Instant Unstake on Individual ETH Beacon Chain Staking Nodes

A key focus and potentially the largest unmet need is providing Instant Unstake services for individual stakers and/or validator pools. Unlike with stETH and other Liquid Staking Derivatives, these users cannot go to a DEX to trade the value of their staked tokens in exchange for ETH. At best there are trustful OTC trades possible for these users. And indeed here is where Parallel’s novel approach can fill a true unmet need for liquidity for a large segment of users.

Clear trade-off between Liquidity and staking Yields.

The combination of individual stakers and Staking Pools comprise nearly 40% of all ETH staked and thus represent a substantial portion of the addressable market for unstaking. Further the Liquid Staking Derivative protocols will likely have similar needs for their own liquidity, and indeed this seems like a potentially significant solution for the entire staking ecosystem.

Total ETH staked by Category of Staker

Data source: Dune Analytics, Defillama

The mechanics of the ETH unstake for individuals and staking pools is the same for Lido’s validators and thus these products have something in common. Of course the ETH redemption process is fundamentally different and merits discussion below.

Redeeming ETH for Individual Stakers and Nodes

To understand how Parallel will offer Instant Unstake we first need to understand how Beacon Chain unstaking works. Following the Shanghai and Cappella updates to the EVM and Ethereum consensus layers (collectively “Shappella”), stakers will for the first time be able to withdraw the ETH they’ve staked along with their validator nodes.

For the safety of the Ethereum blockchain, however, withdrawals will not be instant and the network will place hard limits on how many validators may exit at any given time. This is indeed the direct cause of the liquidity mismatch.

Initiating the Validator Exit Process

As the first step to withdrawal, an Ethereum validator will first need to ensure they have updated their withdrawal credentials to become eligible to unstake their ETH. If they have yet to update those withdrawal credentials this process may itself be delayed as only 16 validators may update credentials per slot. And thus this adds to the wait for those looking to unstake their ETH. Once this is true they may broadcast their intent to withdraw from their validation duties and thus redeem the principal they have deposited on the Beacon chain.

This preliminary process of broadcasting and the withdrawal ceremony may take up to 30 or so hours and thus represents the bare minimum time to unstake. It is at this point however when the validator network enters the node and stake into the exit queue according to their validator index.

The Exit Queue for Validators on the Ethereum Consensus Layer

For the safety of the Ethereum network a maximum of 16 validator nodes will be allowed to exit and fully unstake their ETH within a slot on the Beacon chain, or approximately 1800 validators per day. This number can go up or down in the future depending on the number of total active validators on the Beacon chain.

Those who have staked on the Beacon chain the earliest will have the lowest validator indices and thus would be allowed to exit and withdraw their staked ETH the soonest.

Critically, however, there are two important caveats to the exit queue:

1. The validator must continue to perform validator duties while they wait in the exit queue and are subject to slashing as any other validator.

2. if a validator is slashed their minimum wait is set to 36 days. Or more specifically they will need to wait the greater of 36 days or the length of the full exit queue to unstake their ETH post-slashing.

There is considerable uncertainty on how long the exit queue will grow ahead of the “Shappella” hard fork to Ethereum, though it seems likely that the initial wait can be significant for users to unstake until there is a natural rotation of stakers within the network.

Recent news of SEC settlement with Kraken shows Kraken committed to unstaking all ETH on behalf of US clients from Ethereum’s Beacon Chain as soon as was practicable. The same SEC letter showed they had approximately $2.7 Billion in US staking assets on the platform as of April, 2022. Let’s assume that 70% of Kraken staking was done on Ethereum’s Beacon chain at the prevailing exchange rate of April, 2022—summing to approximately 600k ETH to be unstaked at the time or approximately 60% of its outstanding staked ETH.

Conservatively we estimate that Kraken alone may itself withdraw approximately 750,000 ETH post-Shappella, or about 4 percent of all ETH staked on the Beacon chain. According to our calculations this indicates there will be an exit queue of a minimum of 13-48 days once withdrawals are available to ETH stakers. And indeed this is the minimum wait; we expect more than Kraken US will look to unstake ETH post-Shappella.

See a chart of our estimates below:

Critically for Parallel, the above parameters will be visible on the Beacon chain and can be calculated with a reasonable degree of certainty on an ex-post basis. Or in other words, we will be able to calculate the approximate number of days it will take for an individual staker to fully exit and thus withdraw their stake.

How to Calculate the Value of an “Instant Unstake” Request

There are many idiosyncrasies and details specific to a user’s withdraw request, though ultimately we can evaluate fair market pricing of a validator’s full exit request as equivalent to the value of a Coupon Bond.

As with pricing anything in finance, we need to understand future cash flows, the timing of those cash flows, and ultimately the discount rate to use in order to evaluate the same. With an individual node’s exit request we have two sources of cash flows:

1. Periodic staking rewards accrued to the staker. In finance terms we would term this the “Coupon” of regular interest rate payments paid to the bearer of the bond. We can estimate these staking rewards will be partially withdrawn on a weekly basis. Technically these come in two forms—attestation awards and rewards/tips for block production. But it is reasonable to assume the staker’s withdrawal address will have access to these rewards once per week. NB: Block production awards and tips are far more irregular than attestation awards. Each validator is likely to produce a block and earn associated rewards once every 70 or so days, and we will probabilistically assign this probability via the noted Beacon Chain staking yield oracle. Critically we will only consider staking rewards on the Beacon chain and not the execution layer.

