- ETH 2’s high capital requirements and low rewards for staking were criticized for not being competitive in an era of double-digit DeFi yield
- Institutional investors looking for a bond-like product have been intrigued by ETH2 staking
When the Ethereum Foundation launched its staking campaign for Ethereum 2 (ETH 2) last fall, there were some serious questions about whether it would meet its goals to kick the project off and activate the first phase, or need to delay and re-group.
It wasn’t until the last week of the campaign that the necessary ether was staked, meaning it was locked up by the Foundation for a specified period of time, for the project to take off. And what pushed things over the edge?
For the most part, it was large institutional holders of ether. That list includes exchanges, custodians, funds, whales and some companies like Consensys that have a stake in Ethereum’s future.
For the next generation of Ethereum, staking is important as the network is going through a fundamental infrastructure change from Proof of Work to Proof of Stake. Proof of Work is determined by how much computing power users have at their disposal. Major mining farms with large computing power are the loudest voices on the network and are essential in validating transactions.
On the other hand, with Proof of Stake, authority is measured on how many tokens you are holding. Thus, in order to bootstrap this network, a sizeable amount of tokens need to be held by a large group of people for some time.
These large holders of ETH, like any kind of investor, have a spectrum of risk tolerance. Some would be satisfied to hold ETH and give their clients exposure to the crypto market while earning interest. On the other hand, others with an appetite for investments higher on the risk curve want to invest in enhancing the network that powers their investments in Decentralized Finance (DeFi).
Given the staking rewards for ETH 2, an equivalent interest payout of five to 12 percent, many retail investors decided to take a pass and “smart” institutional money moved in instead.
ConsenSys, a venture studio that supports projects on the Ethereum blockchain, had confirmed that investor interest wasn’t really retail during the early days of the campaign but it’s not exactly a secret. Many industry insiders were saying the same thing.
While retail investors might not have been overly interested, institutional investors were. Institutional investors could look at these “internet bonds” as part of a wider portfolio to bundle together and offer clients seeking exposure to the broader digital asset sector. Although not confirmed, it could be a part of VanEck’s future digital assets ETF.
“There’s a real appetite for investors to get the combination of digital asset upside plus the staking yields. Most ETH 2 stakers so far have been pretty hard-core ETH supporters, but we’re starting to see that turn,” said Tim Ogilvie, founder and CEO of Staked, a DeFi company offering staking custody services and loans against staked assets. “It runs the gamut, but almost every institutional partner we interface with is figuring out a staking strategy. Some are just dipping their toes in, while others have made more significant commitments.”
Staked said that its in the process of launching a fund that allows investors exposure to the yield from ETH 2 staking, without the technical complexity of running the staking operation.
Different motivations to stake ETH 2
To stake ETH 2, one needs to commit 32 ETH (approximately $40,000 at current prices) for a minimum of two years. In an era of double-digit returns on DeFi, this isn’t exactly a competitive investment opportunity for retail investors especially considering the effort involved in setting up a staking operation (if they were able to bypass this and just buy a bond that would be different).
But for DeFi to provide the returns investors have grown to expect, there needs to be an underlying network. With the Ethereum 1 network hitting near 98 percent utilization, high gas fees (the term for transaction fees) will drive users to alternative networks — like Stellar and Solana to TRON and NEO.
“A large percent of ETH2 staking participants are technical and therefore have staked early due to their belief in the ecosystem,” said Clemens Wan, a solution architect at ConsenSys. “Institutions and software companies providing these staking services have taken a long position and prefer low-risk predictable validator rewards in order to form a stable business model.”
“[Many Stakers] are not participating in the ETH 2 for the staking returns but because they believe in the future of Ethereum,” adds Jonathan Shi, CEO and founder of InfStones, a blockchain infrastructure company. “A five to 12 percent return is just not appealing to many.”
Wan says that ConsenSys has been approached by numerous institutions with staking commitments upwards of 1,000 ETH ($1.2 million) each to inquire about its staking-as-a-service options. Custody provider GK8, which operates an air-gapped custody service for staked ETH 2, says they have had a significant amount of inquiries from banks and other financial institutions looking to custody their staked tokens.
The future of DeFi is the future of ethereum
DeFi’s jump into mainstream corporate finance was the topic of a recent Blockworks seminar, where panelists discussed the interest corporations have in doing something other than earning paltry or negative yield on the estimated $7 trillion they have in their accounts. With DeFi, panelists argued, corporations could begin earning seven to 10 percent interest with “good governance” protocols like Compound.
Even if a fraction of that $7 trillion is invested in DeFi protocols as an alternative to corporate savings accounts it would present a significant load on the Ethereum network, which is almost entirely utilized at the best of times. Although there are other networks they are still in their infancy. According to DeFi Prime, of the top 216 projects on the market, 204 run on Ethereum.
Legacy institutional investors are going to be doubling down on DeFi over the next year, and bringing retail investors with them. VanEck, one of the largest ETF issuers, has a digital assets ETF in the works — which will likely have exposure to DeFi. Details are sparse on VanEck’s digital assets ETF, but the company has 56 U.S.-listed ETFs in its portfolio with a total of $54 billion in assets under management.
And none of this is possible if the Ethereum network isn’t up to the task, hence why institutions are the literal stakeholders in the future of the protocol.