Original author: Ansgar Dietrich, Casparschwa, Ethereum Foundation

Original translation: Bai Ding, Geek Web3

This article comes from Ansgar Dietrichs and Casparschwa's discussion on the Ethereum staking mechanism and ETH issuance model on the eth research forum. Geek Web3 has sorted and edited it. These views were put forward in February 2024, and some data may be biased, but their analysis of the Ethereum staking economic model is still worth referring to, and some of the conclusions are still not outdated.

Text: Currently, 30 million ETH are staked on Ethereum, accounting for 1/4 of the total (this is the data in February this year). This proportion is quite considerable, and it is still rising without any signs of slowing down. The figure below shows the change of ETH staked over time, and it can be clearly seen that it is showing a continuous growth trend, and this trend will continue for a long time.

In the future, a large part of the new ETH pledge will be affected by LST (liquidity pledge tokens), such as stETH, etc. This will gradually increase the usage rate and currency properties of LST, but this may bring negative effects.

First, LST has a network effect. Large-scale LST projects will cannibalize all liquidity in the track, and eventually form a winner-takes-all situation, which will intensify the competition in the LST track. In addition, if LST surpasses ETH and becomes the mainstream currency on Ethereum except Gas Token, users will face counterparty risks brought by LST. The currency on Ethereum should be as trustless as possible to truly achieve economic scalability.

(“Counterparty risk” refers to the possibility that the other party may default/fail to fulfill its obligations. In the LST scenario, “counterparty risk” mainly includes theft of user assets, LST price slippage, and depreciation)

Currently, there is no hard upper limit for ETH staking. In theory, all ETH can be pledged to obtain returns. LST significantly changes the cost structure of staking, and almost all ETH may be pledged. Therefore, we believe that Ethereum’s economic model and pledge model should include dynamic adjustment policies to allow the pledge ratio to be adjusted within a certain range. In this way, Ethereum can ensure security within a controllable cost scale and avoid negative externalities. produce.

In this paper, we raise some pressing questions about Ethereum’s economic model that need to be addressed.

Current status and future trends of ETH token issuance strategy

Before we start the discussion, let’s first explore which long-term staking models are feasible under the current ETH token issuance policy. The security of Ethereum depends on a certain proportion of token staking, which can be summarized as POS Ethereum itself has a "demand to attract staking". The demand for staking is clearly stipulated in Ethereum's monetary policy. According to the actual staking weight, the protocol will adjust the ETH issuance accordingly to increase the staking reward for a single node.

However, the staking willingness of ETH holders is diverse and complex, and we can only make reasonable guesses based on the existing information and roughly estimate the long-term impact of changes in staking willingness on staker participation.

The supply and demand curve of ETH staking: using additional ETH in exchange for security

Validator nodes staking ETH will ensure the security of the protocol, and the protocol will distribute token rewards to ETH stakers. This is a win-win mechanism. (Due to space limitations, this article does not discuss specific issues such as "what level of security needs to be achieved". For details, please refer to the article Paths toward single-slot finality) The income of Validators mainly comes from two parts:

Part 1: Rewards issued by the protocol according to a fixed yield curve (that is, rewards allocated to staking participants by issuing additional ETH every year)

Part 2: MEV income obtained by Validator during the block production process.

(The horizontal axis of this figure is the ETH staking participation, and the vertical axis is the staking yield, which describes the staking yield that the Ethereum protocol is willing to provide to meet different staking rates. We can regard the Ethereum protocol as the buyer and the pledger as the seller)

Note: To understand the following content, readers may need to have a basic understanding of the supply and demand curve in economics.

ETH issuance yield curve (solid green line): As can be seen from the curve, as the number of stakers increases, the staking rewards provided by Ethereum to a single node will gradually decrease. When the participation rate of ETH staking is low, the system needs more rewards for validators to encourage more people to stake ETH; when more and more people participate in staking, the marginal contribution of a single validator to network security will decrease, and the demand for staking rewards will also decrease.

