What is Ethereum?
Ethereum is an open-source blockchain protocol that provides a platform for developers to create decentralized applications (dApps). The protocol currently uses a Proof-of-Work (PoW) consensus mechanism to secure the network, but efforts are underway to transition the network to Proof-of-Stake (PoS) consensus which will drastically reduce the amount of energy required to process transactions, and improve the scalability of the network.
Vitalik Buterin published the first Ethereum white paper in 2013, describing a distributed computing platform for executing smart contracts and building decentralized applications (dApps). In 2014, a Swiss non-profit foundation, the Ethereum Foundation, was founded to lead efforts to upgrade the network and develop new features. Ethereum’s mainnet was officially launched in July 2015.
To improve the security and scalability of the Ethereum network, developers have been considering a transition to PoS since the network launched. In November 2020 these efforts reached a milestone in Serenity, an upgrade to Ethereum marking its initial transition to PoS or Ethereum 2.0. Serenity launched Ethereum’s Beacon Chain, whose consensus mechanism is PoS rather than PoW. The Serenity upgrade intends to seamlessly transition the original PoW chain to PoS in an event known as “The Merge”, which is currently expected to occur in September, 2022.
Users may stake their ETH to the Beacon Chain ahead of the official merge to help secure the PoS network and accrue rewards, but this is currently a one-way transaction and users will be unable to unstake or otherwise access their ETH until The Merge is complete and the subsequently planned Shanghai update is deployed to the network.
What is ETH?
ETH is currently Ethereum’s native PoW token serving two primary functions within the network: paying transaction fees and executing smart contracts. PoW ETH is inflationary and there is no maximum supply.
ETH PoS (currently referred to as ETH 2.0, a term that will be deprecated following The Merge) will be Ethereum’s native token following the network’s transition from PoW to PoS. Holders of the PoW ETH token do not need to do anything to transition to the PoS network, but they may stake their ETH to begin accruing awards today. Staking ETH is currently a one-way process, and unstaking will not be possible until sometime in the future.
Under PoW miners are rewarded with ETH for securing the network with newly issued units of ETH. This results in inflation of the total ETH supply, which has no maximum limit. Once the transition to PoS is complete, there will be no PoW miner’s reward and the network’s inflation will be drastically reduced. Under PoS, validators will earn rewards on their staked ETH for contributing to securing the network.
How does ETH staking work?
On Ethereum, certain nodes called validators process transactions and run the network. Validators on Ethereum are responsible for the same thing as miners in proof-of-work systems such as Bitcoin: ordering transactions and creating new blocks so that all nodes can agree on the state of the network. Holders of ETH can participate in staking by either running their own validators, or alternatively by delegating their ETH to a third-party validator. The Ethereum PoS network pays staking rewards to participants that delegate their ETH.
Wealthsimple Crypto allows you to stake ETH. For a more detailed general explanation of staking and the associated risks of staking, please refer to the Wealthsimple Crypto Product Risk Disclosure. Additional information regarding staking of ETH on Wealthsimple Crypto is set out below.
The Merge and Shanghai Update
Ethereum staking is currently a one-way transaction, whereby validators commit their PoW ETH to the PoS Beacon Chain. Withdrawing staked ETH and any ETH staking rewards generated will not be possible until some time in the future.
The Merge, an upgrade to the Ethereum network, will mark the transition of the network’s consensus mechanism from PoW to PoS. This is currently scheduled to take place in September 2022. Six to twelve months following The Merge is the planned Shanghai update, which plans to enable withdrawals of staked ETH and rewards from the network.
It should be noted that The Merge, Shanghai update, and the Ethereum roadmap in general may be subject to change, and estimated timelines may be delayed. Furthermore, it is possible that technical problems may arise during The Merge or Shanghai update, which could result in a partial or complete loss of staked assets.
