Ethereum Staking Deep Dive: Understanding Consensus Layer Rewards (2024)

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Derivatives markets continue to look forward to the US Election, pricing volatility for expiries later than the November 5 date at a significant premium to shorter-dated optionality. This is in contrast to the short term events that dominate the calendar in September, with the Federal Reserve set to join the growing global easing of interest rates after CPI figures in August confirmed that inflation is indeed falling in the US. Attention now turns to the labour market, which poses the stronger risk to the Fed’s dual mandate and may dictate the pace of their impending cutting cycle.

After a 12-day period of spot decline since August 26, prices for both major tokens have finally started to recover over the past few days. This rise has positively affected short tenor futures yields, which have risen significantly in the past week, resulting in a flattened term structure. Implied volatility levels for BTC and ETH short-tenor options have been rising dramatically since the beginning of the month, while short-term skews have dropped and rebounded, now being at similar levels as of last week. As a result, ETH options are consistently skewed towards puts for short-tenor options, whereas short-term sentiment for BTC is neutral again and not expressing such a strong preference.

After the recent drop in BTC and ETH spot prices over the last week, we can observe an overall increase in implied volatility levels across the term structure for both major tokens. The front end of the structure has been particularly affected. For example, ETH 7-day option volatility has risen to the same levels as long-tenor options. Derivative markets remain skewed toward OTM puts for both majors for short term options, showing a significant strengthening in a short-term bearish outlook as spot fails to pick up. The negative sentiment for cryptocurrencies continues with open interest for BTC options showing higher levels for puts, and total open interest for perp swaps on the decline following the most recent sell-off.

Despite volatility levels having largely fluctuated for short-tenor ATM options, from the term structure we can once again observe that, as the US election approaches, volatility for options expiring after the election date is rising. We can additionally observe that skew for short-tenor options has been evolving positively in the past few days, with skew levels slightly rising similarly to what happened in mid-August, indicating a more neutral outlook despite the recent spot volatility. Concurrently, long-tenor options have consistently been pricing in higher volatility levels across the term structure, showing a stronger preference towards OTM calls.

Derivatives markets indicate a similar positioning after the Jackson Hole Economic Symposium to that which we saw last week. Federal Reserve Chair Jerome Powell’s confirmation of the beginning of a rate cutting cycle in the Fed’s September meeting did little to change markets’ expectations on the pace of rate cuts, as it had already priced for 100 bps of cuts across the three remaining meetings of the year. Instead, it was the spot price sell-off on August 28 that moved markets -— with indications of a spate of perpetual swap liquidations in majors, and a small but noticeable spike in short-tenor volatility levels. The term structure of volatility holds a similar shape to last week’s, pricing in a volatility premium for expirations covering the upcoming U.S. presidential election on Nov 5, 2024.

Another week of low volatility, sideways price action has none-the-less provided interetsing trade activity in derivatives. The additional bearishness afforded to ETH over BTC has continued, with a more negative funding rate over the past month, at-the-money volatility premium, and stronger skews towards OTM puts, especially at short-dated expiries. Despite this, the volatility markets of both majors indicate a growing premium priced in for the November 5, 2024 U.S. Presidential election date, with an increased bullishness for expiries after the event expressed by a stronger skew towards OTM calls.

Since recovering from the selloff in the first week of August, spot prices have largely moved sideways. This period of relative calmness has opened up a space for a divergence in sentiment between BTC and ETH, with metrics across derivatives markets indicating a stronger bearishness assigned to the latter in the short term. ETH futures-implied yields trade significantly lower, perpetual swap funding rates have moved intermittently negative, and options on ETH trade with a premium to BTC’s implied volatility across the term structure, with short-tenor OTM puts afforded an implied volatility premium over OTM calls.

The past week of spot price action has been relatively calm in comparison to the two that preceded it. Without an obvious catalyst to drive spot prices back to the highs lost in last week’s selloff, the recovery has floundered somewhat. Derivatives markets reflect the elevated uncertainty, with volatility levels trading at their July highs despite a resolution to the inverted shape of their term structure. Sentiment remains more bearish for ETH, which prices in a higher level of implied vol, lower funding rates, and stronger skew towards OTM puts.

