Can you make money from Ethereum 2.0?

• Updated

Is ‘staking’ the innovation that the cryptocurrency has been waiting for?

Collage-style image of a young girl holding a mounted ETH coin aloft                                 
ETH grew exponentially through 2021 – Photo: Shutterstock
                                

If you track cryptocurrencies, chances are that you have an opinion or two about Ethereum. Bitcoin might be the world’s most successful cryptocurrency by market cap, but Ethereum is still a clear second.

Critics have argued that Ethereum has never really achieved its potential but soon they may be forced to revise their views. For even though Ethereum has seen a meteoric rise in 2021, there are changes afoot which make it a currency to keep an eye on for other reasons.

In particular, the introduction of a new iteration of the technology, Ethereum 2.0, should interest investors for a number of reasons and not just for trading. Whisper it, but there may be passive income streams that Ethereum 2.0 offers which might prove to be lucrative if Ethereum can address some of the technological issues that are holding it back.

Ethereum basics

According to its developers, Ethereum was born out of a concern that too many of the world’s applications were being stored centrally by a small number of companies such as Amazon, Microsoft and Google.

Ethereum’s creators, the most high-profile of which is arguably the Russian-Candian entrepreneur Vitalik Buterin, set out to enable users across the globe to write decentralised applications using the Ethereum blockchain. If data was stored in thousands of different places, its owners believed it would be more secure and could not be tampered with.

Central to this innovation was the concept of smart contracts. These are a computer protocol intended to digitally facilitate, verify or enforce the negotiation or performance of a contract without the influence of third parties. This means that transactions are, in theory, irreversible and transparent. This sounded like an amazing project which inspired many of the early crypto enthusiasts.

Yet there have been technical issues with the way in which Ethereum has developed that have limited its ability to scale. Applications that run on its dApp store – think the equivalent of the Apple Store or Google Play – haven’t exactly had widespread appeal and the top Ethereum dApp attracts only a few thousand users per day. Even if a dApp were to attract mainstream adoption, it’s unclear if Ethereum could support it.

Ultimately, for numerous technical reasons, deploying code on Ethereum is more expensive than using a centralised service such as Amazon Web Services (AWS) and it runs much slower.

What’s the difference between mining and staking?

Ethereum hopes to address this with one of the biggest changes to Ethereum 2.0 – the shift from mining to staking. Up until now Ethereum has run on a Proof-of-work blockchain system. Similar to, though not identical to, the way that Bitcoin works, miners compete to solve a hugely difficult cryptographic problem. In order to mine, individuals need to equip themselves with substantial hardware and be prepared to pay astronomical electricity costs.

By contrast, Proof-of-stake reaches a consensus through a set of nodes known as validators. To participate in staking, investors need to run a validator node to stake through and have at least 32 ETH tokens (current price more than $150,000 [£111,965]) in a deposit. This enables the staker to create a block. Validators from across the Ethereum network are selected to vote on new blocks semi-randomly with other validators agreeing on the result, thereby achieving a consensus.

Similar to mining, staking will create a rewards system, although quite how much income stakers will be able to generate has not yet been decided.

Buterin has suggested that it could be anything between 1.5% and 18%, depending on how much Ethereum is staked. Yet the consensus among seasoned Ethereum watchers seems to be that the real-world figure is likely to be in the region of 5%.

Can Ethereum staking offer easy passive income?

The issue for many investors is that, while this sounds an intriguing way of generating a passive income, there are still technical drawbacks to overcome. Stakers won’t require a high-powered computer – it has been suggested that even a Raspberry Pi would suffice – but, in order to support one of the validator blocks, the computer will need to be online all the time. It still sounds like a lot of work and expense.

What may make staking Ethereum a lot more attractive to investors is if they undertake the process via a third party. Several companies are planning to offer staking in a number of different ways.

First, users can join a pool, which means that they can take part with just one ETH (around $4,700) as opposed to the $150,000 they would need to own 32 ETH.

Alternatively, some companies will offer staking as a service – users simply invest their money and the company takes care of the rest for a fee. It is possible that investor platforms might offer ETH staking as a service too.

Ethereum 2.0 and staking are expected to go live in 2022. The first phase began with the December 2020 launch of Altair, the upgrade to the Ethereum Beacon Chain.

What does staking mean for Ethereum’s price?

So where does this leave someone who is contemplating investing in Ethereum? To begin with, the rollout of Ethereum 2.0 is a lengthy process. In addition to staking, Ethereum will introduce a concept called sharding – a method of partitioning a large database into smaller pieces known as shards. Each shard will have its own chain of transactions and the theory is that it will significantly speed up transactions and enable Ethereum to scale.

It is clear that Ethereum, as it is now, has operational/scalable issues and that, in theory, Ethereum 2.0 will address these. How this will impact on its share price remains to be seen. ETH grew exponentially through 2021. At time of writing, it was higher than $4,700, which is 10 times better than a year earlier, in November 2020, at $470 a coin. Much depends on whether Ethereum can convince investors that its new iteration not only succeeds in solving its scalability and technical issues, but also that it can do so without compromising the existing Ethereum platform.

The next few months are going to be fascinating in so many ways for Ethereum.

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