By Nelson Ryan
The Ethereum community is currently discussing changes to ETH staking economics, including changes to the issuance curve in the Electra Proposal and stake targeting in Endgame Staking Economics: A Case for Targeting. These changes have the potential to significantly change the economics of the Ethereum network and the staking industry supporting it. To fully understand the context behind these proposals it is important to recap on the history of the economics of Ethereum since moving to proof of stake and the staking market around it.
Pre-merge Ethereum operated on a Proof of Work model with the initial block rewards assigned for miners to secure the network set at 5 ETH per block. This emissions figure gradually reduced over time down to 3 ETH per block and then eventually 2 ETH per block due to proposals EIP-649 and EIP-1234. The EIP proposals were intended to delayed the effects of the difficulty bomb, a mechanism intended to increase the difficulty of mining Proof of Work (PoW) blocks to push miners towards Proof of Stake (PoS) over time. As a result of these proposals, the difficulty bomb was delayed by 18 months and 12 months respectively, given the transition to PoS took longer than initially expected. It’s worth noting that these delays removed the difficulty increase, which meant that the generation of new ether would happen much faster shifting from 30 second block times to 13 second blocks on 2017-10-16, when the first ice age was delayed.
The Ethereum community’s attitude to issuance over time has always trended towards that of minimal issuance. The Ethereum network was moving towards Proof of Stake and the community saw security as a necessary cost borne by the network which should be minimised beyond what is necessary to keep the network secure.
Source: Ultrasound Money
Leading up to the merge, Ethereum also implemented EIP-1559 adding a mechanism in which a portion of ETH gas fees were burned, directly linking net inflation rate to on-chain usage of the network. This set ETH on a path towards deflationary net issuance over time, a goal strongly supported by the Ethereum community. Since the merge, the total ETH supply has on net decreased by 0.15% thanks to this burn mechanism introduced, more than offsetting issuance over that period.
With the launch of the beacon chain, proof of stake went live and ETH holders with 32 ETH could become a validator helping to secure the network. Validators on Ethereum earn the issuance yield which comes from newly issued ETH paid each block. ETH issuance grows as staking participation grows to ensure adequate incentive for validators to secure the chain.
Source: Endgame Staking Economics: A Case for Targeting
As can be seen in the graph above, the issuance yield for validators falls sharply at first and then levels off more gradually as staking participation grows. The reason for the high initial yields is to strongly incentivise some minimal level of staking participation to secure the chain, with incentives levelling off as staking participation gets higher. Validators also earn MEV yield in the form of fees paid by block builders. The MEV yield can make up a meaningful percentage for the total yield for validators, but does not scale with staking participation so is diluted as staking participation grows.
Source: ETH Staking Dune Dashboard
Since the launch of the beacon chain, ETH staking has only grown over time. Today there is currently 33.2m ETH staked or around $95.6b in current market value staked. To put that in perspective that is just over 1m validators and 27.8% staking participation with 29.1% of that attributable to Lido the largest LST provider on Ethereum.
Source: ETH Staking Dune Dashboard
Today most of that staked ETH sits with LSTs (Liquid Staked Tokens), CEXs (Centralised Exchanges) and Staking Pools (Centralised Staking Providers).