Following the market selloff and the surge in volatility we have witnessed last week, derivatives market seem to have stabilized. Volatility has dropped for both BTC and ETH at the front end of the term structure, and funding rates returned positive for BTC while slowly rising for ETH. The period of market distress we have observed after the sudden risk-off event appears to have abated for now. However, skew has confirmed the trend we highlighted last week, as longer-dated volatility smiles remain skewed towards OTM calls and shorter tenors show a preference for OTM puts. While sentiment in the long-run still remains bullish, markets still show caution in the short term.

In the 15 years since its inception, BTC’s price action has displayed an uncanny pattern of repetition. Looking at BTC’s historical price data, we can subdivide each of the three historical cycles of strikingly similar price action for BTC: recovery, boom and bust. The most recent bull run, which started in late 2022, is currently 624 days in. Compared to historical averages, this cycle could last another 350 days, though returns in each cycle have diminished over time. Lower disposable capital among retail traders (as indicated by the lower level of personal savings, following a period of high and persistent inflation) has thus far been expressed in the lack of the exuberance that we’ve come to expect in bull cycles. The changing intra-asset correlation structure between crypto and meme coins suggests that a different type of investor may be behind the most recent rally in prices: institutions. The renewed co-movement with equities coincides with the launch of BTC Spot ETFs in early January 2024, as well as the unlocking of a new pool of demand for crypto.

A week of bullish narratives for crypto at the BTC Nashville conference and the launch of ETH Spot ETFs has been followed by a starkly contrasting sell-off. Crypto has once again proved its position as a 24-hour macro indicator, as it reacted strongly to the weaker-than-expected nonfarm payroll report on Aug 2, 2024. Alongside other risky assets, the news saw a sharp sell-off across crypto assets. However, it hasn’t yet seen the same wipeout of leveraged positioning or elevated volatility levels in the way that we’ve come to expect from double-digit crashes.

One of the largest global market selloffs since the COVID pandemic took its toll on crypto-spot prices, resulting in double-digit selloffs that were harder felt by ETH and alts than BTC. The selloff saw funding rates spike negative as accumualted long positions were likely liquidated, and the volatility term structure inverted as traders rushed to cover exposure to further downside moves in the short term. However, volatility levels did not spike above their year-to-date highs for either major, and longer-dated volatility smiles remained steadfastly skewed towards OTM calls. This indicates that while this was strong move in the short term, traders are not yet concerned about long-term performance.

Using SOFA structured products to express market views offered several advantages over taking the same exposure on offchain or centralised alternatives. Trading options positions onchain removes counterparty risk as settlement is ensured by the verifiable logic of a smart contract and full collateralisation. Trading on SOFA offers exposure to the RCH token, which is airdropped to users on a periodic schedule. These tokens are awarded to users according to the proportion of volume that they trade in each recording period. Onchain positions in SOFA structured products are tokenised using leverage the ERC-1155 token standard. This allows for custom position parameters to be stored on the token itself, allowing for a more accurate valuation of the position so that it can more easily be composed and used as collateral in other trades.

The dramatic events of last weekend’s assassination attempt on Donald Trump have coincided with a strong recovery in crypto spot and, consequently, derivatives markets. Traders appear to express the “Trump Trade” just one week after spot prices crashed as the Republican candidate saw the probability of his re-election soar. Futures: Yields have recovered their pre–sell-off levels, and continue to express a healthy demand for leverage using derivatives contracts. We see similar levels in both BTC and ETH, despite ETH’s impending ETF launch, while open interest levels remain consistent with pre–sell-off levels. Perpetuals: While we don’t see a recovery in the number of open contracts to pre–sell-off levels, we do see a return to a moderately healthy positive funding rate paid from longs to shorts in all markets except TON. Options: Volatility at short tenors has rallied once again in response to short-term spot moves, first compressing the term structure and then steepening as the front end falls down once again. As it has done several times during short-term price volatility, short, sudden moves in spot price haven’t been enough to meaningfully lift long-run expectations of volatility.

While volatility has generally been on the rise for both BTC and ETH, the term structure of volatility has changed dramatically especially at shorter tenors, now having inverted at the front end and continuing to trade at a premium for ETH options compared to BTC options. Volatility skew suggests that call options are preferred for both digital currencies. A general bullish trend is observed but more strongly for BTC, as reflected in the future implied yield chart and the perp swap funding rate, if not the skew of its volatility surface. Despite the recent approval of an ETH spot ETF, BTC is still holds a stronger bullish sentiment in derivatives space.

