What Ethereum’s Merger Means for Crypto Stake Rewards

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

Ethereum’s long-awaited merger on Thursday, September 15 – where the blockchain transitioned its protocol from a proof-of-work to the much more energy-efficient proof-of-stake consensus model – will certainly 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 Perfumo, chief strategy officer at Kraken, which is currently the fourth largest cryptocurrency exchange in the world.

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

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

How Investors Make Money on Bets

Similar to holding a dividend stock, investors who stake their cryptocurrencies are theoretically able to benefit in two ways – from the underlying asset’s price appreciation, and from the additional reward they earn each time they confirm a transaction, known as the annual the percentage rate, or APR.

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

Since validators take risk through their exposure to the underlying asset, investors should not buy crypto solely for its potential APR, Perfumo said. “However, if you have conviction in Ethereum over your time horizon and you feel that staking gives you a way to increase the reward of the asset while you hold it, it sounds like a good idea,” he added.

Prior to the merger, Ethereum holders were able to stake the Beacon Chain, with one major caveat – they were unable to withdraw their holdings, meaning the percentage of Ethereum being staked has only grown over time. But withdrawals should be allowed once the Shanghai fork of the merger is completed in the next six to nine months, Perfumo estimates.

While theoretically each crypto holder can stake by themselves as opposed to staking on an exchange, in practice it is much more difficult to stake alone because validators must constantly monitor the software or risk paying an inactivity penalty. Ethereum also requires all solo validators to have at least 32 ether before they can stake, and the cost of nodes and servers can add up quickly, Perfumo said.

On the other hand, exchanges like Kraken and Lido – which charge a fee on returns – allow users to contribute an amount of their choice, and can also minimize truncation penalties through redundancy mechanisms. Because Lido gives users one derivative ETH token for every Ether they stake, users can even unstake their coins by swapping back the two currencies. However, since these exchanges effectively manage the custody of a user’s assets, Perfumo stressed the importance of choosing a reliable exchange to minimize counterparty risk.

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

Stakers will now earn all the rewards after merging

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

“Returns are expected to go up because the fees that used to flow to miners will now go to stakers,” he explained to Insider. “You’re going from a yield that’s currently around 3.8% – it varies a bit – but our modeling shows that it will potentially double or even triple.” Lido’s estimates are in line with estimates made earlier this year by other crypto analysts that post-merger returns could increase to between 7% to 15%.

However, Perfumo says the exact post-merge reward rates are difficult to predict, especially as the ether becomes more liquid over the course of a few months.

“If people are allowed to unstake, the reward rate will be more variable, in the sense that it can go up and down, depending on how many people bet. It is possible that over time the reward rate could skew to disadvantages because the liquidity of being able to unstake encourages people to bet,” he explained.

In addition, platforms can lower reward rates to compensate for the fact that mining is much higher in energy consumption than staking. “You don’t need to have such a big incentive model to encourage validators to work on the platform,” Perfumo said.

Since he believes that Ethereum rewards will not necessarily increase after the merger, Perfumo stressed that investors should still keep their personal time horizon in mind when it comes to Ethereum staking, and only consider staking if they are comfortable locking down their holdings for the 5 p.m. at least another six months.

This article is intended to provide generalized information designed to educate a broad segment of the public; it 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.