Total staking yield curve (green dashed line): The fixed issuance income of ETH plus the MEV income constitute the total staking income of the staker. It should be noted here that the MEV yield is calculated as follows: the total amount of MEV income (about 300,000 ETH last year) divided by the total amount of ETH staked.

Since the total amount of MEV income is basically fixed, as the number of validators increases, the MEV yield will drop rapidly, and eventually the staking yield will approach the simple ETH issuance rate. It is worth noting that Ethereum's MEV income has been quite stable in the past period of time (see MEV-Boost Dashboard). Although this may change in the future, in order to simplify our discussion scenario, it is temporarily regarded as fixed.

From the above curve, we can read two key pieces of information:

  • To avoid too low staking participation, Ethereum sets high rewards to attract more stakers when staking participation is low.

  • The marginal utility of each staker decreases, that is, as the stake participation increases, the issuance rate of ETH tokens gradually decreases.

However, the above pledge yield curve fails to ideally regulate the participation of pledge. First, the curve cannot effectively limit the threshold of the pledge ratio. Even if all ETH is staked, the staking incentive will remain at about 2%. In other words, at the level of incentive design, Ethereum does not have precise control over the final staking ratio. In general, except for ensuring the minimum security of the system through high incentives in the initial stage, the protocol does not guide the staking level to a specific range.

It should be noted that the above mentioned are only nominal returns and do not take into account the dilution effect caused by the additional issuance of ETH itself. As more ETH is issued, the dilution effect will become more significant. We will ignore the dilution effect for the time being and will discuss it in detail later.

Supply-side analysis of ETH staking

The above article discussed the demand curve for staking, which is the staking yield that the Ethereum protocol is willing to provide to meet different staking ratios. Now let’s turn our attention to the supply curve. The staking supply curve shows the willingness of ETH holders to stake at different yields, revealing the conditions required for different staking participation.

Generally speaking, the curve will be upward-right sloping, which means that the network needs higher incentives to achieve higher staking participation. However, since the willingness to stake cannot be directly observed or accurately measured, the shape of the supply curve cannot be specifically described, and we can only speculate through qualitative analysis.

In addition, the supply curve is not static, and we will explore how the staking cost changes over time and how this change affects the staking decision of ETH holders. In other words, changes in staking costs will cause the supply curve to shift, causing ETH holders' demand for staking incentives to change.

We can only fit the historically observable staking levels into an approximate staking supply curve. The intersection of the demand curve and the supply curve at each specific point in time reflects the actual staking participation rate achieved in history.

The horizontal axis of this figure is still ETH staking participation, and the vertical axis is the staking yield. As shown in the figure, since the launch of the Ethereum beacon chain, the total amount of ETH staked has continued to increase, and the supply curve of the staked amount has moved downward. Even at a lower staking yield, ETH holders' willingness to stake will still increase. From the historical trend, it is reasonable to expect the supply curve to continue to move downward in the short term. However, it is worth exploring in depth the issue of long-term staking balance, and we need to carefully analyze the composition of the supply side.

When any ETH holder decides whether to stake, there are usually two main factors to consider: the staking benefits and the required costs. Generally speaking, the staking income of unit assets in the hands of validators is the same, but there are significant differences in the cost structure of different types of pledgers. Below is an in-depth comparison of the differences between independent stakers and Staking Service Providers (SSPs).

Independent Stakers vs. Staking Service Providers

SSPs accept users' ETH and complete the staking operation on their behalf, charging a certain service fee. Usually, they will provide users with LST as a staking certificate, and users can use LST for secondary market transactions (such as stETH). For LST holders, the liquidity of these tokens depends on the overall usage rate of LST and the support rate of third-party protocols for it.

Our focus is on SSPs such as Lido that issue LST. As for SSPs that do not issue LST, they can be regarded as special cases where the liquidity value of LST is zero and will not be discussed in this article.

For most people, individual staking does not require trusting a third party, but the threshold for participation is high and the operation is cumbersome; in contrast, LST requires a certain degree of trust, but has significant simplicity and liquidity advantages.

