Ever since Ethereum’s shift to a proof-of-stake (PoS) consensus mechanism, an increasing number of users are getting in on the staking action to reap the rewards that come with it. Institutions are also paying attention, given the decrease in network risk and volatility following “The Merge.” This has led to concerns about how much ETH is getting locked into staking contracts, potentially interfering with liquidity on the network.
Developers are already proposing possible solutions to limit the rate of staking, which benefits overall network health but has now limited the opportunities for users to earn a yield from the network. Coupled with an ongoing DeFi winter, there just aren’t as many lucrative returns opportunities in this space as there once were. Truth is, without profitable and reliable alternatives, ETH holders are going to continue to be drawn to staking as the best means of generating return on their assets.
The rise of Ethereum staking
It’s been about a year since Ethereum successfully completed the Merge, in which the blockchain switched from a proof-of-work (PoW) consensus mechanism, like Bitcoin, to a PoS one. This was done to significantly improve the efficiency of the Ethereum network and allowed users to earn a passive income by staking their ETH to secure the network. Ethereum 2.0 was born.
Overall, this has been seen as a positive move for the Ethereum network. A significant number of users have staked their assets already, to the tune of 20% of all circulating Ether. In theory, this sounds great, as the idea is that a diverse array of users are both helping to ensure the security of the blockchain and are being rightly rewarded for doing so. The reality, however, is a bit different.
The rise of large staking providers have made it easier for virtually anyone to get involved, but this is causing the amount of ETH that is staked to continue to quickly rise. At the current trajectory, the amount of ETH locked up could balloon up to as much as 50% by May 2024 and even approach 100% by December next year, according to projections in an Ethereum Improvement Proposal co-authored by Ethereum co-founder Tim Beiko. While actually seeing the entire supply of Ethereum get locked up won’t happen, this situation could still cause a significant liquidity crunch that limits the functionality of the blockchain ecosystem, decentralized apps, and services built on top of it.
This fiasco has led to Ethereum developers approving a new proposal that would control the rate at which new validators could stake ETH. Known as EIP-7514, this change will modify the “churn limit” function to give it a maximum value that will regulate how many validators are able to join or exit the network within a given timeframe. The proposal is already being included in the Cancun-Deneb upgrade that was slated for this October but will likely now be delayed until early next year.