Spot prices have performed a significant recovery since bouncing off the lower bound of their recent range almost one week ago. As a result, delivered volatility has stayed at its highs and has materially increased implied volatility at short-tenor options and inverted the term structure. The recovery has inspired a return to double digit yields implied by both BTC and ETH futures markets, but only the former asset sees a similar sentiment expressed by its perpetual swap funding rates. ETH still has its months-long-held volatility premium over BTC of around 10 points, but its short-tenors did not push as close to the levels at the back end of the term structure leaving its term structure slightly steeper.

Futures: Future-implied yields have recovered from their spike lower, but continue their downward trend over the month. Perps: Despite the recent bearish price action, we don’t see a widespread or persistently negative funding rate in perpetual swap markets except for TON. Open Interest in majors has fallen during the period of spot market volatility as traders close out positions Options: ETH volatility trades at a 10–15 point premium to BTC’s at all tenor points on the term structure, has recovered its volatility smile skew toward OTM calls much faster than BTC, and has seen incredible trade volumes in calls that far outweigh the activity in its puts. ETH derivatives markets continue to reflect different positioning when compared to BTC, which may be linked to hopes and expectations of the imminent launch of its first Spot ETFs in the U.S. However, ETH’s volatility premium above BTC is not a new phenomenon, and is also reflected in the increased realized volatility with which it has moved for much of the past month.

The latest venture of spot prices down to the bottom of their range has seen volatility levels at short tenors spike while traders rush to protect against further downside price action. While funding rates has remained steadily positive and short tenor future-implied yields have recovered some of their lost ground, volatility smiles remain skewed towards OTM puts and short tenor volatility has not fallen back from the levels of longer dated tenors. ETH retains its 10 vol point premium over BTC volatility at equivalent tenors and its term structure trades much flatter, continuing a trend that we have seen several times over the past month of range-bound price action.

As spot prices trade at their lowest levels since early May, we see a stark divergence in the sentiment priced in by BTC and ETH options markets. ETH continues to trade with a 10-15 volatility premium across the term structure, and the most recent move lower in spot prices has seen BTC vol smile skew turned decidedly bearish at short tenors while ETH smiles skew neutral or towards calls at all tenors. While the fall in future-implied yields has recovered to last weeks levels, funding rates in the two majors have repeatedly charged short positions since the 9th June -- a phenomenon that we observe across perpetual-swap markets.

As spot prices trade at their lowest levels since early May, we see a stark divergence in the sentiment priced in by BTC and ETH options markets. ETH continues to trade with a 10-15 volatility premium across the term structure, and the most recent move lower in spot prices has seen BTC vol smile skew turned decidedly bearish at short tenors while ETH smiles skew neutral or towards calls at all tenors. While the fall in future-implied yields has recovered to last weeks levels, funding rates in the two majors have repeatedly charged short positions since the 9th June -- a phenomenon that we observe across perpetual-swap markets.

This week's edition of our DeFi Analytics report.

Yields implied by futures prices have declined over the past week, steepening term structures that have experienced several inversions in the past month. The reduction in leverage has been more pronounced for BTC compared to ETH, as ETH's perpetual swap funding rate remains active but below the levels observed at the end of May. Volatility expectations are trending slightly upward, in line with the increased market choppiness over the last week, and ETH volatility markets continue to command a premium. Reflecting their futures markets, ETH's skew indicates slightly more bullish positioning than BTC's, with both vol smiles moving closer to neutral for shorter-dated expiries.

This week's edition of our DeFi Analytics report.

With BTC failing once again to break range highs, implied vol at the front-end of the term structure for both majors has increased over the last week, whilst vol at the back-end has either drifted lower, or continues to trade sideways. This had led to a more compressed term structure. The vol smile skew for BTC has largely traded sideways, and still remains skewed towards OTM calls. However, ETH is skewed towards OTM puts at short-dated tenors as implied vol for OTM puts has risen approximately 8% over the last week. In addition, demand for leveraged long exposure has fallen as investors look to exercise caution following BTC’s inability to break range highs. Annualised yields have fallen across the term structure, and funding rates continue to trade close to zero.

