What Is Ethereum Staking? How Does It Work?

September marked a long-awaited upgrade of the Ethereum (ETH) network to a proof-of-stake consensus mechanism.

Ethereum previously ran on a proof-of-work model similar to Bitcoin (BTC), which uses vast amounts of electricity. It also led to problems with scalability and high transaction fees.

By adopting proof of stake, experts say the Ethereum merge will reduce the network’s energy consumption by 99.95% and boost transaction speeds.

But what exactly is proof of stake? How can regular investors partake in Ethereum staking themselves?

What Is Ethereum Staking?

You’ve probably heard of cryptocurrency miners who validate transactions on proof-of-work blockchains like Bitcoin.

Crypto miners solve complicated mathematical puzzles with high-powered computers that use large amounts of electricity.

Some leading cryptocurrencies that employ proof-of-work models—especially Bitcoin—have drawn widespread criticism for their rapidly growing energy consumption.

Staking is the main alternative to proof of work.

Rather than employing high-powered computers to solve mathematical puzzles, however, Ethereum staking involves locking up ETH on the blockchain—staking it, as it were—to earn the opportunity to validate transactions and yield more ETH as a reward.

How Does Ethereum Staking Work?

To become a validator—otherwise known as a staker—network participants need to lock up 32 ETH on the blockchain. That’s a tidy sum worth more than £40,000 at today’s ETH prices.

Validators are then randomly assigned the responsibility of validating transactions, constructing new blocks and maintaining the overall functionality of the blockchain. In return for locking up their ETH, stakers earn a yield paid in ETH.

The yield will fall if a validator fails to validate a block once assigned the responsibility.

Validators can also be penalised under “slashing”—when the network confiscates some or all of a validator’s staked ETH—for engaging in malicious activity, such as colluding to validate blocks incorrectly.

Ethereum Staking Pools

Given current prices, 32 ETH is a very high threshold to get involved in Ethereum staking. Most ordinary investors are not in a position to lock up this amount of ETH to become validators.

That’s where staking pools come in. They provide a way for individuals to collaborate to fulfill the minimum mark of 32 ETH required to become a validator. Corresponding rewards are then divided pro-rata among pool participants.

Ethereum lacks a native protocol that supports staking pools. Many big cryptocurrency exchanges, such as Kraken, and third parties offer Ethereum pooling features.

For example, Binance users can stake their Ethereum for a 6% annual percentage yield (APY).

Staking pools, including those offered through crypto exchanges, allow more ETH holders to participate and earn passive income.

How Much Can You Make Staking ETH?

There is no fixed rate for how much ETH staking pays. Instead, it will vary depending on the number of participating validators at any given time. When fewer validators exist, the protocol increases rewards to incentivise more stakers to join.

Currently, stakers are earning roughly 4% to 7% annually.

In terms of Sterling gains, the percentage rate for the yield earned will be contingent not only upon this gross rate but also upon the Ethereum price, which has shown extreme volatility. ETH shed more than 54% of its value last year alone.

Is Staking Ethereum a Good Idea?

If you anticipate holding Ethereum over the long term, staking could be worthwhile. The incremental yield earned will boost the total ETH you hold.

There are situations where staking may not be suitable. For one, you sacrifice liquidity as the ETH will be locked up for several months.

The most important consideration here is your time horizon and willingness to hang on to ETH.

Ethereum, like other cryptocurrencies, is a volatile, high-risk investment that can quickly shift directions. Before investing in Ethereum or any crypto, you should do your due diligence and be prepared for the volatile nature of this type of investment.