After comparing these two staking methods, we can draw two important conclusions:

1. There are obvious differences in the cost structure of independent pledges among different ETH holders. The level of technical content, hardware conditions and operation and maintenance costs, as well as confidence in custody security, all make the supply curve of independent pledgers Steeper. This means that for the number of independent stakers to significantly increase, either a significant increase in staking returns or an improvement in the UX of the staking operation is required.

2. In contrast, the cost structure of users who use SSPs for staking is basically the same, and the main difference is only reflected in the assessment of SSP operating risks and the concerns about the slippage between LST and ETH. Therefore, the supply curve of SSP is relatively flat. This means that to attract more ETH holders to stake LSD liquidity, the required yield increase is relatively small, and the staking participation rate can be expanded more smoothly.

Additionally, the cost of independent staking is not affected by staking participation, while the cost of holding LST is likely to decrease over time and with increased usage of SSPs for the following reasons:

1. Enhanced "currency attributes" of LST: When the popularity of a certain LST increases, we can expect it to be supported by more and more projects, beyond the use scenarios of native ETH, such as more DeFi protocols integrating LST, and the second-layer network defaulting to liquidity staking for bridged ETH, etc. When the ETH staking ratio is high enough, LST may even surpass unstaked ETH in terms of liquidity, reversing the liquidity gap between the two.

2. Reduced risk of smart contracts: Over time, LST's smart contracts will undergo a lot of practical tests, and risks will be further reduced through formal verification and other methods.

3. Improved robustness of the governance system: As usage increases, LST-related governance mechanisms will become more mature and robust. For example, the LDO + stETH dual governance proposal reflects the progress of the LST governance system.

4. Reduced expectations of large-scale risks: When a certain LST occupies a large enough proportion of the overall market, it may be regarded as "too big to fail". Therefore, users believe that various forces in the market will remedy the situation in a timely manner when SPPs have problems.

5. Profit balance for LSD service providers: When the usage rate of LST is high enough and its liquidity is good enough, SSPs can reduce the unit service fee to maintain profitability and attract more users to participate.

Overall, the existence of SSPs and LST has significantly flattened the pledge supply curve, which means that there is no need to continue to increase pledge incentives to promote an increase in the total amount of Ethereum pledges. It can be speculated that LSD will continue to play an important role in driving the growth of staking volume. However, in the long-term time dimension, staking incentives are not a constraint on the growth of ETH staking. So how large can ETH staking reach?

Long-term equilibrium point of pledge rate

Taking into account factors such as demand and supply, we can infer the long-term equilibrium state that ETH staking can maintain. As mentioned earlier, when the staking participation rate is low, the demand curve shows a clear tendency, but there is no clear conclusion about the specific staking ratio that may be achieved in the long run.

We then explained that as the cost and risk of staking decreases, the supply curve will gradually move downward over time, making more and more people willing to participate in staking, and LST is the main driving force. However, the shape of the supply curve itself cannot be quantitatively analyzed, and it is not clear whether it is steep enough to reasonably regulate staking participation.

Therefore, the equilibrium point of the overall pledge ratio cannot be calculated accurately, and there is a wide range of possibilities, which may even be close to 100%. The figure below shows that even small differences in the supply curve in the long term may cause the equilibrium point of the pledge ratio to shift.

In fact, the most critical issue is not how high the pledge participation rate will be, but that once such a high pledge rate occurs, it will bring a series of hidden dangers. This article proposes some policy adjustment suggestions to prevent this from happening.

Pledge ratio analysis: Under what circumstances is a lower pledge ratio better?

The staking rate can be defined as the ratio of ETH staked to the total ETH supply. The current total ETH supply is about 120 million, of which about 30 million are staked, and the staking rate is about 25%. Before discussing the potential problems that a high staking rate may bring, we must first clarify a standard:

At what level of pledge rate can the security of Ethereum be guaranteed? According to a previous discussion record of the Ethereum Foundation, we can know that the current pledge level is sufficient to ensure the economic security of Ethereum.

This leads to a question: if the current pledge rate is already able to ensure network security, is it necessary to pursue a higher pledge rate to achieve "over-security"? In our opinion, although a high pledge rate can enhance the security of the network, it may bring some negative externalities, affecting ETH holders, independent pledgers, and even the operation of the entire Ethereum protocol.

