Staking on Ethereum 2.0: A Simplified How-to Guide

As the world of cryptocurrencies continues to evolve, our crypto guides aim to equip you with the necessary knowledge to navigate through this dynamic digital asset landscape. One significant development is Ethereum’s transition to its final phase, commonly known as Ethereum 2.0, which denotes Ethereum’s shift to a new consensus mechanism.

In this forthcoming phase, Ethereum takes a leap from its current Proof-of-Work model, where new blocks on the network are mined, to a Proof-of-Stake model where new blocks are created via a specific staking mechanism, known as Ethereum staking. This fundamental transition is designed to enhance the network’s scalability, security, and sustainability.

The anticipated launch of Ethereum 2.0, initially slated for 2020, signals a transformative era for Ethereum. This Ethereum staking guide provides an in-depth look at this crucial development in the Ethereum blockchain ecosystem, demystifying the principles of staking and its impact on the future of Ethereum.

As Ethereum transitions to this staking model, it is vital to understand what Ethereum staking entails, the benefits it brings, and how it influences the Ethereum ecosystem.

Ethereum 2.0: the proof-of-stake algorithm

To understand how proof-of-stake works and how it can be used, it is important to examine the basics of its technology. The proof-of-stake (PoS) algorithm is a consensus mechanism that uses a different technology from classical mining to generate new blocks in the blockchain. PoS is based on a weighted random selection that determines which network user is authorised to generate the next block based on predetermined criteria. These criteria include the staker’s wealth and the duration of participation. As soon as a node (validator) in the network is selected, the actual process begins.

The validator verifies the validity of the transactions in the blockchain and signs it if successful. The block is then added to the blockchain. In mining (a.k.a. extraction), with the Proof-of-Work (PoW) algorithm, whoever provides the most computing power receives the largest share of the mining fee. As a rule, miners receive a fixed commission in the cryptocurrency of the blockchain for which they have created a new block. On the other hand, in the case of PoS, creditors receive a portion of the transaction fees earned on the blockchain. To become a validator and manage your own node, you need to block a certain number of ETH coins on the blockchain.

The higher a participant’s commitment to a node, the greater the chances that he or she will be selected as a staker. Therefore, the richest participants in the network may not always create the next blockchain, as additional selection criteria have been added to the algorithm. There are no additional entry requirements and anyone who blocks their ETH on the blockchain can participate in the staker.

Ethereum 2.0: Here’s why the algorithm is changing

The great success of the Ethereum blockchain quickly revealed the problems of the PoW algorithm used. Mining is not very energy efficient. Moreover, many Asian companies have a clear advantage over private miners due to low energy prices and huge mining facilities.

The proof-of-stake algorithm is particularly useful as a consensus that decentralises the generation of new blocks. In combination with sharding technology (division of large databases), data throughput can be increased thousands of times. The potential lies in increasing the number of transactions per second from the current 14 to over 100,000. In practice, the consensus mechanism can be divided into several sub-categories, each of which differs in its own way. Ethereum 2.0 includes proof of stake. Meanwhile, other projects rely on other forms of proof-of-stake algorithm.

For example, Daniel Larimer, developer of several cryptocurrency projects, has developed the so-called proof of stake proxy, DPos. This assigns voting rights in proportion to the coins in the cryptocurrency chain. Users then elect a number of delegates who manage the blockchain on behalf of their constituents. The delegates receive a reward for their bet and divide the commission among their constituents. The distribution of funds is again based on wealth, so the richest voters also receive the highest commission.

Staking Ethereum 2.0: what is the possible profit?

As is often the case, the number of participants determines the possible commission a backer will receive. If about one million ETH were to be used in Beacon Chain, it would produce an annual return of about 18%, while 30 million ETH deposited in Beacon Chain staking would only produce a return of 3.3%. To run the Genesis blockchain, a smart contract must have 524,000 ETH deposited, which is equivalent to 16,000 validators. You can find numerous calculators online that show the possible return on investment.

How can I participate in the Ethereum Staking programme?

