A Guide to Ethereum Tokenomics: Updating Max Effective Balance

July 27, 2023

TLDR

  • There are practical limits to just how many validators Ethereum can accommodate
  • EIP-7251 would help alleviate Ethereum’s limits by increasing max effective balance from 32 to 2048 ETH
  • This proposal does not change the minimum ETH required to activate a validator, this stays constant at 32 ETH
  • Compounding rewards on Ethereum could become possible
  • Some additional changes are likely required to maintain certain design goals of Ethereum; ensuring that changes to the active validator set is one example

Current State

Effective balance is an important figure for Ethereum stakers – it is used to calculate consensus layer (CL) rewards as well as the probability of being selected for various duties (e.g., proposing a block). Currently, the highest this value can be is MAX_EFFECTIVE_BALANCE (‘Max Effective Balance’) or 32 ETH (see here). In other words, a validator with a balance over 32 ETH, say 45 ETH, currently, earns no more rewards than a validator with a balance of 32 ETH, and is no more likely to be selected to propose a block. Also, when a validator’s balance exceeds this amount it is captured in the withdrawal sweep, this means the amount above 32 ETH is sent to the staker’s withdrawal address.

Because 32 ETH is both the max effective balance and the amount required to activate a validator, compounding is not possible. The closest approximation to compounding is if stakers accrue enough rewards to activate more validators, i.e., they earn a multiple of 32 ETH. Even then, it takes time to deposit the ETH and become part of the active validator set.

The (Suggested) Change

But what if the parameters were to change? A validator would still need 32 ETH to activate, but if the max effective balance was increased, this would allow for rewards compounding.

In fact, this change proposed by Mike Neuder of the Ethereum Foundation (EF) is currently being considered by the Ethereum community. Known as EIP-7251, this proposal considers increasing max effective balance from 32 to 2,048 ETH. There is an additional aspect of this proposal that would allow for the consolidation of active validators, but this part of the proposal seems to be more unsettled than other aspects. For more on this proposal see this FAQ.

Some Considerations

If the proposal were to only change max effective balance, there could be some additional consequences:

  • Heightened Slashing Penalties: When a validator commits a slashable offense a few things happen; the first two are that they are exited from the active validator set and they incur a penalty equal to 1/32 of their effective balance (see here). If max effective balance is increased and a validator chooses to hold more than 32 ETH, this penalty would increase.
  • Partial Withdrawal Sweep: Currently anything above max effective balance is swept to the staker’s withdrawal address ( see here). If max effective balance were to be increased there wouldn’t be any partial withdrawals until this new, higher balance is reached. There are active discussions on this topic and potential solutions have been offered, such as making partial withdrawals manual (see question 9 of the FAQ).
  • Queue Skipping: Stakers are able to deposit additional ETH to a validator that has already been activated. They might wish to do this if their effective balance is significantly below 32 ETH. However, if max effective balance is increased, it could make more sense for a staker to deposit additional ETH to an existing validator and thereby skip the queue rather than activating a new validator.

These items and more were discussed on the two consensus layer calls occurring on June 29th (see here around 46.25 into call) and June 15th (see here around 59.40 into call). The idea of including this proposal along with another (EIP-7002) – makes the timing of this upgrade hard to estimate – assuming it attains the required support from the community. That said, it is likely something worth thinking about now as it could have some significant impacts.

Today’s ETH Tokenomics

Token Issuance

Ethereum creates newly issued ETH to pay validators to run the network. Validators do this by performing several duties – attesting, proposing and taking part in the sync committee. These rewards are referred to as consensus layer (CL) rewards.

On a network-wide basis, Ethereum pays about 2,000 ETH per day to validators (based on our calculations). As more validators are added, this figure will increase and network-wide rewards grow in proportion to the square root of staked ETH. On a per-validator basis rewards decrease in proportion to this amount, i.e., the square root of ETH staked, yielding the familiar chart:

The Burn

Since EIP1559, Ethereum has burned the base fee of transactions. Base fees are set by the protocol and increase as block size rises above the target and decrease as the block size falls below the target. From an Ethereum user’s perspective, the base fee can be interpreted as the minimum amount that must be paid to have transactions included in a block.

There are also priority fees or tips, which are optional fees that users can pay to (potentially) expedite the inclusion of their transactions in a block. These tips are collected by validators and are referred to as execution layer (EL) rewards.

The net impact of new issuance and the burn determine the net supply dynamics of Ethereum. Generally, net supply of ETH is related to demand for block space. As can be seen from the chart below, following the Merge, net ETH supply was modestly positive, but has more recently declined:

(Ultrasound.money)

The dynamic is more impressive when compared to what issuance would have been under Proof-of-Work (POW):

(Ultrasound.money)

Tokenomics With Higher Max Effective Balance

What might tokenomics look like with the increase in max effective balance? 

To begin with, the rate at which ETH could be staked would almost certainly change. Currently there is a limit of nine validators per epoch, or 2,025 per day or 64,800 ETH/day. However, if validators can add more ETH per validator (as per the changes above), even with the same churn limit of 9 validators per epoch, there could be a much higher rate of ETH deposited. For instance, if the average validator deposited 64 ETH instead of 32 ETH, the average daily rate of ETH added would double to 129,600.

Beyond this, if already active validators are able to consolidate, this could reduce the number of active validators which would decrease the churn limit; for every 65,536 validators that are consolidated with others, the churn limit would decrease by 1 (or 225 validators per day).

As mentioned previously, the queue itself would likely become de-emphasized as stakers with already active validators could skip the queue and simply add to their existing validators or, as just mentioned, they could activate a validator with significantly more ETH.

Many of the design decisions chosen by the Ethereum community are not arbitrary. For instance, the churn limit, which dictates how quickly new validators can be activated and how quickly existing validators can exit, was designed so as to limit just how quickly the active set of validators could change. It’s plausible that if this change were to move forward, the churn limit could be changed to reference the amount of staked ETH rather than the number of validators, for example. In fact, this is touched on in the FAQs written by Mike Neuder of the EF – specifically, see question 11 on ‘top-ups’.

One validator = 32 ETH is a factor that has been around since the launch of Beacon Chain. Changing has large implications and offers a lot of potential benefits. Careful planning and consideration is being undertaken and is exactly what is required for this to be successfully adopted.

Staking Ethereum with Figment

Figment is the largest independent ETH staking provider with 4.78% share of staked ETH. If you are interested in staking Ethereum, Figment offers a host of services aimed at delivering safe and reliable staking rewards for your assets. 

Our 250+ institutional clients rely on Figment to provide best in class staking services including seamless and easy integrations, detailed rewards reporting, insights, MEV-Boost activation on ETH, double-sign slashing, and downtime penalty coverage. Figment’s team has extensive Ethereum knowledge intended to help dive into the specifics such as rewards and staking information. Meet with us to learn more about Ethereum staking.

The information herein is being provided to you for general informational purposes only. It is not intended to be, nor should it be relied upon as, legal, business, or investment advice. Figment undertakes no obligation to update the information herein. 

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