0 some time ago, but as the long-awaited Merge—the moment that the current Ethereum blockchain will be merged with the Proof-of-Stake Ethereum 2.0 chain—draws closer, there’s more and more interest in staking ETH. In this post, we’ll first briefly cover some of the background, namely how Ethereum 2.0 will work, and then we’ll focus on different ways that you can stake ETH. From running your own validator node to staking less than a single Ether that you had left over in your wallet, or even deciding to leverage yields with a riskier approach, we’ve got all the scenarios covered.
As you probably already know, perhaps the biggest change that will be introduced with Ethereum 2.0 is the transition from Proof-of-Work to Proof-of-Stake. We won’t go into much detail here, as this was covered in-depth in our previous post on the topic, but the gist of it is that mining Ethereum will no longer be possible. Instead of advanced hardware setups that are constantly solving extremely difficult cryptographic problems, transactions on Ethereum 2.0 will be included in the blockchain by validator nodes which stake ETH. The incentives for preventing malicious behavior are also different: rather than simply wasting expensive computational resources, malicious actors will have their stake slashed, meaning that they will lose part (or all) of their staked ETH.
Staking ETH on the Ethereum 2.0 Beacon Chain is already possible, but until withdrawals are enabled after the Merge (which could be 6 to 12 months from now), it won’t be possible to withdraw your staked ETH, but you’ll immediately start earning staking rewards. If you want to run a validator node, the hardware requirements for this are incomparably lower than with mining, but there are two main constraints: you need (1) 32 ETH to stake and (2) a reliable setup (including a reliable internet connection). If your node has too much downtime, your stake could be slashed, even if you’re not attempting any deliberately malicious behavior.
If those constraints mean that this option isn’t for you, there are other ways to stake ETH without running your own node, and this is where Liquid Staking solutions come into play. Essentially, these work in the following way: a service (which may be more or less decentralized) sets up validator nodes, which stake ETH that comes from various users. The yield generated is then distributed proportionally to the different users that contribute to the stake.
From the user’s point of view, this is fairly simple: you deposit 1 ETH (or any other amount) to the protocol and receive an equal amount of a token that represents staked ETH. In the case of Lido, the most popular solution currently, this token is called stETH. The stETH in your wallet then automatically accrues the yield generated by staking, and it acts like a standard token in the sense that you can trade it, transfer it, use it in DeFi protocols etc. In fact, instead of minting stETH, you can simply buy it on a decentralized exchange, making the process that much simpler.
So what are the pros and cons of liquid staking? On the one hand. it enables your staked ETH to be—as the name implies—liquid, meaning that you can sell your stETH for ETH (or any other token) at any point, while this also obviates the need for any hardware or technical knowledge on your part. On the other hand, there are some risks involved: with more decentralized protocols (such as Lido), smart contract risk is most important, while centralized solutions introduce counterparty risk. But for many, some smart contract risk is greatly outweighed by the convenience.
One thing to note is that, while you can always sell stETH for ETH, there’s no guarantee that 1 stETH will be worth 1 ETH until withdrawals are enabled. When that happens, the peg will be completely safe, but until then, it’s up for the market to decide how to price stETH. This doesn’t affect you if you plan on holding stETH until post-Merge, but it does severely affect those that try to leverage up to squeeze more yield from staking.
Leveraging yields is simple: you get some stETH, and then deposit it as collateral into Aave or a similar DeFi lending/borrowing protocol. Then, you use this collateral to borrow ETH, which you then swap for stETH and deposit this stETH as more collateral. Rinse and repeat.
This might sound like free money, but it introduces a whole new class of risk. Now, the price of stETH needs to stay very close to that of ETH for your strategy to work. Depending on how leveraged you are, having the price of stETH drop 5-10% in relation to ETH can cause you to be liquidated, losing all your collateral. If this sounds like something only the bravest of degens would do, we’ve recently seen that institutions were heavily involved in leveraged yield strategies as well, with the Celsius situation being the best example for how things can go wrong.
Overall, this shouldn’t be surprising: it’s a basic economic law that yield is always correlated to risk. If you’re very cautious, you can earn a stable (if not life-changing) yield with negligible risk, whereas if you thrive on adrenaline, you can crank up the leverage and get much more of both yield and risk. The point is simply to know where you are on that spectrum and what level of risk you’re comfortable with.