Ether.Fi announced that it has successfully concluded a fundraising round, raising $5.3 million. The platform offers liquid staking, which enables users to earn rewards for validating a blockchain network by locking their cryptocurrency while still having the option to invest their locked funds elsewhere. Liquid staking has surpassed decentralized finance to become the second-largest crypto sector, with a total value of around $14 billion locked in.
Even though the SEC has its eyes on staking in the U.S., Ether (ETH) holders are showing a strong interest in liquid staking platforms. However, it’s important to note that these platforms are centralized and custodial, which means they are susceptible to similar threats as Coinbase and Kraken.
Ether.Fi addresses the issue of maintaining control over Ethereum validator operations while allowing users to keep their keys safe. With the EtherFi protocol, users can maintain custody over their assets and preserve the ability to interact with other protocols. The decentralized nature of retaining control over keys helps reduce counterparty risk. Ether.Fi is a lot more decentralized in comparison with other protocols like Lido.
Each validator created using the protocol will be converted into a non-fungible token (NFT). The NFT will be owned by Ethereum stakers who deposit at least 32 ETH, and it will represent their financial stake in the validator. In the future, the NFT can be split into smaller pieces through smart contracts for managing liquidity pools and protocol treasuries.
Three principles that Ether.Fi is following
Decentralization in staking: The team assures that the protocol will always remain non-custodial and decentralized, ensuring that stakers retain control over their ETH.
Having a sustainable business model: The team has announced their commitment to long-term planning, with a focus on decades rather than short-term gains. They emphasize that their approach is not based on the principles of Ponzi schemes.
Taking the right decisions for the Ethereum community: The team has stated that if they make a mistake, they will take responsibility for it and promptly take corrective action.
Ether.Fi roadmap – What makes it different from Lido?
Ether.Fi has two primary distinguishing factors.
- Stakers create and keep their own keys for the ETH they have staked.
- Every validator launched through Ether.Fi mints an NFT.
In most delegated staking protocols, the staker deposits their ETH and is then connected with a node operator who generates and keeps the staking credentials. However, this method often results in a custodial or semi-custodial mechanism, despite the possibility of a non-custodial implementation. This puts the staker at risk of opaque and substantial counterparty risk.
With Ether.Fi, the staker can retain control of their ETH keys while delegating the task of staking to a node operator, thereby reducing their risk exposure considerably.
The protocol of Ether.Fi creates an NFT for each validator that is launched through it. These NFTs are used to mint the eETH token, a Liquid Staking Derivative, from a pool of liquidity.
The NFTs hold control of the 32 ETH that is staked and also contain metadata associated with the validator. This metadata includes details such as the client it is running, the location of the validator, the operator of the node, and any node-based services that it is running. These NFTs provide the ability to build a programmable layer over the staking infrastructure, which will become even more effective when it is eventually integrated with EigenLayer.
As for the road map, there are three main phases.
- Delegated staking
- Liquidity pool
- Node services
Delegated Staking — Phase 1
To be assigned a validator node to run, a node operator needs to submit a bid. If they are a trusted node operator, a nominal bid is enough to signal availability. However, if they are a trustless node operator, they need to participate in an auction mechanism and the validator is assigned based on their winning bid.
When a staker deposits 32 ETH into the Ether.Fi deposit contract, it activates the auction mechanism, which assigns a node operator to operate the validator. Along with this, the deposit also generates a withdrawal safe and two NFTs – T-NFT and B-NFT. The T-NFT represents 30 ETH and can be transferred, while the B-NFT is soulbound and represents 2 ETH, which means that it is not transferable. The 2 ETH can only be recovered if the validator is exited or fully withdrawn.
The staker uses the winning node operator’s public key to encrypt the validator key, which is then submitted as an on-chain transaction.
To retrieve the staked ETH, the staker (or node operator) can issue the exit command to exit the validator and move the funds to the withdrawal safe. After that, the staker can burn the NFTs to get back their ETH minus fees.
The B-NFT serves two purposes: firstly, it supplies the deductible for slashing insurance in the event of a slashing event. Secondly, it represents the responsibility of keeping an eye on the validator node performance. Due to the added responsibility and risk, it pays a boosted yield which is about 50% higher than the T-NFT. Ether.Fi also offers notifications and alerts to make it effortless to monitor validator performance.
Liquidity Pool and eETH — Phase 2
If you have less than 32 ETH or don’t want to monitor validator nodes, you can still participate in Ether.Fi staking. You can mint eETH by joining the NFT liquidity pool. The pool contains a combination of assets including ETH and T-NFTs, where ETH only makes up a small portion of the assets at any given time.
