On the 1st of December 2020, the staking contract of Ethereum launched, offering holders to stake Ether, in plain English, verify transactions on the Ethereum network by locking up their Ether. For nearly 2.5 years, the staking contract was a one-way street, making stakers unable to unstake. However, on April 12, 2023, staking on Ethereum turned into a two-way street on account of the Shanghai hard fork, at long last providing stakers with the option to unstake.
Still, in the time past the Shanghai hard fork, considerably more Ether has been staked than unstaked. To be exact, a net total of slightly more than 25,300 validators have joined the staking contract. Each validator represents 32 Ether, by which about 809,600 more Ether has been staked following the Shanghai hard fork. This implies that 18.78mn Ether is presently staked, amounting to around 15.6% of the total supply of nearly 120.26mn Ether. Also, about 72,500 validators are in the activation queue waiting to enter the staking contract, expected to be fully enrolled within the next around 40 days.
Although the activation queue to stake is somewhat comprehensive, it is nowhere near setting the staking ratio of Ethereum side-by-side with other proof-of-stake cryptocurrencies. Take Solana and Avalanche. They have staking ratios of 71.5% and 60%, respectively, whereas Ethereum is set to have a staking ratio equal to 17.55% once the present activation queue has been cleared given that no unstake.
After all, over the next two years, we expect staked Ether to approach 35mn to 40mn, after which we anticipate that it slowly nears 45mn. However, we view a staking ratio above 50%, meaning at least 60mn staked Ether, as highly unlikely. Although other cryptocurrencies present a staking ratio much higher than this level, Ethereum has characteristics that largely discourage substantial staking. This involves a lower staking reward, the requirement of 32 Ether for a single validator, queues to stake and unstake, negative supply growth following the merge, so non-stakers do not feel forced to stake upon otherwise inherent constant dilution, and a second-to-none ecosystem of applications to elsewhere employ Ether if not staked.
A higher staking ratio causes greater issuance and lower staking rewards
The staking ratio of Ethereum attracts attention mainly thanks to two factors, both of which largely impact the future fundamentals of the cryptocurrency. The Ethereum network responds to additional validators by increasing the overall issuance of Ether rewarded to stakers, however, this is not realized linearly, causing individual staking rewards to decline. For example, by the present 18.7mn staked Ether, the network issues about 720,000 Ether yearly rewarding stakers with an issuance reward of 3.8%. In contrast, provided that the amount of Ether staked more than doubles to the upper end of our near-term estimate of 40mn Ether, Ethereum would then issue 1.06mn Ether at an issuance reward of 2.6%. This triggers over 300,000 extra Ether to be issued yearly at a total present cost of over $550mn, sooner rather than later for the market to absorb, whereas stakers are to be rewarded with over one percent less in issuance rewards.
In fact, one should not merely consider the issuance reward, as the overall staking reward consists of an issuance reward, transaction tips, and maximal extractable value (MEV). The latter two are related to the reward of proposing a block. In case the number of validators doubles, any given validator is half as likely to propose a block, ultimately reducing both tips and MEV rewards by half. These two types of rewards together paid roughly 2.6% in annualized rewards since the Ethereum merge on the 15th of September 2022. Altogether, given that staked Ether increases to 40mn, the staking reward is reduced by up to 2.5 percentage points yearly from 6.3% to around 3.8% for all stakers.
A greater Ethereum staking ratio is not strictly great
This indicates that both non-stakers and stakers are worse off by a greater staking ratio. Both parties get diluted relatively more by the greater issuance. To make matters worse, stakers simultaneously receive substantially less in staking rewards.
Indeed, in this case, relatively more Ether has shifted from non-staked to staked, suddenly receiving a staking reward compared to nothing previously. Based on this factor, one may argue that it is just a zero-sum game, in that the increased issuance and reduced staking reward are transferred to the newly staked Ether, but it yet deteriorates the fundamentals of Ethereum the more the market deems it necessary to stake Ether. Such a shift also signifies that there are limited other applications and use cases wherein to utilize Ether rather than stake them, overall reducing the value of the Ethereum network. So, the community should in fact call for less staking rather than more, although it means that less Ether is locked in the staking contract short-term. In the best case, less staking is accomplished by expanding the ecosystem, so there are more on-chain alternatives to staking.
All things being equal, it would be another case given that the Ethereum network benefited widely from additional validators with respect to scalability, decentralization, or security, but that is not true. To set the record straight, regarding scalability, the transactional output remains the same no matter the number of validators. Next, the network does not by default become more decentralized provided that more Ether is staked, as it is rather the staking distribution among holders, exchanges, liquid staking providers, and other intermediaries that is vital in this context. Lastly, the Ethereum proof-of-stake mechanism is so resistant to outside attacks that it barely achieves a higher degree of security beyond a certain staking threshold that was arguably reached a long time ago.