Ethereum 2.0 Staking: Part 1

Let’s figure out what Ethereum 2.0 staking is and how it works, consider its yield and the penalties in the validator’s work.

What Is Ethereum 2.0?

The process of shifting Ethereum’s consensus algorithm was officially launched in December 2020. As a result, ETH is set to start running on Proof-of-Stake. Such innovations aim to ensure the project’s scalability, reduce power consumption and improve blockchain network security. The new version of Ethereum will test the concept of blockchain shards (shard chains).

Ethereum’s algorithm change is divided into several phases:

1. Phase 0 — the Beacon Chain coordination blockchain launch, which became available in test mode on December 1, 2020. Its primary purpose is to test the PoS mechanism for Ethereum. 
2. Phase 1 — sharding. Separate blockchains (shards) were introduced in 2021. Their task is to function autonomously in parallel with the main network. The novelty of using shards for the Ethereum network is that they will distribute the transaction processing workload among a specific set of nodes rather than across the entire blockchain network as in the original Ethereum. The Beacon Chain network serves as a link to connect all the nodes and also provides consensus between all the shard chains.
3. Phase 1.5 — the Ethereum network becomes the Ethereum 2.0 shard chain. The original blockchain is to become just one of the shard chains of ETH2. The transition was planned for the summer of 2022 but was moved by the developers to the end of the year.
4. Phase 2 — the transition to Ethereum 2.0. The final phase will allow all network fragments to function freely. Shards will be fully functional smart contracts and provide the ETH2 algorithms. The final phase is scheduled to be implemented in 2023.

Once the Beacon Chain is launched, both the original and test Ethereum blockchains will operate concurrently. Users can now convert ETH coins into ETH2 tokenized ones, however, not vice versa. Ethereum 2.0 coins can be used for trading, but their main purpose is staking. 

Removing coins from staking and exchanging ETH2 at a rate of 1:1 to ETH will be possible after the final transition to the PoS algorithm. However, according to the official portal, the number of locked coins in the Ethereum network is about 12.8 million ETH, or about $26 billion at the time of writing. Plus, there are more than 380,000 validators.

What Is Ethereum 2.0 Validators’ Yield?

The most important factor for taking part in Ethereum 2.0 staking is its profitability. The yields of investments in ETH are affected by several factors crucial to ETH2 staking:

1. The duration of the validator node in the network.
2. The number of locked coins to create the node.
3. The proportion of all circulating coins in the ETH2 network.

Therefore, the reward amount of each validator in the ETH2 network is individual and depends on the overall issuance volume. The more coins the validator deposits, the higher the reward will be. However, as the total number of locked coins in Ethereum 2.0 increases, validators’ yields will drop.

There are additional rewards available for validators in ETH2. They can be obtained for:

1. Block offer. The reward for the block creation is approximately 0.005 ETH.
2. Proper attestation. Attestation is the process of voting for block creators and consists of several components. The maximum possible reward for the correct attestation is 0.00002 ETH.
3. Attestation on time. The reward for accelerated voting can be around 0.000005 ETH. 
4. Violation report. Whistleblowers can receive 0.0625 ETH for reporting inappropriate actions of the validators in the network.

Ethereum 2.0 Validators’ Penalties

Maintaining the Ethereum 2.0 validator node comes with some risks concerning the possible reduction of profitability or complete loss of staking profits. 

So, in the ETH2 network, there are the following penalties:

1. Improper attestation. The voting process takes place in three phases, for each of which you can get a penalty. You can only pass the attestation process by voting for the correct source, target, and head blocks. Any error will result in a penalty.
2. Low activity of the validator node. Missing the attestation will lead to the penalty of three basic rewards. Keep in mind that if the node is inactive for more than three epochs (about 20 minutes), its participation in consensus provisioning will no longer be considered necessary. 
3. Severe violations. There are several violations in the ETH2 network, the penalties for which can range from 0.5 ETH to deprivation of the entire balance. These violations are known as slashing, i.e., shorting. The violations punished by an instant reduction of a stake include double proposing, surround voting, and double voting.

Minimizing or avoiding Ethereum 2.0 staking penalties altogether is possible. However, staking on your own is quite time-consuming and requires the investor to constantly monitor running nodes and uninterrupted power to equipment. Collaborative staking often reduces the risk of penalties but doesn’t minimize them. 

Delegating ETH to staking via crypto exchanges or SaaS platforms saves investors from any expenses because the service will pay all penalties. However, using such services isn’t free, and the return rate can be much lower.

Pros & Cons of Moving to Ethereum 2.0

Ethereum’s transition to the Proof-of-Stake algorithm is an ambitious challenge, so there are risks for investors and ETH network holders. Yet, the upcoming changes can open up many income advantages for coin holders.

Disadvantages of Ethereum 2.0 include:

1. The threat of centralization. ETH’s transition to PoS could disrupt the blockchain’s decentralization. In practice, many PoS-based systems have partially or completely sacrificed independence in favor of scalability. Ethereum 2.0 may not be an exception.
2. Network security. The technical complexity of the transition process to the new algorithm brings a high probability of vulnerabilities in the code, potentially making ETH2 a target for hacker attacks.
3. Coin concentration among whales. The move to the PoS algorithm potentially increases the chances of large ETH holders multiplying their capital, thereby further concentrating coins into whale’s accounts.

The undeniable benefits of Ethereum 2.0 are:

1. Reduced entry barrier. The new ETH algorithm will eliminate the need to use expensive hardware, such as ASICs, to run the validator node. Therefore, the participation of small investors in the network is expected to increase, potentially contributing to the widespread adoption of Ethereum.
2. Higher asset values. Improved scalability and blockchain bandwidth will also potentially simplify the process of creating a node for validation, which could positively impact trader sentiment. Increased demand for ETH will also boost its value.
3. Additional benefits for holders. ETH2 staking allows token holders to multiply their capital and receive passive profits from staking, which was not available in classic Ethereum.

So, despite the technical difficulties and the high hurdle Ethereum developers have set for themselves, the network upgrade to ETH2 is steadily approaching. Ethereum 2.0 staking has become mainstream in the cryptocurrency community, attracting more and more passive income seekers every month in anticipation of the coming changes. 

Read about Ethereum 2.0 staking in practical terms and how to make passive profits in the second part of this article.