When someone deposits ETH into the pool, they receive eETH tokens in exchange. If a staker has T-NFTs, they can also deposit them into the pool and receive eETH tokens based on the value of the T-NFTs.
If you have eETH as a staker, you can exchange it for ETH in the liquidity pool at a 1:1 rate, but only if there is enough liquidity available. If there isn’t enough liquidity, attempting the exchange will result in the validator exiting.
Stakers who want to stake with B-NFTs and earn higher yields will deposit their ETH into the pool. Then, they will join a queue to receive a B-NFT allocation. These stakers act as bond-holders, and their role is similar to that of full-node stakers who have sold their T-NFT.
The bond-holder stakers are placed in a queue, and when the amount of ETH in the liquidity pool reaches a certain threshold, the next bond-holder in the queue is assigned. They initiate the staking process by generating private keys and staking 32 ETH. This generates two NFTs: the T-NFT, which is added to the pool, and the B-NFT, which is given to the bond-holder.
An exit request is initiated on the oldest T-NFT once the amount of ETH in the liquidity pool drops below a certain threshold. This will generate an event that must be monitored by the bond-holder who corresponds to that particular T-NFT. To facilitate this, Ether.Fi provides a notification service for bond-holders at no cost.
When you request to exit as a validator, a timer starts and your exit time is recorded. If the timer runs out and you have not successfully exited, you will receive a penalty. The penalty gradually increases. If the holder of the bond is unable to request an exit, the node-operator will receive a reward for ensuring the validator exits on time.
When the validator leaves, the T-NFT and B-NFT are destroyed and the remaining ETH (minus fees) is added to the liquidity pool.
Node Services — Phase 3
This is a speculative phase and a lot of technical decisions are still undecided. However, the use of NFTs to represent the economic value of staked ETH creates a programmable layer on the staking infrastructure, providing incentives for both node operators and stakers.
NFTs can be utilized for providing node services, for which specific metadata parameters need to be set within the NFT contract. This implementation requires the node operator to have the Ether.Fi client bundle and be registered for node services. Enrolling a node to offer additional services necessitates the consent of all three parties involved – the node operator, the B-NFT holder, and Ether.Fi.
The Challenges of Decentralized Staking
Before diving into the challenges, it’s important to understand what decentralized staking entails. Staking is the process of participating in transaction validation on a proof-of-stake (PoS) blockchain. This process is decentralized because it occurs on a network that is not controlled by any central entity.
Now, let’s inspect the challenges you might face when staking your cryptocurrencies.
1. Complexity and User Experience
For the uninitiated, staking can be a complex process. Some PoS networks require users to run a node, which involves having a certain level of technical expertise. Setting up a node requires both hardware and software, which may demand learning new skills.
Furthermore, the user experience for staking platforms often leaves much to be desired. Crypto wallets and interfaces can be difficult to navigate, making the staking process intimidating for newcomers.
2. Locked-In Periods and Reduced Liquidity
When you stake your cryptocurrencies, they are often locked in for a specified period. During this lock-in period, your assets are illiquid, meaning you cannot sell them or move them. If you need to access your funds urgently, this could pose a significant challenge.
3. Slashing Risks
Slashing is a mechanism used in some PoS networks to discourage dishonest behavior. If a staker’s node is found to be malicious or even faulty, a portion of their staked cryptocurrency may be “slashed,” or taken away. This risk can deter potential stakers who are concerned about accidentally violating network protocols.
4. Concentration of Power
Despite the decentralization aspect, staking can sometimes lead to a concentration of power. Larger stakeholders have more decision-making power, which can lead to centralization within the network. This development may go against the primary ethos of decentralization in blockchain technology.
5. Crypto Volatility
The volatility of the cryptocurrency market is a significant factor to consider. While staking can provide a steady return, the value of that return is tied to the value of the cryptocurrency. If the price of the coin drops significantly, so too does the value of your staking rewards.
6. Network Changes and Updates
Changes or updates to the network protocol can influence staking strategies. If the network switches from PoS to another consensus mechanism, for instance, staking rewards could disappear entirely. Stakeholders must keep up-to-date with the latest network changes and developments to mitigate such risks.
While the challenges of decentralized staking are significant, they are not insurmountable. With careful research, proper risk management, and a deep understanding of the staking process and specific network protocols, stakeholders can mitigate these issues. Remember, crypto investments should not be based on potential returns alone, but also on a thorough understanding of the associated risks.
Conclusion
Staking is an exciting development in the crypto world, offering a way to earn passive income from crypto holdings. But like all investment opportunities, it comes with risks and challenges. As an investor, understanding these challenges will put you in a better position. Several platforms like Ether.Fi are making crypto staking easy. However, true decentralization is what this new platform is striving to provide, in comparison to partially centralized protocols like Lido.