The network effect of LST currency attributes (LST): Refusing to take risks

LSTs are competing fiercely for currency attributes. Due to the existence of network effects, this competition often presents a "winner takes all" situation. As the application areas of LST continue to expand, its practicality will increase, and its market share will gradually increase. The currency attributes of LST will be strengthened in many aspects, such as on-chain and off-chain integration, liquidity, and the ability to resist governance attacks.

In a high-staking environment, if a single SSP controls the majority of the stake, it is likely to be considered too big to fail. If most ETH is staked at that SSP, it will be difficult to punish it effectively. If a dominant SSP infiltrates the core of Ethereum protocol governance without having to take corresponding responsibility to users, this centralized governance risk will undoubtedly have a profound impact on Ethereum's decentralization.

If most ETH is involved in liquidity staking, in fact, in most scenarios except Gas Token, the real currency will be LST. However, LSTs, whether issued by ETFs, CEXs or on-chain staking pools, come with different trust assumptions and carry significant risks. Ultimately, users will inevitably bear additional risks from operators, governance, legal and smart contracts, which is obviously not an ideal situation.

In addition, although LST boasts that it can restore the liquidity of pledged ETH, its effect as collateral in DeFi is certainly not as good as native ETH. For the Ethereum network to achieve true economic scalability, its currency must be as trustless as possible, preferably using ETH itself.

Minimum Viable Issuance — Serving User Experience

Ethereum's minimum issuance amount MVI is the minimum issuance amount required by the Ethereum network to maintain its security and functionality, aiming to balance the security of the network and the inflation rate of ETH. According to the MVI principle, sufficient staking participation must be ensured to ensure the security of the protocol, but the staking amount should not be too much.

When the staking level reaches a certain critical point, the security of the protocol is already solid enough, and the marginal utility brought by additional staking will gradually decrease, and may even have negative effects (for example, increasing network load, diluting the rights of ETH holders, etc.). In addition, staking is a basic service required by a protocol, and the protocol should pay reasonable rewards for staking to attract users to participate, rather than forcing users to participate due to asset dilution pressure.

If the issuance of ETH continues to increase, all ETH holders and stakers will face greater dilution risks, but SSP will not be negatively affected. Because the ownership of the pledged ETH does not belong to SSP, SSP only earns income by charging service fees, and the dilution of ETH value has nothing to do with it. Not only that, if more people participate in LSD staking to hedge against inflation, the service fees collected by SSP will rise.

Assuming a scenario: the participation rate of Ethereum staking is 90%, the annual staking yield is 2%, the liquidity staking accounts for 90% of the total staking value, and the average SSP fee rate is 10%, the equivalent of 0.16% of the Ethereum market value will be paid to SSP every year, which is about 200,000 ETH, or about $530 million at the current price. This $530 million is actually equivalent to a hidden tax on all ETH holders.

Real yield: Nominal yield — dilution effect

Similar to the nominal interest rate and real interest rate in finance, the real yield is the real yield after eliminating the dilution effect in the nominal ETH staking yield. As more and more people participate in staking and Ethereum inflation, the nominal yield brought by ETH staking will gradually be diluted, and the real yield can more clearly reflect the real incentive of staking. The staking yield curves we discussed before are all nominal yield curves.

The above figure reflects the impact of the dilution effect on the returns of stakers and non-staking ETH holders. For ETH holders who do not stake (shown by the red line in the figure), since their nominal balance remains unchanged but they suffer the dilution effect brought by inflation, their actual returns are obviously negative. In order to clearly describe this impact, we can analyze the staking ratio "S" into two cases.

When the staking ratio is low (left part of the curve), the actual yield curve (solid green line) is closer to the nominal yield curve (solid gray line). This is because there are fewer stakers and the protocol distributes fewer rewards by issuing more ETH, so the ETH inflation rate is very low and the dilution effect is relatively light. In this case, the main incentive for staking comes from positive returns, which is the green area in the figure.

