Many features of proof-of-stake appear intuitively straightforward from a high level, yet are misunderstood even by experts who devote their lives to understanding crypto assets. This has resulted in an enormous amount of disinformation in the area, with large Twitter accounts drawing attention from the newbie masses while making fools of themselves to anybody with even a basic grasp of the second-order implications of staking.&nbsp; This article aims to clear up a few misconceptions and urge the reader to consider what else they may be missing about Ethereum Staking Yield.<h2>Misconception Correcting</h2>Many individuals mistakenly assume that everyone should stake their tokens, maybe inspired by Layer 1s with high staking percentages. When you get into the details, the scenario becomes even more complicated.Individually, the decision to stake may be approximated as a straightforward balancing of yield, staking risk, liquidity disadvantages,&nbsp; cost and effort.<blockquote class="">Actual Yield = Yield (1 - Discount Risk) - Liquidity Premium - Cost and effort</blockquote>In a nutshell:<blockquote class="">A = Y × (1 - D) - L - C</blockquote><ul><li>A, the actual staking yield, is the return perceived by a validator after all other variables have been taken into account. If the actual staking yield is favorable, then the ether holder should stake their tokens.</li><li>Y, the staking yield, is the validator's average projected yield for the staking term. Yields for genesis stakers may have been above 10% at first, but with their tokens frozen for numerous years, they may have received an average yield of 7%.</li><li>D, or the risk discount, is a direct adjustment to the staking yield that accounts for validator outage and potential reward slashing. It can also be employed to include pool or exchange expenses.</li><li>L, liquidity premium, is the opportunity cost of being tied into staking. For instance, if you're committed to staking, you won't be able to utilize the same ether to flip NFTs, transfer funds immediately, or sell your tokens if the need arises.</li><li>C stands for cost and effort: If their return on investment is only 0.1% annually, few individuals will go through the trouble of putting up a node. For them to be encouraged to manage things themselves, they would need a couple of percents each year.&nbsp; Additionally, you should also include the expense of maintaining your home validator.</li></ul>Each Ethereum holder must perform this calculation to see if their actual staking yield is positive or negative. If the outcome is favourable, the holder should decide to stake; but, if the outcome is negative, the risks and disadvantages exceed the rewards, therefore they shouldn't start locking up their tokens.<img src="https://cdn.builder.news/news/11ed4ac67a9207b6a8e6023f659fee92.jpg" alt="ETH Staking" title="ETH Staking" width="600" height="282" class="lykafe0">ETH stakingIt makes sense given this logic that liquid staking derivatives (LSDs) have attained the level of popularity they have:<ul><li>The validators are managed by typically trustworthy operators, which reduces the risk discount.</li></ul><ul><li>LSDs let you depart before withdrawals are enabled, maybe at a loss but still safer than being trapped holding eternally.</li><li>LSDs boost liquidity by allowing you to withdraw fast through Curve rather than sitting in the validator queue.</li><li>LSDs are more efficient since you don't have to manage the validators yourself,</li><li>Liquid staking providers take a portion of the yield to reimburse, but for the vast majority of holders, LSDs are an effective instrument for capturing yield.</li></ul>We may define the positive of the actual staking yield by reordering the formula:<blockquote class="">Y × (1 - D) &gt; L + C</blockquote>The decision of whether to stake becomes whether the staking return after discounting for risk is greater than the opportunity cost of staking and the effort necessary to run a validator.When conventional financial practitioners enter the market and start talking about ETH staking as the risk-free rate or as an internet bond, they usually overlook the risk inherent in the transaction. A more accurate portrayal is as follows:<blockquote class="">RFR = Y × (1 - D)&nbsp;</blockquote>The establishment of a risk-free rate creates a split between financial traders and engineers. To maximize the dollar worth of ether, an appealing financial approach is to establish a high risk-free rate in order to draw as many tokens as possible into the staking contract and create a supply constraint. This line of thought leads to pricing models based on discounted cash flow (DCF) estimates or similar, in which analysts represent staking yield as earnings from a corporation, implying that a larger yield should boost the token price up.The unspoken consequence is that a high RFR makes it practically hard for anyone else to compete. If you have a risk-free rate of 10%, everything else, including DeFi, NFTs, blockchain games, and so on, must either create yield or appreciate at a rate greater than that rate (plus a spread for the increased risk). A high risk-free rate essentially results in a static ecology over time.For non-speculators, there are two critical realizations:<ul><li>A low staking yield is preferable to high staking yield when it comes to enabling a thriving ecosystem.</li><li>A high staking ratio indicates that a blockchain is failing.</li></ul>The resemblance between staking ether and purchasing an internet bond is more nuanced: purchasing a bond reduces yields because you're locked into a rate unless the bond is floating rate, in which case the rate on floaters is usually designed to keep the spread consistent as an underpinning quantity the same as LIBOR or the Federal funds rate changes. When staking ether, the holder retains lengthy yields. To remind you, the yield is now inflated and will almost probably decrease in the future months, so being long yields is not optimal. Staking ether also carries a high level of risk if the holder does not hedge against changes in spot pricing.