Implication Of Proof Of Stake
The Blockchain Sector @ 2022-11-29
The Blockchain Sector provides information relating to emerging financial technologies. It should not be considered financial advice. Disclaimer below.
The long term implications of Ethereum’s migration to proof of stake are yet to be seen.
The protocol is no longer distributing newly minted ether to miners. That distribution has been cut by around 90% and the remaining 10% is going to stakers. Stakers are investors that hold and lock up Eth to gain staking rewards which are currently around 5.4% APY.
Staking rewards are offset by a balancing mechanism where the gas fees on transactions are burnt. If you use Metamask to do a transaction you pay a gas fee or transaction fee. This fee used to be paid to the miner whereas now it is destroyed which reduces the circulating supply. This is expected to create a deflationary effect where Ethereum’s circulating supply should reduce from 122m currently to around 100m at which point it should plateau.
See the current supply distribution and burn at:
https://ultrasound.money
There isn't a fixed limit or defined circulating supply here and whether Ethereum is inflationary or deflationary largely depends on the network demand for block space.
One key point is that the new issuance of tokens isn't going to miners who have electrical and hardware costs where they need to sell their ETH to raise local currencies to meet overheads. Staking rewards go to long-term investors who are, in my opinion, much less likely to sell and release these newly issued ether tokens onto the market.
This is going to have a dramatic effect on supply and demand over the next five years.
A negative point to consider is the release of locked staked ETH in the beacon chain which amounts to nearly $20B USD worth. This is due to be released as part of the Shanghai update planned for March 2023. This update will also include scaling solutions to make on-chain data more available and increase the efficiencies of layer 2’s.
This unlock could cause a significant supply into the market place which could offset the recent improvements to ETH tokenomics. However this is likely only going to be a temporary one off event and there will be a significant percentage who continue to stake their digital assets.
It’s not just the economics of Ether that are changing, staking has a knock on effect throughout DeFi.
Staking Rewards & DeFi Protocols
We've already seen the emergence of liquid staking tokens like Lido Finance and Rocketpool. Lido is now one of the biggest DeFi projects by TVL and their staked Ethereum token stETH contains over $5.4 billion of ETH locked and staked.
Over the next few years I think we are going to see people building on top of this and using the lego bricks of DeFi to tap into some of this #RealYield that's coming from the consensus mechanism to create value, built on real yields, fees and earnings, rather than ponzi tokenomics around the inflationary governance tokens.
There are going to be all sorts of opportunities opening up for blockchain developers. I’ve experimented with a couple of code designs already:
Building stablecoins, using stETH as collateral for the ethGlobal hackathon
https://github.com/jamesbachini/usETH
A perpetual vault for charities using stETH yield
https://jamesbachini.com/web3-tutorial/#building-giveforever-dapp
This is just touching on the surface of what's going to be possible.
The staking sector of DeFi is going to be a booming industry to look at during the next market cycle. New and emerging projects can rapidly grow because of the real revenues creating better risk and reward for investors.
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Disclaimer: Not a financial advisor, not financial advice. The content I create is to document my journey and for educational and entertainment purposes only. It is not under any circumstances investment advice. I am not an investment or trading professional and am learning myself while still making plenty of mistakes along the way. Any code published is experimental and not production ready to be used for financial transactions. Do your own research and do not play with funds you do not want to lose.