Staking ETH is the Best Protection Against Inflation, if You Are a Validator
Ethereum’s new proof-of-stake consensus mechanism is “a regressive capital tax system” that results in the rich getting richer at the expense of ordinary users, according to a post in the CryptoCurrency sub-Reddit that has gone viral. Posted by u/SenatusSPQR, the thread argues that the maximum 12.1% reward for staking on Ethereum is available only to the highest tier of stakers, and that most users earn smaller rewards that effectively fail to keep up with current rates of inflation in much of the globe.
In fact, the post suggests that, through transaction fees, non-staking holders and users of Ethereum end up losing between 0.5% and 3.5% of their holdings each year. This is before taking into account inflation, which currently tops 8% in economies such as the United States and the European Union.
However, replies to the thread point out that most alternative systems — including proof-of-work — result in some form of centralization of wealth, while its author has also previously written about how “99% of cryptocurrencies centralize over time.” This echoes arguments made on Crypto Twitter, for example, with Ethereum founder Vitalik Buterin making similar points earlier this month about PoW, in response to posts from developer Udi Wertheimer.
Ethereum Staking Can Beat Inflation, If You’re A High-Tier Staker
While many will no doubt quibble over details, the basics of the argument above are quite sound, in that there’s no disputing that those who don’t stake for themselves — and who use some kind of pool or crypto-exchange to stake — have to pay a significant fee.
By holding a minimum of 32 ETH and running an Ethereum node themselves, stakers can claim full staking rewards for themselves. This means they keep Ethereum block rewards and transaction fees (above the base rate), as well as any profits from MEV (miner extractable value).
On the other hand, if someone doesn’t hold at least 32 ETH, they’ll have to use either a pool (e.g. Rocket Pool or Lido) or an exchange. This means they will have to pay a fee, which is taken as a percentage of their staking rewards.
This fee can vary, with Kraken and Coinbase, for instance, taking a 15% and 25% commission, respectively. Such a fee reduces a user’s profit from staking, reducing the chances that passively staking ETH will earn them a yield that beats current levels of inflation.
As bad as this might be for anyone who’d hoped to earn a profit from staking alone, SenatusSPQR argues that the situation is even worse for non-staking holders of ETH. This is because of transaction fees, with SenatusSPQR using the example of an average ETH holder who pays between 0.15 ETH and 1.05 ETH in transaction fees per year.
Even with ETH becoming inflationary post-Merge, the argument runs that the average ETH holder loses between 0.6% and 1.2% of their ethereum per year.
It’s worth pointing out here that the ‘average’ ETH holder owns 30 ETH, with such a figure being the average only because a small number of extremely large holdings skew the mean value towards the higher end of the spectrum. In reality, more ETH holders will own much less than this, meaning that transaction fees disproportionately affect them more.
Indeed, for someone who owns only a small amount of ETH, staking becomes prohibitively expensive, given the transaction fees inherent to staking and unstaking, and then the commissions paid to pools or exchanges.
As SenatusSPQR writes, “When you hold 32 ETH and can set up your own node, a two-time fee of say 0.05 ETH isn’t all too bad. When you hold 3 ETH, pay a transaction fee of 0.05 ETH to start staking, then pay fees of 10-15% over your staking rewards and 0.05 ETH to unstake again, it’s not as good.”
Centralization in Crypto
The post than goes on to make a broader point about staking, which is that the rewards from staking tend to be financed by fees and transactions costs paid for by smaller, ordinary users.
“What staking does is redistribute the value already present within ETH – from the poor to the rich, from non-stakers to stakers, from small stakers to big stakers,” the SenatusSPQR writes.
This reflects recent posts from programmer Udi Wertheimer, who on September 12 tweeted that staking rewards aren’t really rewards, but rather penalties paid by “people who don’t stake.”
And PoW penalizes anyone who has a smaller percentage of hashpower than their percentage of the coin supply ☺️— vitalik.eth (@VitalikButerin) September 12, 2022
(Actually, it penalizes much more than that because profit < revenue, but you get the point)
Of course, Ethereum founder Vitalik Buterin countered Wertheimer’s argument by suggesting that a similar thing applies to proof-of-work cryptocurrencies such as Bitcoin, in that these penalize “anyone who has a smaller percentage of hashpower than their percentage of the coin supply.”
The original poster of the Reddit thread also had similar criticisms for PoW, writing in the replies to his initial post, “I don’t want to imply in any way that I think Proof of Work is any better.” And back in July 2021, he wrote a blog post in which he argued that economies of scale in mining tends towards centralization, giving larger players disproportionate power and influence.
“A larger miner has a stronger negotiating position for ASICs. They have a stronger negotiating position for energy contracts. They have access to cheaper capital. They can more efficiently maintain their ASICs,” he wrote.
In other words, the problem of centralization within crypto is not one that’s going to go away anytime soon, regardless of whether the market ends up veering more towards proof-of-stake or proof-of-work. Although, in the case of PoS, SenatusSPQR suggests decreasing transaction fees, staking rewards and minimum staking amounts as ways of mitigating the problem.
This would certainly help with reducing the centralization already witnessed with staking pools and services, with a report from Nansen recently finding that 64% of all staked ETH is controlled by only five entities: Lido, Coinbase, Kraken, Binance and Staked.us.
Out of the last 1000 blocks, 420 have been built by just Lido and Coinbase.— Martin Köppelmann 🦉💳 (@koeppelmann) September 15, 2022
There’s a strong argument to to the effect that this hardly the kind of consolidation and centralization that crypto was meant to give birth to, yet it’s precisely what has happened as a result of Ethereum instituting a minimum staking amount of 32 ETH. Whether this minimum will remain in place in perpetuity remains to be seen, but for now it does seem like it could risk increasing centralization within crypto rather than decreasing it.