No special equipment is required to participate in the lottery as a validator. However, there are some barriers to entry regarding staking. In addition to technical knowledge, this includes the 32 ETH that must be invested in a smart contract. The so-called Beacon Chain – also known as ‘Phase 0’ – represents the beginning of Ethereum 2.0. Once a deposit has been made in the contract, the validator receives a validation key. Then, special software must run on a computer permanently connected to the Ethereum network. This software is a client node and there are several well-known variants. Among the most prominent are:

• Prysm client
• Nimbus
• Teku
• Lighthouse

The Ethereum Foundation publishes its Launchpad, which serves as a starting point. The Launchpad guides through the implementation process and accompanies stakeholders on the way to the validator. 32 ETH, however, are not the only assets that validators have to accumulate. In addition, there are gas costs in the network. For example, when renting a cloud server from Amazon Web Services (AWS), they must expect a higher, three-digit annual fee. Besides an ETH deposit, technical knowledge, a suitable server and a validation key, a novice validator also needs an online wallet.

Many experts recommend using the well-known MetaMask wallet. But why is a web wallet necessary? The reason is the connection of ETH to the Ethereum 1.0 Mainnet and the connection to the Ethereum 2.0 Beacon Chain. Since these two chains use different cryptographic classes, they generate completely new key types. Together with ConsenSys, the Ethereum Foundation has developed a special interface that can be accessed via launchpad and requires a web wallet.

Staking pool on Ethereum

Certainly not everyone will have the means to shell out 32 ETH to register as a validator. However, there is another way to participate in Ethereum 2.0 staking. There are pool operators who organise and distribute staking prizes to participants. In particular, major trading hubs such as Binance, Crypto.com and Kraken act as pool operators and offer dedicated staking portfolios. The commission is often distributed proportionally according to the amount of ETH deposited. The advantages of participating in a staking pool are obvious. He can participate in a staking pool without having to hold all 32 ETH required to be a participant. He does not have to incur server rental costs, have technical knowledge or lock a large deposit into the blockchain for a long period of time. This is an important aspect.

Positioning Ethereum 2.0: the risks

As already mentioned, the operation of the validator requires unrestricted and continuous access to the network. The ETH is stored in the wallet and the proof of ownership must always be accessible via an internet connection. This is considered a potential risk of attack. The validator is obliged to hold the ETH for several months or years.

If the share price goes up or down, the user cannot sell their ETH. Especially if the price falls sharply, the commission generated can no longer compensate for losses, so staking becomes a loss-making activity. However, in addition to potential losses due to periodic price drops, there is also a risk to the deposit from violating the rules themselves. Approvers who do not follow the rules may be penalised. There are two potential penalties for pairing Ethereum.

On the one hand, a reduction of the staking reward and, on the other hand, a partial loss of the initial deposit. The reward is also reduced in the case of minor violations – for example, when the approver cannot be contacted. The partial loss of the deposit usually only occurs in the case of more serious violations.

This includes the consistent validation of erroneous blocks or careless duplication of transactions. Furthermore, there is another danger, especially in the early phase of Ethereum 2.0. There is no definitive guarantee that the new protocols are reliable, that there are no bugs and that smart contracts are safe from hackers. To minimise this risk, the developers of the Ethereum Foundation, with the help of experts, repeatedly checked their code. As a result, some important components underwent intensive testing.

Summary

Before the end of 2020. Ethereum is entered an initial phase with the aim of moving to version 2.0. This involves a number of interesting innovations that completely change the platform for decentralised applications. Ethereum is becoming faster, more resilient, more secure and, in addition, more scalable.

This is ensured, among other things, by the new Proof of Stake system, which is perhaps the biggest change. After all, PoS is replacing conventional mining with staking technology. The aim of the Ethereum Foundation was to decentralise the creation of new blocks. Anyone can participate in the stakes – regardless of hardware and energy costs – and support them as a so-called validator when they find new money. Deposit the required 32 ETH yourself or join the staking group. The potential profit, which is a source of passive income, depends entirely on the number of validators participating in the network. If you want to start trading or buying Ethereum, you are in the right place in our review of the best bitcoin trading platforms.