Ethereum validators receive interest on their ETH for staking based on the number of validators operating on the network. The number of validators operating on the network determines the amount of rewards distributed. If there are few validators, rewards will generally be higher to encourage more ETH holders to stake and contribute to securing the network. Conversely, if there are many validators operating on the network, rewards will generally be lower. Interest rewarded to validators is automatically calculated by the Ethereum protocol and paid to validators when staking rewards are distributed.
Wealthsimple Crypto arranges to stake ETH with validator nodes operated by the following infrastructure providers:
Coinbase Crypto Services is a subsidiary of Coinbase Global Inc, based in the United States.
Time in proof-of-stake Ethereum is divided into slots (12 seconds) and epochs (32 slots). One validator is randomly selected to be a block proposer in every slot. This validator is responsible for creating a new block and sending it out to other nodes on the network. In every slot, a committee of validators is randomly chosen, whose votes are used to determine the validity of the block being proposed. Rewards and penalties are issued at each epoch, approximately 6.4 minutes.
Warm-up & Cool-down Periods
Staking ETH at the protocol level takes time before rewards begin to accrue. Once staking has been initiated, a validator enters a queue to become “activated”. In the first stage, the staking transaction is submitted to the Ethereum network. After approximately 7.5 hours, the network will acknowledge the ETH to be “deposited” to the staking contract. Once this step is completed, the ETH deposit is officially accessible to the PoS Beacon Chain and will remain in a “pending” state until being activated.
Only four validators are activated per epoch, or approximately 900 validators per day. Depending on the length of the queue and network congestion, activation may take days or even weeks to complete. Once activated, a validator will begin accruing rewards for securing the network.
Withdrawing staked ETH or rewards from a validator balance is not yet supported at the protocol level. Support for withdrawals are planned through the Shanghai upgrade following The Merge. One should anticipate their staked ETH being locked for at least six to twelve months following The Merge, which is expected to occur September 2022. After the subsequent Shanghai upgrade, it will be possible to withdraw portions or all of one’s stake. Similar to the activation of a validator, a queue will be formed for users attempting to unstake and withdraw their assets. This exit queue is estimated to be 6 validators per epoch, or approximately 1350 validators per day.
The Ethereum network pays staking rewards from newly issued ETH, and user fees paid to the network. After The Merge, the Ethereum network’s inflation rate is expected to be approximately 0.5%.
Ethereum PoS computes and issues staking rewards once per epoch. Rewards accrued in a given epoch are issued in the first block of the following epoch.
When rewards are received, Wealthsimple Crypto will calculate and distribute your share of ETH staking rewards to your Crypto Account. For each epoch, your share of ETH staking rewards is proportionate to the amount of ETH that you had staked and was warmed up when the epoch began.
Currently, staking rewards cannot be withdrawn, sold, or otherwise accessed until the Shanghai update has been successfully deployed to the network. This update is expected to occur at least 6-12 months after The Merge, which is expected to take place in September, 2022.
Wealthsimple Crypto charges you a fee equal to a percentage of staking rewards received by you. The amount of the fee for ETH is set out in our Fee Schedule. This fee is deducted when rewards are distributed to you.
Custody of Staked ETH
ETH staked using the Staking Functionality is staked from dedicated accounts held with one or more of Wealthsimple Crypto’s custodians. Wealthsimple Crypto’s custodians will continue to hold the private keys required to control ETH held in these stake accounts.
On Ethereum PoS, slashing is a penalty for a validator’s dishonest behavior, such as proposing multiple blocks in a single slot or submitting contradictory attestations. In either case an attestation penalty is levied on such validators daily over the course of 36 days before the validator is finally ejected from the staking process. The amount slashed is determined by how many validators are being slashed at a given time - if for instance there were a coordinated attack on the network the penalty may be very severe, including the complete destruction of all staked assets. Slashed validators will be unable to withdraw their ETH or otherwise re-stake until after the Shanghai upgrade.