When the staking ratio is high (the right side of the curve), the gap between the actual return and the nominal return curve gradually increases. As more and more stakers participate, the issuance of ETH increases, and the dilution effect becomes more obvious. In addition to the reduction in actual returns, part of the incentive for stakers comes from "dilution protection", that is, hedging inflation through staking. In extreme cases, when the staking ratio is close to 100%, the actual return on staking will only consist of MEV returns, and the inflation rate of Ethereum will be very high at this time because tokens will be continuously issued to reward stakers.

In summary, the biggest difference between high and low staking ratios is the different composition of staking returns. Under low staking ratios, users will receive actual positive returns. When the staking ratio increases, due to the high inflation rate, users can only get less returns to offset the dilution effect, which is called "dilution protection". The higher the Ethereum staking ratio, the more newly issued ETH, and the higher the nominal returns of staking users. However, high nominal returns do not mean high actual returns.

It is important to emphasize that this change in the composition of returns does not reduce the incentive of staking. If we only look at the results, dilution protection and positive returns of real money are equally attractive to users. However, the two different types of returns have completely different meanings to users: when the staking ratio is low, staking is a profitable service paid for by the Ethereum protocol; on the contrary, when the staking ratio increases, staking becomes a helpless measure to hedge against inflation.

Therefore, if the staking ratio moves to the right to the top, we may end up in a worst-case scenario: staking provides extremely limited actual returns and poses a threat of asset dilution to those who are unwilling to accept LST.

Under the same staking policy, any staker will definitely choose a strategy that actually brings him higher returns. However, in the design of Ethereum’s protocol, users cannot choose at all, because the protocol’s issuance curve determines the final equilibrium state of staking (when the long-term staking supply curve is fixed). For profit considerations, any user can only choose to participate in the staking strategy.

Independent staking is less feasible

SSPs have fixed costs, and the more they stake, the lower the unit cost, which inherently has economies of scale. As the amount of ETH managed by SSPs increases, their marginal efficiency will also increase, which can lower costs and charge lower service fees, attract more users, and achieve higher profits. Based on these advantages, successful SSPs may be seen as "too big to fail", which reduces the tail risk they face and further strengthens the scale effect.

(Tail risk: the risk of extreme events, which have a very low probability of occurrence but often lead to huge losses once they occur)

On the contrary, independent stakers need to bear all costs themselves. The costs will not decrease with the increase in the amount of stake, but will increase due to the increase in network load. This is one of the reasons why Ethereum passed the EIP-7514 proposal.

According to the previous analysis, as more and more staking income is used to hedge inflation rather than to obtain actual income, the actual income of the stakers is increasingly dependent on MEV, and MEV income is highly volatile, which will cause the total income of independent stakers to fluctuate. In contrast, SSP can distribute the total MEV income proportionally to all Validator verification nodes it manages, effectively reducing the impact of staking income fluctuations on its overall operating results.

As the usage of LST increases and its monetary properties strengthen, the gap between independent staking and LSD staking will further widen. In other words, as the staking rate increases, the competitive disadvantage of independent staking compared to LSD staking becomes more and more significant.

In many jurisdictions, governments tax staking income based on notional income rather than actual income adjusted for dilution effects. LSTs are able to provide holders with some protection from this tax impact through certain structural designs, which is generally not possible with independent staking. As the gap between notional and actual returns grows, independent stakers are further outpaced by LSD stakers in terms of their returns.

Based on this, we put forward the following views:

1. Holding native ETH should be economically viable, ensure a good user experience, and avoid value dilution due to security risks, so as to better protect the interests of ETH holders.

2. In order to achieve true economic scalability, Ethereum’s universal currency should be as trustless/trustless as possible. Only in this way can the robustness and wide applicability of the entire system be ensured.

3. Dilution protection of asset value becomes the main incentive for staking, which is an undesirable result for both stakers and ETH holders. Relying on dilution protection as an incentive may bring unnecessary market volatility and weaken the original intention of the staking mechanism.

