Is ETH staking the best impact investment?

How do we define a good impact investment? To me, it first has to be a good business model in and of itself, and then, one that benefits from the impact it is creating.

In other words, it needs to fulfil 3 criteria:

1. Sustainable source of income - i.e. non-ponzi and non-charity sources

2. No stakeholders should be worse off than before - i.e. on par with the status quo or better off, no one is actually doing charity

3. Impact goals function as flywheels of the business

To back my bold claim, let’s look at how a hypothetical business model based around Ethereum staking fares against these tests.

The business model

An ETH staking service with validator nodes operated by people in underserved communities. More proficient operators get allocated more ETH to put to work and draw fees from.

There are 2 main benefits to this model -

1. Improving decentralisation of the Ethereum network via geographical and jurisdictional diversification of nodes, leading to stronger censorship resistance for the network and lower slashing risks for stakers

2. Enabling people in underserved communities to earn a fee from running nodes

Test 1: Is there a source of sustainable income?

First, we need to identify where the money is coming from.

As economic activity on the Ethereum network continues growing with each cycle, the income that goes to validators will also increase collectively. To recap, the source of this income is the transaction fees that users pay when interacting with businesses built on top of the Ethereum network.

Today, solo node operators enjoy 6.0% of real yields per year on average this way. Meanwhile, people without the know-how to run their own nodes pay a service fee of between 10% to 25% (out of the 6% yields) to platforms that do it for them.

This annual service fee - e.g. 0.6% on asset value staked - is the source of sustainable income in this example.

Test 2: Are any stakeholders worse off than before?

Let’s introduce the stakeholders.

1. Users: These are the people who pay transaction fees to interact with the Ethereum network. Smart contracts make their tasks cheaper by removing layers of middlemen and reducing trust assumptions, which means they are likely to continue paying.

2. Stakers: These people are sitting on ETH and want to put them to work, earning yield. They pay a service fee for the convenience of doing so without having to run their own nodes. This fee will be split amongst all subsequent stakeholders below.

3. Node operators: These will be the people from underserved communities that will be maintaining the validator nodes.

4. Hardware sponsors: Because we are dealing with underserved communities, hardware costs will be a challenge for them. This is where hardware sponsors come in. They can be any individual or company who wants to contribute to the cause of uplifting these underserved communities - i.e. making an impact investment.

5. Service sponsors: Someone will need to train, certify, and guide new node operators because they will be handling large amounts of assets.

6. Insurance sponsors: Because the node operators are not the asset owners themselves, there will always be a fear of negligence or dishonesty on the part of the node operators - leading to slashing events.

   Even though these risks can be mitigated using tools such as Distributed Validator Technologies (DVTs) and remote signers, the most effective method will still be to have an insurance fund that acts as the first line of defence against any slashing events.

   Standing on the shoulders of giants - using a ratio of 4:28 ETH (Insurance: Stake) sufficiently covers tail risks as described in a study conducted by Stader Labs, but we can increase this ratio as needed.

7. Platform: These are the players providing the tech infrastructure that enables this business model to work in a low-friction and trust-minimised way (“Vaults”). Existing liquid-staking projects are best positioned to power this - e.g. Lido V2, Stakewise V3, Rocketpool, Stader Labs

8. Marketing / Distribution: As with any product, reaching and engaging the intended audience - i.e. the Stakers - is paramount. The message here is that staking with this Vault helps uplift underserved communities. The hardware, service, and insurance sponsors will also want publicity for supporting this cause.

Putting it all together in a value chain -

Economics of each stakeholder

Now let’s put the economics of each stakeholder to the test.

A) Defining the assumptions:

B) Economics breakdown

C) The test - Is anyone worse off than before?

1. Node operators: They learn a new highly scalable knowledge-based skillset. Their earnings scale with ETH price and volume (as they display higher levels of proficiency)

2. Hardware sponsors: Because we need to consider the lifespan of hardware, let’s first convert the 20.52% annual yield into an equivalent IRR of 9.20% using the median lifespan of 6.75 years.

   Now we can compare this 9.20% yield against the current 1-year treasury yield of 5.25%.

   Naturally, this is not risk-free, but in exchange, the yields of the hardware sponsors increase proportionally with the price of ETH.

3. Service sponsors: Because there is no lifespan to the training and certification service, we can compare the 8.11% yield directly with the current 1-year treasury yield of 5.25%.

   Similar to hardware sponsors, the yields of the service sponsors increase proportionally with the price of ETH

4. Insurance sponsors: As insurance sponsors also stake ETH without running their own nodes, we can compare their yields against those of the Stakers - i.e. 6.36% vs 5.40% - or an 18% boost. They are effectively enjoying leverage on their yields in exchange for the additional slashing risks they are underwriting.

5. Platform: Because the industry is actively trying to decentralise itself, this model enables platforms to capture a new market and retain their current shifting market.

6. Marketing / Distribution: Earnings scale with volume and ETH price - nuff said.

Test 3: Do impact goals function as a flywheel of the business model?

First, let’s measure the impact by using the minimum wage of each country in SEA, by comparing the additional income node operators can earn each month against this benchmark.

Aside from Singapore and Brunei, this additional income is a non-trivial boost of at least 19% to minimum wage earners.

And this is assuming ETH price stays at the current level. What will the impact look like as the Ethereum network continues growing?

Now imagine if we increase the number of validators managed per node operator from 10 to 20 as they become more proficient..

The flywheel

Okay so if the impact this model can create is significant, it means there will be sufficient motivation for more people to take up the mantle of node operator. This solves the supply side of the business equation.

As more people from underserved communities aspire to become node operators - e.g. to create better lives for themselves and their families - the selection pool becomes larger and more diverse.

The effect is a likely better overall performance from the selected node operators and a reduction of risk for the other stakeholders.

As demand increases, more impact can be created. Now loop it.

Closing thoughts

Because users of blockchain (i.e. payers of transaction fees) tend to be from the more developed countries today, this model effectively transfers wealth from those who are better off to those who are worse off in a non-charitable way. To me, this is the most sustainable method of helping people.

I recognise that some logistics are not addressed here - e.g. who holds the validator keys, how to prevent MEV theft, etc - and I have some thoughts on them as well.

In fact, this is a project I am currently exploring!

I am actively having conversations with parties that are keen to participate as stakeholders under each category and I’d love to have a chat with anyone who would like to be involved!