• Team Sygnum

The potential of staking


The problem of scalability


Despite the significant potential for consensus protocols to transform the financial industry in various ways, the obstacle of scalability has yet to be overcome. In consensus mechanisms, scalability is a trade-off inherent to decentralisation, such as with Bitcoin – meaning most blockchain networks are slower than traditional centralised networks, presenting a barrier to growth. This is particularly so in proof-of-work (PoW) mechanisms, and protocols such as Tezos and Cardano have instead adopted a proof-of-stake (PoS) mechanism which is capable of a higher transaction throughput.

PoS will also soon be adopted by Ethereum, the world’s second largest protocol by market capitalisation, in “Ethereum 2.0”. This change from PoW to PoS, combined with sharding (the breaking up of the network into individual segments, or shards), could increase the capacity of the Ethereum network exponentially while maintaining decentralisation. However, this new crypto-economic incentive structure has the potential to transform the dynamics of the network and community. 


Moving away from computing power to staked amounts


In PoW, transactions are validated by miners, who compete to solve cryptographic hash puzzles. The first one to solve the puzzle confirms the transactions on a block and receives a block reward in exchange.

The more computational power that a miner has, the higher the chances of solving the puzzle. This means that “mining” is both expensive and requires significant computational power.

PoS mechanisms do away with this computational arms race. Instead, participants can “stake” their crypto, with the probability of being selected as a validator being proportional to the amount staked. Staked amounts are also locked up on the blockchain, which provides economic disincentives against malicious behaviour– any such behaviour could cause the validator to forfeit their stake.


Sharding+ Proof of Stake = Increased scale while maintaining decentralisation


The problem with blockchain transactions is that they are sequential – only one block can be added to the blockchain at a time, creating bottlenecks. Sharding essentially splits the blockchain into multiple “shard chains”, allowing a corresponding number of transactions to be validated simultaneously. Ethereum plans to deploy 64 shard chains in Phase 1. [1]

At the same time, Ethereum’s PoS structure increases the accessibility of participating on the network. Unlike mining which requires sophisticated hardware and access to adequate electrical power, anyone who wishes to be a validator simply needs to stake a minimum amount of 32 ETH (about USD 9,000), which levels the playing field. While sharding is theoretically also possible with PoW mechanisms, miners would only need a relatively small amount of processing power to attack an individual shard chain. The shift to PoS therefore increases the resilience of a sharded blockchain. 


Another benefit of PoS mechanisms is environmental sustainability. With PoW mining requiring energy-intensive graphic processing units (GPUs) to solve cryptographic hash puzzles as quickly as possible, University of Cambridge researchers estimate that Bitcoin mining globally consumes about 64 TWh of electricity each year [2] – roughly the equivalent of Switzerland’s [3] electricity usage. 


Staking rewards – a new income opportunity for investors


One of the incentives to stake on the Ethereum network (or on Tezos and other PoS protocols) is the staking rewards which are distributed to participants, and this will be available even to the average Ethereum investor. The amount of the reward is still uncertain, but this offers a stable yield-generating opportunity for investors (keeping in mind price changes of the “underlying”).

Ethereum’s shift towards a more sustainable and scalable model could position it for stronger growth as the go-to network for decentralised apps in the longer run. Staking is also expected to reduce the inflation rate and incentivise a longer investment holding period – increasing the potential for Ethereum to function as a store of value. Together with a potentially stable yield from staking, this would make it a more resilient investment opportunity, with the chance to profit from both dividend-like staking rewards on top of capital appreciation.



[1] https://docs.ethhub.io/ethereum-roadmap/ethereum-2.0/eth-2.0-phases/

[2] https://www.theverge.com/2019/7/4/20682109/bitcoin-energy-consumption-annual-calculation-cambridge-index-cbeci-country-comparison

[3]https://www.axpo.com/ch/en/about-us/media-and-politics/power-market-switzerland.html#:~:text=Electricity%20production%3A%20Over%20the%20past,net)%20amounted%20to%2063.5%20TWh.







Disclaimer

This document was prepared by Sygnum Bank AG. This document may contain forward looking statements and may be subject to change. The opinions expressed herein are those of Sygnum Bank AG, its affiliates and partners at the time of writing. The document is for informational purposes only and contains general material. It is for use by the recipient only. It does not constitute any advice or recommendation, an offer or invitation by or on behalf of Sygnum Bank AG to purchase or sell assets or securities. It is not intended to be used as a general guide to investing, and should be used for informational purposes only. When making an investment decision, you should either conduct your own research and analysis or seek advice from an expert to make a calculated decision. The information and analyses contained in this document have been compiled from sources believed to be reliable. However, Sygnum Bank AG makes no representation as to its reliability or completeness and disclaims all liability for losses arising from the use of this information.

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