4. A high staking participation rate will further exacerbate the competitive disadvantages of independent stakers in the market, and may make more users inclined to use SSPs for staking, leading to the centralization of staking, which is not conducive to the decentralization and security of the network.

The staking ratio that Ethereum can achieve in the future is still uncertain. We need to take proactive measures to determine an optimal staking ratio to prevent negative effects caused by excessively high staking ratios. Even if a high staking ratio may be beneficial to some people, this choice should be made after full consideration, rather than being randomly affected by external market factors.

The ultimate goal of the staking participation ratio

I believe that Ethereum’s staking policy should be based on the staking ratio, not the amount of ETH staked. The supply of ETH fluctuates due to EIP-1559 and the issuance mechanism, and using the staking ratio as a standard can adapt to this supply change. Although the current ETH supply changes very slowly, falling by about 0.3% per year since The Merge, its long-term impact cannot be ignored. Establishing a policy based on the staking ratio can maintain stability over a longer period of time without frequent adjustments.

As mentioned above, the current issuance curve ensures a minimum level of staking, but lacks a mechanism to limit the upper limit of the staking ratio, which may lead to an excessively high staking ratio. We believe that a sound token issuance policy should set upper and lower limits on the staking ratio to ensure network security and maintain a reasonable level of participation. Specifically, the policy should strive to keep the staking ratio within an "optimal range that ensures network security while avoiding negative externalities."

To this end, Ethereum can set super-high rewards for too low staking ratios, and super-low rewards or even negative rewards for too high staking ratios to adjust the staking ratio. In this way, Ethereum can regulate staking participation. The curve of this policy design can refer to the example proposed by Vitalik, which shows how to adjust rewards under different staking ratios to guide staking behavior.

As shown in the issuance curve in the figure, the rewards are generous when the staking participation is low, which is consistent with the current policy. As the staking participation increases, the staking income gradually decreases until it turns negative. In other words, the staking income will eventually decrease to the point where it is no longer attractive, thereby inhibiting staking behavior. However, this negative income state will not last long, and the staking participation will gradually decrease due to the regulation of this mechanism and reach equilibrium at a certain appropriate level. Therefore, a model that presents this yield curve pattern can ensure that the staking ratio remains within a reasonable range.

In fact, to achieve a reasonable staking ratio range, it is not necessary to choose a curve where the return quickly turns negative. Curves that only control the staking rewards at zero or close to zero after a certain critical point may be sufficient to achieve the same effect, which can both curb excessive staking and maintain the stability of the system.

The impact of determining a reasonable pledge ratio range

The advantage of determining a reasonable staking ratio is that it can effectively avoid the various negative effects brought about by a high staking ratio. However, this strategy is not without its drawbacks. An obvious example is that the rewards faced by independent stakers in this case are volatile. Similar to the environment with a high staking ratio, under the strategy of determining a reasonable staking ratio, a large part of the incentive source is MEV income, which will increase its volatility.

Therefore, although there are many advantages to determining the range of staking ratios, it may also increase the volatility of existing returns. MEV risk can be addressed by introducing mechanisms such as Execution Tickets or MEV Burn, or by setting staking fees to balance the volatility of returns to a certain extent. Some people are also opposed to setting the staking ratio within a certain range. One representative view is that doing so may reduce the overall equilibrium return, thereby intensifying competition between independent stakers and SSPs, as well as competition between different SSPs.

The logic of opponents is that the overall equilibrium return is reduced, resulting in insufficient capital supply. The staking form adopted by some SPPs may be more beneficial to the Ethereum protocol, but due to the lack of competitiveness of their projects, it is difficult for them to survive with sustained profits, resulting in lower overall utility of Ethereum. To deal with this problem, it is still necessary to distinguish between nominal returns and actual returns.

Although the strategy of determining the pledge ratio range may reduce the nominal return, the actual return may not be affected. The following diagram further illustrates this point.

The above figure shows the scenario of the system reaching long-term equilibrium when a certain range of staking ratios is adopted, and the figure below roughly shows the scenario under the current Ethereum token issuance curve. Both examples are based on the same assumption: about 100 million ETH are involved in staking, that is, the long-term staking supply remains consistent, so this comparison is meaningful.