With few macro and crypto-specific events on the immediate horizon, volatility has largely continued to trade sideways in both majors over the past week as spot prices trade near range highs of $68.9K and $3.8K. The vol smile skew for BTC and ETH at short-dated tenors has increased from previous neutral levels, as implied vol for OTM puts has fallen. Over the past month, demand for leveraged long exposure in both majors has increased as futures yields have risen consistently, indicating that investors are willing to pay a premium above spot price in order to gain exposure to the underlying asset. Over a shorter lookback period of a few days, yields at short-dated tenors have fallen in both majors, although the long term trend remains intact.

Block Scholes' Crypto Senti-Meter aggregates several measures metrics to measure the sentiment expressed by crypto-asset derivatives markets. Our index methodology leverages 4 years of advanced derivatives analytics, and is strongly correlated with movements in spot prices.

Volatility has fallen across the term structure in both majors over the past week as they continue to trade near range highs of $68.9K and $3.9K. Following the news of an upgrade in the probability of an Ethereum ETF, implied vol spiked at the front-end, inverting the term structure. This inversion has since corrected itself, with implied vol at the front-end falling. BTC’s vol smile skew has fallen to more neutral levels as implied vol for OTM calls falls, indicating reduced short-term bullish sentiment. However, ETH is heavily skewed towards calls due to implied vol for OTM puts falling, as investors reposition themselves due to the recent ETF news. Demand for leveraged long exposure, which is stronger in ETH, fell at the start of the week, as indicated by spot yields, before rising again at the front-end.

In our report ahead of the Dencun upgrade in March, we forecast a swift migration of L2 transaction data to the new, dedicated blob space. We also expected the swift recovery in gas usage to the 15 million unit per block target, but at a much lower base fee due to the lower usage by L2s. While we were correct to predict a fall in the base fee burned, the impact on the net supply dynamics of ETH has been swifter than we expected. The new supply of ETH minted on the Beacon chain now outweighs the burned supply for the first time since the Merge, removing a potential tailwind that failed to support ETH against BTC during the last 18 months of under-performance.

Volatility has continued to gradually rise across the term structure, with ETH spiking at all tenors over the last day following an upgrade in the probability of an Ethereum spot ETF being approved. With implied volatility spiking particularly at the front-end, the term structure has become inverted. Implied volatility for ETH options now sits at levels not seen since April. The vol smile skew also recovered towards calls over the past week, but has since sold off at the front-end as investors rush to purchase OTM puts for downside protection as spot price reaches range highs of $71K and a $3.7K. Leverage in futures markets has increased, particularly at short-dated tenors which have risen beyond longer-dated tenors, indicating a demand for leveraged long exposure that is stronger for ETH.

This week's edition of our DeFi Analytics report.

Volatility has gradually risen across the term structure as BTC trades near its range lows of $60K, but has still not deviated from its longer term downward trend. ETH continues to trade 5-7 vols higher than BTC. Despite a strong start to the month where skew recovered following the spot sell-off which saw investors purchase OTM puts for downside protection, the skew at short-dated tenors has traded with some uncertainty recently. ETH’s skew continues to trade lower than BTC’s, indicating more bearish positioning. Leverage - indicated by perpetual swap funding rates and futures-implied yields - has increased, particularly at short-dated tenors which have risen beyond longer-dated tenors, indicating demand for leveraged long exposure as both majors sit at precarious levels.

This week's edition of our DeFi Analytics report.

Volatility has fallen following the recent spot sell-off, during which implied vol at short-dated tenors had spiked above longer-dated tenors and inverted the term structure. ETH continues to trade between 5-10 vols higher than BTC. In addition, the sell-off in spot saw a strong skew towards puts in both majors as investors became concerned with buying OTM puts for downside protection. This has since recovered - due to the selling of OTM puts - although ETH’s skew trades slightly lower than BTC at short-dated tenors, indicating more bearish positioning. Leverage as indicated by perpetual swap funding rates and futures-implied yields has increased slightly, but still remains far below the extremes observed in March.

This week's edition of our DeFi Analytics report.

Leverage as indicated by perpetual swap funding rates and futures-implied yields remains much lower than the extremes we saw ahead of the flush-out at the end of March. Implied volatility levels have crashed lower for both tokens and across their term structures, led by a significant under-performance in shorter-dated tenors. Vol smiles remain intermittently skewed towards OTM puts at short tenors as the market appears to brace for further downside in the short term. ETH vols trade some 5 vols higher than BTC’s across the term structure, with both future-implied yields and vol smile skews indicating more bearish positioning than in BTCs markets, particularly in the short term.