<h2>The case of EIP 1559</h2>The most visible example of a misunderstanding upgrade is the burning of transaction fees. Often regarded as financial engineering aimed to boost token prices, EIP-1559 reduces the RFR and makes it simpler for dApps to contend with staking in a proof-of-stake environment.The major community narrative surrounding EIP1559 has long been deflationary supply, yet token burning is really a net negative for infinite holders (who should lean towards staking to ensure non-debasement).A mental model that might assist understand this is to reframe token burning as a dividend to all ether holders rather than a reduction in supply. Through this perspective, transaction fees that would otherwise have gone entirely to stakers are distributed to all community members—when deployed with a PoS blockchain, EIP-1559 is a net-decentralizing process, not the centralizing mechanism that bitcoin holders sometimes allege. EIP-1559 has recently been criticized as a kind of pro-cyclical monetary policy. This creates a feedback loop, which should result in stronger peaks but less dampened bottoms.One of the major challenges with reasoning about first and second-order effects in crypto is that there are so many correlated and inversely linked measures that it is very simple to extrapolate incorrectly. In this situation, the gas market might influence the utilization of the network rather than the price of the crypto asset—lowering gas costs reduces burn, but lower gas prices encourage network usage. This impact is comparable to the Federal Reserve creating money during a recession: in principle, every piece in circulation becomes less valuable, but with more money flowing around, the economy can recover faster than if austerity were implemented.Meanwhile, the lower revenue from stakers owing to the burning of transaction fees (instead of using fees to cover stakers) keeps yields low, further driving network activity.<h2>Real yield versus Nominal yield</h2>The debate regarding real staking yield and fully diluted values has shifted dramatically in recent months, with yield farming receiving special attention. Many Layer 1s, on the other hand, continue to promote high staking returns while providing minimal return if adjusted for inflation because of their high staking ratios.According to the graph below, the bulk of the largest proof-of-stake networks gives almost no return for staking one's tokens.<img src="https://cdn.builder.news/news/11ed4ac67a920de7a8e6023f659fee92.jpg" alt="Real yield vs Nomial yield" title="Real yield vs Nomial yield" width="600" height="459" class="lykafe1">Real yield vs Nomial yield. Source: Stakingrewards.comDelegating tokens on Cardano, for example, is frequently viewed as a straightforward method to produce nearly 3.56% income, however, after correcting for debasement and costs, the yield really becomes negative. It's a crazy situation: you're supposed to lose money, yet you still have to pay taxes on the tokens you make.<img src="https://cdn.builder.news/news/11ed4ac67a921139a8e6023f659fee92.jpg" alt="Cardano staking yield" title="Cardano staking yield" width="600" height="78" class="lykafe2">Cardano staking yield. Source: Stakingrewards.comThe situation for Ethereum is now significantly better, however, this is mostly because of the low staking ratio and token burning. The staking ratio will grow when the migration to proof-of-stake stabilizes and withdrawals are permitted (derisking staking), bringing down the real staking yield.By delving further into Ethereum's yield structure, we can design a crude yield diagram that excludes MEV and token burning to define a yield floor and a debasement ceiling. Although nominal yields maintain above 2% till 60% of tokens are staked, real yields fall below that level as the staking ratio reaches 30%—if 60% of ether is staked, baseline real rates fall below 1%.Such high stake ratios are just not a suitable network dynamic. Locking up tokens and assuming slashing + liquidity risk for a 1% return is not an efficient condition for a blockchain built to act as a global computer. The only individuals who should be thrilled with these yields are indefinite-duration speculators who want to protect their market share but don't want to use the network.By estimating the entire actual yield collected by validators, we can additionally frame the declining rewards of staking. When the validator count reaches 30% of the total ETH supply, extracted yield begins to fall, and any subsequent validator additions resemble pure inflation instead of yield extraction.Essentially, the diminishing benefits from staking more ether outweigh the rise in total real staking yield from the installation of a marginal validator. It would be preferable for the validator pool to reimburse the marginal validator their anticipated staking income rather than stake!<blockquote class="">Real Yield Extracted = Real Yield x&nbsp; Staking Ratio</blockquote>By using a 30% staking ratio and a more realistic model that takes token burning and MEV into account in the present low gas scenario, the true yield is startlingly low at only approximately 3%. Most of the DCF or yield models you see today, which predict returns of up to 8%, are only viable in the near term when stakeholder participation is still at or below 10%. Higher staking ratios do not allow for significant real returns until we return to a high-fee environment, but a large portion of this actual return comes from token burning, from which non-stakers would also profit.After taking into account MEV, stakers hit the same maximum extraction barrier at about a 30–35% staking ratio in terms of real yield extraction. MEV might potentially drop this threshold even more because a greater staking ratio indicates that less ETH is being actively exchanged, which lowers gas prices.It should be noted that many members of the community anticipate that The Merge will raise demand for Ethereum, which might result in greater on-chain activity, burn rates, and MEV. No one of my models has ever attempted to define or depended on a demand spike from The Merge.Burn is excluded from the derived real yield curve because including it would cause the relationship to increase linearly with the percentage of supply current staked. This would be deceptive because non-stakers also benefit from network supply deflation. The relative extraction compared to non-stakers is more interesting than the absolute value.Some bottom linesIt is more vital for everyone to have the opportunity to stake than it is for everyone to stake. If a blockchain delivers genuine use, one expects that the staking alternatives may provide enough income to keep 60% or 80% of tokens static eternally.Glamorizing the non-use of a cryptocurrency, whether marketed as a decentralized virtual machine or a peer-to-peer currency system, is the pinnacle of pursuing financial performance above usefulness, and will eventually lead to the stagnation and demise of communities who pursue it. High staking yields, in our opinion, encourage return-seeking and should be prevented.Ironically, the advice that bitcoin holders frequently give to others to never spend their currency fits very well with proof-of-stake: since any staker, by definition, keeps their share of the market and will not be devalued, PoS enables store-of-value crypto assets to be immediately locked up forever without being concerned about future issuance or potential endgame destabilization that could result in changes in monetary policy.<div class="pr-block-special">Disclaimer: This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

Let's dive into Ethereum Staking Yield to clear up some misconceptions about it!

The Truth About Ethereum Staking Yield