In the figure below, most of the staking incentives are used for dilution protection, so the actual yield is only maintained at about 0.5%. In the scenario on the left, the system will reach a lower nominal yield equilibrium point, but due to the lower inflation rate, the actual yield will increase to about 1.4%.

This example clearly shows that determining the range of staking ratios will reasonably increase the actual yield and ease the competitive pressure among stakers. In addition, this is also beneficial to ETH holders who do not participate in staking because it can minimize the risk of dilution.

Open Questions

The strategy proposed in this paper is to determine a reasonable pledge ratio. However, there are some problems that need to be solved.

1. What is the ideal range of pledge ratio?

Regarding the staking ratio, we have discussed the undesirable range, but have not explicitly proposed the ideal staking ratio range. In fact, this issue is quite complicated and requires in-depth discussion within the community, and will refer to some opinions of Vitalik and Justin.

The core of the problem lies in the trade-off - lower staking participation increases the risk of the protocol being attacked, while too high staking participation may bring negative externalities. In order to better determine the staking range, we can model the utility under different staking ratios. A possible utility curve is shown below:

2. How to choose the appropriate staking yield curve to achieve the target range?

After determining a reasonable staking ratio, designers also need to choose a suitable staking curve to achieve a balanced participation in Ethereum staking. Designers need to carefully evaluate the pros and cons of different curves and pick the most suitable solution. At the same time, designers can continue to explore other mechanisms, such as a feedback control system similar to EIP-1559, to dynamically adjust the staking issuance curve according to network conditions to ensure that the curve matches network needs to the best match.

3. How to ensure incentive compatibility in situations of near-zero or negative issuance?

Incentive compatibility was proposed by Nobel Prize winner Leonid Hurwicz and is an important principle in mechanism design. Specifically, if a mechanism can unify the individual interests within the system with the overall interests of the system, the system is incentive compatible.

The original intention of Ethereum PoS issuance is to attract validators to participate in consensus through economic incentives. However, under certain staking participation rates, the issuance income may approach zero or even become negative. Although in this case, validators may continue to stake for MEV income, if there is a lack of regular staking rewards, the verification nodes may lack sufficient motivation in block generation and verification. In other words, when the staking issuance is too low, the consensus mechanism may face the risk of failure.

To solve this problem, the Ethereum protocol can charge a certain fee to all validators and redistribute it based on whether the validators are competent to re-establish incentive compatibility. However, the implementation of this solution will increase the complexity of the protocol, so its feasibility and effectiveness need to be further explored.

4. How to set the target range in a relative (staking ratio) rather than absolute (fixed ETH amount) way?

In fact, the pledge issuance level can also be set to a certain absolute amount of ETH, such as 30 million or 40 million ETH. However, in order to make the issuance policy more forward-looking and adaptable, it is better to directly use the pledge ratio as the assessment parameter. In order for the issuance policy to target a specific pledge ratio, the protocol needs to control the ETH pledge amount and supply.

5. When the staking participation rate exceeds the target range, how to restore it to the target value?

If the current staking participation rate is within the target range, it is of course the most ideal situation. However, if it exceeds the range, certain measures must be taken to reduce the staking participation rate, so that some stakers will not be able to earn enough and will withdraw from staking. Even if we use the most moderate means to reduce participation, this process will have an adverse impact on some stakers. How to minimize this impact is still a problem that needs to be solved.

in conclusion

We discussed the current Ethereum staking incentive policy and token issuance plan, explained in detail the negative externalities of the issuance plan, and explored a new policy that can solve the problem, which is to set the staking ratio within a target range.

However, given some unresolved issues, especially the lack of validator fee mechanism and on-chain MEV capture mechanism, it will take some time to achieve this policy. We propose to reform the current ETH staking and token issuance policy during this period as a key step towards the target policy.

To this end, we have put forward a proposal to reform the pledge issuance policy in the upcoming Electra upgrade (for related content, please refer to the article Electra:Issuance Curve Adjustment Proposal).