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Explaining Ethereum's 'Risk Free' Rate of Return

Validated Individual Expert

One sliver of the crypto market seems to be rebounding: staking. Despite the doom and gloom cast over the entire blockchain industry after the cascading crisis that was 2022 and the fact that the global economy is in uncharted territory, as noted by Federal Reserve Chair Jerome Powell at Jackson Hole, proof-of-stake (PoS) revenue generation has almost rebounded to all-time highs.

As Bloomberg’s Sidhartha Shukla noted in a recent article, the total value locked, or TVL, for liquid staking protocols has surged 292% to $20 billion over the past year and some months. That’s just shy of the $21 billion locked in leading decentralized staking protocols Lido and Rocket Pool in April of 2022, right before the TerraUSD stablecoin death spiral.

To some extent, a rebound in Ethereum staking valuations makes sense – even at a time of general disinterest in decentralized finance (DeFi).

If you remember, Ethereum went officially live with staking on Sept. 15 in an event forever commemorated as “the Merge.” That date shifted the narrative on crypto, at least somewhat, after Ethereum nullified the longstanding criticism of crypto’s carbon footprint by ditching energy intensive miners. (Bitcoin being Bitcoin, it still has its eco critics — but perhaps not for long.)

While it took a few weeks for the withdrawal/unstaking fervor to die down, staking has so far served Ethereum users well – paying out an annualized rate between 3%-4% to anyone with the spare 32 ether (ETH) needed to stake to become a validator. And lest we forget that staking exists in part to shield the World Computer from attacks, it hasn’t failed yet.

Liquid staking – or a democratized form of staking that allows smaller holders to pledge ETH to companies or smart contracts that collate funds and pay out staking rewards commensurately to people otherwise priced out – is such an attractive proposition that many have begun calling it “the on-chain equivalent of government bonds.”

The lingo actually used is “crypto’s risk free rate of return,” but Bloomberg being Bloomberg there’s no way an editor would let a comparison to three-month U.S. Treasury bonds fly — even if the whole concept of a “risk free” rate is an economic impossibility (and essentially a marketing term for U.S. government debt).

Useful fiction or not, staking on Ethereum is comparatively safer than pledging funds to say a DeFi lender. Or worse, a centralized lender like Gemini Earn, BlockFi or Celsius (all defunct). And in a year where liquidity is hard to source and DeFi hacks keep on happening, staking is the obvious choice for many who want to put their capital to work.

Protocols like Lido even give out a proxy token to stakers (i.e. stETH, or staked ETH), which can be used across DeFi while staking rewards roll in.

None of this is to suggest that staking is by any means riskless. Lido’s dominance of the sector in particular is a massive red flag for many, who are concerned about any vector of attack that could put Ethereum security at risk. But given the hardware and capital requirements to become an Ethereum validator, it’s unlikely the trend will reverse and people will choose to spin up nodes the old-fashioned way.

To some extent, staking is where the crypto industry was skating even before Ethereum’s embrace. Investor favorites like Cardano and Solana beat Ethereum to the punch in rolling out their at one time “experimental” staking systems while pre-existing chains like Dogecoin and Zcash are studying how to make the shift. Most if not all blockchains built to run crypto-powered apps launched in the recent market upcycle, like Sui and Aptos, launched with some version of proof-of-stake in place.

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