Ethereum Staking Rewards Rate: A New Tool for Risk Transfer

August 29, 2023

In September 2022, Ethereum underwent a pivotal transition to a Proof-of-Stake model. Protocol staking, which involves bonding Ethereum to a validator, renders significant technological benefits for Ethereum by enhancing network security and reducing energy consumption. The Ethereum network entices holders to engage in staking by offering rewards in the form of newly issued Ethereum and a share of transaction fees. These rewards are distributed approximately every 6.4 minutes, forming the basis for a staking rewards rate (SRR)—a projection of the yearly earnings a staker could realistically achieve by staking their Ethereum under prevailing market conditions.

The staking rewards rate within Ethereum’s ecosystem mirrors the concept of a risk-free rate in traditional finance. In contrast to alternative activities generating crypto returns—such as lending tokens to centralized entities for profits or participating in decentralized liquidity pools—protocol staking empowers users to uphold custody of their funds, earn rewards tied to the protocol, and circumvent the introduction of counterparty risk linked to centralized entities or decentralized exchanges. Essentially, Ethereum’s rewards mechanism stands out as a comparatively low-risk avenue for reaping rewards, and its reward rate can be regarded as crypto’s equivalent of a risk-free rate.

Prominent investment funds and managers have grappled with valuation concerns when evaluating and appraising digital assets. This predicament revolves around determining the “token cost,” analogous to assessing equity cost in a discounted cash flow model. The major outlying input to a crypto-asset discounted cash flow model is the risk-free rate, in which case Ethereum’s rewards rate might now be used. While designating a blockchain protocol as entirely “risk-free” remains imprudent, Ethereum’s protocol staking is broadly recognized as a secure approach for holders to earn rewards while retaining control and ownership of their assets. The rewards rate within Ethereum has the potential to serve as a risk transfer tool, on top of which a forward curve can be built, and as a performance benchmark, serving as a reference rate utility for market participants.  All of this to unlock the next generation of financial products based on Ethereum.

Here are some examples of how an Ethereum staking rewards rate may be used:

Rewards Rate or Total Return Swap – Major Ethereum holders may opt to swap their fluctuating rewards rate for a fixed rate and vice versa. Asset managers overseeing Ethereum ETFs, for instance, might opt for a fixed rate aligned with their product’s terms. Conversely, a speculative fund or proprietary trading firm might seek the potential upside of a floating rate. This novel rewards rate swap, powered by an underlying Ethereum staking rewards benchmark rate, enables investors to secure predictable cash flows, hedge collateralized positions, and assume risks with potential upsides if they anticipate a rise in the floating rate over time.

Rewards Rate-based Futures and Options – Futures that allow those that hold Ethereum or have client or supplier obligations in Ethereum to hedge against fluctuation in staking rewards rate. One could also create a total return future or swap for Ethereum to hedge against both the staking rewards and the volatility of the asset. The annualized staking rewards rate can serve as an underlying benchmark for both products.

Staked Ethereum Lending – One could use a staked Ethereum position as collateral to receive a short term loan, with  the staking rewards rate being paid to the lender as interest. This use case could apply to asset managers who have redemption or liquidity obligations where there’s a duration mismatch with the Ethereum unbonding schedule, which is generally between 2-7 days. The seeker of liquidity could borrow Ethereum from a trading desk to meet their liquidity obligations and repay the loan in ETH plus fees, which may also include the rewards earned while the staking position was unbonding (exiting validators continue to earn rewards while they are in the 2-7 day exit process).

What factors influence the Ethereum staking rewards rate

Factors influencing the Ethereum staking rewards rate are dynamic, fostering a two-sided market and a demand for a staking rewards benchmark. On a network-wide scale, consensus layer rewards—granted for actively validating and proposing blocks—rise with an increasing number of active validators, while per-validator rewards decrease due to higher validator participation. Execution layer rewards comprise of the fees, commonly referred to as priority fees or “tips,” paid in Ethereum by users conducting transactions on the network. These rewards depend on user demand for blockspace and can be challenging to predict, given their responsiveness to network activity. Protocol emissions decrease as more validators join, yet the rewards rate can escalate due to an overall uptick in network activity.

In Conclusion

Figment developed the MarketVectorTM Figment Staking Rewards Reference Rate to serve as the industry standard for the annualized rewards earned by staking Ethereum. The rewards rate is inclusive of all on-chain activity, available daily, and customizable. As more market participants have demand for a staking rewards rate to manage their business and portfolios, a natural market has developed and we’re here to offer our rewards rate to those building the future of financial services

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