In the event that a supported Ethereum validator is slashed, Wealthsimple Crypto has no obligation to replace any lost ETH or otherwise provide compensation for any losses. The negative impact of slashing will be allocated to all clients using the Staking Functionality at the time of slashing event, in proportion to the amount of ETH they had staked.
How does ETH compare to Bitcoin?
ETH differs from Bitcoin in a few key ways.
First, ETH powers the underlying proof-of-stake process for Ethereum, a blockchain entirely separate from the Bitcoin blockchain. Since Ethereum uses proof-of-stake instead of the proof-of-work method of Bitcoin, ETH tokens are staked as part of the validation mechanism, in contrast to BTC which are mined as a result of the proof-of-work algorithm.
The second major difference between ETH and Bitcoin is their age. Ethereum’s mainnet was launched in 2015, compared to Bitcoin’s 12 or so years. Despite this difference in age, however, Ethereum has rapidly reached a competitive market capitalization and level of token distribution.
However, it should be noted that although ETH is different from Bitcoin, it is far from independent from it. Bitcoin, the coin with a larger market (by a long shot), can influence the price of all other cryptocurrencies. If Bitcoin crashes, there’s a good chance that ETH will feel the burn too (not directly as they operate entirely distinctly, but through overall market sentiment.) It is not clear, but unlikely, that a significant drop in ETH’s value would have a material impact on Bitcoin.
Before trading or staking any crypto assets it is important to understand the risks. This overview is a starting point for you to perform your own research prior to investing in a crypto asset. First and foremost, no Canadian securities regulatory authority has expressed an opinion about Ethereum, including an opinion that ETH is not itself a security and/or derivative.
We evaluated ETH based on publicly available information, including (but not limited to):
- The creation, governance, usage and design of ETH, including the source code, security and roadmap for growth in the developer community and, if applicable, the background of the developer(s) that first created Ethereum;
- The supply, demand, maturity, utility and liquidity of ETH;
- Material technical risks associated with ETH, including any code defects, security breaches and other threats concerning ETH and its supporting blockchain (such as the susceptibility to hacking and impact of forking), or the practices and protocols that apply to them; and
- Legal and regulatory risks associated with ETH, including any pending, potential, or prior civil, regulatory, criminal, or enforcement action relating to the issuance, distribution, or use of ETH.
As part of its assessment, Wealthsimple reviewed and considered:
- the design and operation of staking ETH, including:
- bonding/unbonding or warm-up/cool-down periods;
- any limits on the number of active validators;
- the mechanism for selecting validators;
- slashing or similar penalties; and
- token inflation;
- any publicly available security assessments; and
- where feasible, the number and identity of validators participating in staking.
Like all other crypto assets, there are some general risks to investing in ETH. These include short history risk, volatility risk, liquidity risk, demand risk, forking risk, cryptography risk, regulatory risk, concentration risk, electronic trading risk and cyber security risk. Please review the Product Risk Disclosure for additional information regarding these risks, as well as other general risks associated with using the Wealthsimple Crypto platform.
Further, the Ethereum Foundation and the Ethereum community are not under any legal or regulatory obligation to disclose material information to the public regarding their activities. Holders of ETH have no recourse to the Ethereum Foundation or Wealthsimple if ETH declines in value for any reason.
WDA has prepared this Crypto Asset Statement based on publicly available information. Although WDA has taken steps to obtain information from apparently reliable sources, information contained in this Crypto Asset Statement may be inaccurate, incomplete or out-of-date. WDA emphasizes that this Crypto Asset Statement is not exhaustive of all risks associated with trading or staking ETH. Investors should perform their own assessment to determine the appropriate level of risk for their personal circumstances.
WDA is offering Crypto Contracts in reliance on a prospectus exemption contained in the exemptive relief decision Re Wealthsimple Digital Assets Inc. dated June 18, 2021. Please be aware that statutory rights in section 130.1 of the Securities Act (Ontario) and similar statutory rights under securities legislation of other Canadian jurisdictions do not apply in respect of this Crypto Asset Statement.
Last updated: October 12, 2022