2. The Principal paid to the staker upon successful exit and withdrawal. In bond terms we would call this the Face Value of the bond. We evaluate this along with our discount rate and our estimate for days until a successful withdrawal.

To summarize we would price the value of the unstake as follows:

$$\frac{Principal_{Total} \times(1- \frac{r_{Slashing}}{365}\times T)}{(1+\frac{r_{Borrow}}{365})^T} + \sum_{i=1}^{T/7}\frac{Principal_{Effective} \times \frac{r_{Staking}}{52}}{(1+\frac{r_{Borrow}}{52})^i}$$

$Principal_{Total}$: The total ETH staked for a given validator. Note that any balance above 32 ETH will be periodically swept and automatically withdrawn to a user’s withdrawal address approximately every week. NB: For the purposes of the Instant Unstake calculation, any $Principal_{Total}$ over 32 ETH will automatically be withdrawn to the user’s withdraw credentials approximately once per week.

$Principal_{Effective}$: This is the amount of ETH on which rewards are calculated. This may differ from $Principal_{Total}$ as it will always be $\le 32 \ ETH$, while $Principal_{Total}$ may be above 32 ETH.

$T$: Days until successful Validator exit and ETH withdrawal. This is the $Max(36 \ days, Exit \ queue \ wait)$ to account for the risk of slashing which will automatically extend the user’s minimum exit queue time to 36 days.

$r_{Slashing}$: the ex-post estimated risk of slashing for the specific validator expressed as an Annual Percentage Rate (APR). Currently we estimate this to be 0.00038% on an annual basis as per our analysis in How do we Evaluate Slashing Risk to a Validator?

$r_{Borrow}$ : the borrow rate available for the Instant Unstake expressed in Annual Percentage Yield (APY)

$r_{Staking}$ : the estimated staking reward rate for a specific node through time of withdraw as expressed as APR. Critically we may only take into account Beacon chain rewards and not Execution layer/EVM rewards within the context of total $r_{Staking}$. For technical reasons we cannot guarantee that the user can transfer their EVM rewards to the Parallel contract and thus these will not form part of our total staking estimate. Finally, we assume that staking rewards are accumulated once per 7 days.

NB: for both $r_{Slashing}$ and $r_{Staking}$ we may use Ethereum Beacon Node API’s as an off-chain oracle to get the most up-to-date estimates.

Armed with the above information we can thus appropriately determine the price Parallel would be able to pay the validator for an Instant Unstake.

How much is a Staking Node Balance Worth?

We can begin to see how much a staking position is worth by using specific values for the above parameters.

Pricing a Staking Position with the Following Parameters

• $Principal_{Effective}$ of 32 ETH

• $r_{Staking}$ as the prevailing staking rate according to beaconcha.in at time of writing: 5.2%

• $r_{Slashing}$ as 0.00038% as per How do we Evaluate Slashing Risk to a Validator?

• $r_{Borrow}$ as a variable shown below

• $T$ days until full withdrawal

Evaluating Value of a Staking Position as a Function of Interest Rates and $T$ Days until Withdrawal

Data source: Parallel calculations

If Bob has 32 ETH staked on a Beacon Chain node with the above parameters due in 100 days, an $r_{Borrow}$ of 5% would given him an Instant Unstake valuation of 31.57 ETH, while an $r_{Borrow}$ of 20% would result in 30.30 ETH. Clearly Bob would like the lowest borrow interest rate possible, but this will ultimately be a two-sided market in which liquidity providers will give their best offer for those looking to Instant Unstake.

How do we Evaluate Slashing Risk to a Validator?

The best estimate for $r_{Slashing}$ , or the rate at which we risk slashing, may also greatly affect our valuation for the Instant Unstake position. As with anything we want to ground ourselves in data, and we look to Beacon chain results to see real slashing rates from the beginning of 2022 in the chart below:

Historical slashing of Ethereum validators.

Data source: Beaconcha.in, Dune Analytics

Historical data shows a total of 60 validation nodes were slashed in the past 14 months with an average penalty of 0.8333 ETH. This clearly pales in comparison to the aggregate 17.4 million ETH staked across 541,000 validators through time of writing. Each of these individual slashing events cost individual nodes up to 1.002 ETH, and these outsized violations also forced the aforementioned validator nodes to exit. Withdrawals for these balances will only be possible post-Shappella, and these slashings represent considerable expense for the affected validators.

These risks are thus non-trivial for the individual node, but a resounding majority of node operators have never seen a slashing event and thus the aggregate risk for a single node is virtually zero.

The challenge is thus to ensure incentives remain aligned between the Instant Unstaker and the user or protocol which purchases their staking node deposit. A node operator must continue their validation duties while on the Exit queue on the Beacon Chain. And as such, the user who buys the Instant Unstake note may lose with a dishonest staking node operator who neglects to fulfill their duties.

On this front we may launch whitelisting services to provide staking node operators with fair assessments of slashing risk. Without the whitelist we must simply assume very high slashing risk estimates and thus lower payments in exchange for Instant Unstake requests.