September 24, 2022

  • Ethereum recently revamped its protocol from a proof-of-work to a proof-of-stake model.
  • Industry analysts predict that this upgrade could triple current Ethereum stake returns.
  • Here’s how investing will change in light of Ethereum’s merger — and what it means for returns.
  • This article is part of “Master Your Cryptocurrency,” an Insider series that helps investors improve their cryptocurrency skills and knowledge.

Ethereum’s the long-awaited merger he Thursday, September 15 — where the blockchain switched its protocol from proof-of-work to a much more energy-efficient proof-of-stake consensus model — will surely be immortalized as one of the most important events in crypto history. It represents the next evolution of digital assets and future growth in the space, according to Thomas Perfum, head of strategy at Kraken, who is currently the fourth largest cryptocurrency exchange in the world.

There’s another reason why the merger was so important, Perfumo told Insider — it will ultimately increase the total market capitalization of invested crypto assets from 25% to 30% to over 50%.

For context, proof-of-work protocols like Bitcoin verify blockchain transactions by having miners solve computational puzzles, while proof-of-stake systems like those used by Solana, Cardano, and Polkadot randomly select validators who have invested — or locked. their crypto assets – for more than two to three weeks. While validators are chosen randomly, they are more likely to be selected if they have a higher stake and have held their stake for a longer period of time than others.

How investors make money from investments

Similar to holding dividend stocks, investors who invest their cryptocurrencies can theoretically benefit in two ways – from appreciation in the price of the underlying asset and from the additional reward they earn each time they verify a transaction, known as the annual percentage rate, or APR.

Because Ethereum validators also make money gas fees, higher transaction volume means higher yield. And since each block only has a fixed number of rewards, the reward rate decreases as the total number of validators and staked cryptocurrencies competing for those rewards increases.

Because validators take risks through their exposure to the underlying asset, investors shouldn’t buy cryptocurrencies just for the potential APR, Perfumo says. “But if you’re confident in Ethereum over your time horizon and feel that the investment offers you a way to increase the reward of the asset while you hold it, it sounds like a good idea,” he added.

Before the merger, Ethereum owners could invest in its Beacon Chain, with one big caveat – they couldn’t withdraw their assets, meaning the percentage of Ethereum invested only grew over time. But withdrawals should be allowed after the Shanghai merger fork is completed in the next six to nine months, Perfumo estimates.

While theoretically, any cryptocurrency owner can the stakes themselves Unlike investing in the stock market, it is much more difficult to invest solo in practice because validators have to constantly monitor the software or risk paying a penalty for inactivity. Ethereum also requires all solo validators they hold at least 32 ethers before they can invest, and node and server costs can add up quickly, Perfumo said.

On the other hand, exchanges like Kraken and Lido — which take a fee from the yield — allow users to contribute an amount of their choosing, and can also minimize penalty reductions through redundancy mechanisms. Since Lido gives users one derivative ETH token for every Ether they invest, users are even able to cancel their coins by simply exchanging the two currencies. But since these exchanges effectively manage the safekeeping of users’ assets, Perfumo stressed the importance of choosing a trusted exchange to minimize counterparty risk.

Lido currently lists its Ethereum APR as 3.8%, while Kraken advertises its annual Ethereum reward rate ranging from 4% to 7% due to variability between transaction demand and validator supply, Perfumo explained. He added that rewards differ between blockchain protocols because newer ones may offer higher base returns for the supply of the currency, while more mature networks with large validator networks like Ethereum offer a smaller percentage of new tokens relative to the total supply.

Stakers will now earn all rewards after merging

One of the biggest takeaways from the merger is that the reward pool for validators has now increased significantly, said AD, the pseudonym used by Lid’s head of marketing and community.

“Yields are expected to rise because the fees that previously flowed to miners will now flow to shareholders,” he explained to Insider. “You’re going from a yield that’s currently around 3.8% – it fluctuates a bit – but our modeling shows it’s going to potentially double or even triple.” Lido’s estimates are in line with estimates from other crypto analysts earlier this year that post-merger yields could rise between 7% that 15%.

However, Perfumo says that exact post-merger reward rates are difficult to predict, especially as ether becomes more liquid in a few months.

“If people are allowed to void, the reward rate will be more variable, in the sense that it can go up and down, depending on how many people are betting. It’s possible that over time the reward rate could be skewed to the downside as the liquidity of the void ability encourages people to invest,” he explained.

Additionally, platforms could lower reward rates to compensate for the fact that mining is much more energy intensive than investing. “You don’t have to have such a big incentive model to encourage validators to work on the platform,” Perfumo said.

While he believes Ethereum rewards won’t necessarily increase after the merger, Perfumo stressed that investors should still keep their personal time horizons in mind when it comes to investing in Ethereum, and only consider investing if they’re comfortable locking up their assets. for at least another six months.

This article is intended to provide generalized information designed to educate a broad segment of the public; does not provide personalized investment, legal or other business and professional advice. Before taking any action, you should always consult your own financial, legal, tax, investment or other professional for advice on matters affecting you and/or your business.

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