This week's edition of our DeFi Analytics report.

Following a bounce in spot price at range lows, BTC and ETH currently trade at $66K and $3.2K respectively. Funding rates remain close to zero for both majors, and future-implied yields are near their lowest levels in more than a month as BTC trades in the middle of its sideways trending range. In the past week, volatility at short-dated tenor options has fallen, correcting the front-end of BTC and ETH’s previously inverted term structures. The fall in volatility was matched by a recovery in skew from OTM puts to more neutral levels at all tenors less than 3-months, indicating that investors are less concerned with buying OTM puts for downside protection.

This week's edition of our DeFi Analytics report.

Funding rates and future-implied yields are near their lowest levels in more than a month after the weekend’s spot selloff took prices back to the bottom end of the sideways trending range. Volatility at short tenor options rallied, causing an inversion in both BTC and ETH’s term structures at the front end, without lifting volatility levels at longer-dated expiries. The rise in volatility was matched by a strong skew towards OTM puts of volatility smiles at all tenors less than 3-months, indicating a strong switch in sentiment towards a demand for downside protection.

This week's edition of our DeFi Analytics report.

ETH lead another attempt by spot prices to cross above the year-long highs recorded in March. With it, we saw a return to high levels of leverage in derivatives markets: high yields implied by futures prices, high perpetual swap funding rates, and a rally in short dated at-the-money implied volatility that briefly inverted the term structure. However, the rally was shorter lived and smaller in size than that which took BTC prices to all-time highs. Furthermore, while volatility continues to trade flat across the term structure at its higher, 70-80% range, futures markets report a collapse in funding back to their longer-held trend.

This week's edition of our DeFi Analytics report.

After reaching locals highs of $71k and $3.7k earlier in the week, both BTC and ETH spot prices have fallen. This pullback has resulted in a slight decrease in demand for leveraged long exposure, reinforced by the increased skew towards puts in the smiles of both majors. However, excess demand for downside protection is less extreme when compared to earlier in the month where the 25-delta risk reversal skew for BTC and ETH reached lows of -9% and -17% respectively. Rather, the bearish turn in derivatives appears to be a repeat of the leverage flush out that we have seen several times during this rally. Implied volatility has risen for both majors, and particularly in short-dated tenors which has resulted in a flattening of the volatility term structure from its previously steep shape.

This week's edition of our DeFi Analytics report.

After a pullback earlier in the week, both BTC and ETH have bounced to $70k and $3.7k respectively. Future-implied yields have risen, whilst implied volatility for both majors remains within a tight range. Perpetual swap funding rates remain positive, but low. The term structure for BTC and ETH - which was previously inverted - has corrected, with implied volatility at short-dated tenors falling below the volatility at long-dated tenors, suggesting reduced demand for long volatility exposure at shorter tenors. Furthermore, the 25-delta put/call skew has increased for both majors, indicating that traders are less worried about buying protective puts to hedge possible impending downside.

This week's edition of our DeFi Analytics report.

We previously observed increased demand for downside protection, indicating that the market may be positioning itself against any potential retrace. Following a rally to all-time high levels, the market has pulled back. Short-dated tenors show a significant decrease in spot yields for BTC and ETH, signalling a shift in near-term market sentiment. Funding rates, although positive, have cooled from their monthly highs, indicating reduced demand for leveraged long exposure. Fluctuations in BTC and ETH's ATM vols suggest ongoing market uncertainty. Additionally, the 25-Delta Risk Reversal has shifted towards puts at short-dated tenors, indicating a bearish sentiment that is more pronounced in ETH than BTC.

Future-implied yields and perpetual swap funding rate showcase the high demand for leveraged long exposure enjoyed by traders during the rally in spot prices to all-time high levels. We also see a slightly inverted term structure of volatility, suggesting high demand for long volatility exposure at shorter tenors. However, the breakthrough of the psychological $70K and $4K barriers has brought with it an increased demand for downside protection in 3- to 6-month tenor puts (and more prominently for ETH), indicating that the market may be positioning itself against any potential retrace below the freshly printed recorded levels.

This week's edition of our DeFi Analytics report.

Weekly crypto-derivatives market analytics, spanning futures, options, and perpetuals.

This week's edition of our DeFi Analytics report.

October has brought implied volatility back into the mid-50s once again, as strong demand for participation in any further upwards moves sees the skew of both majors volatility miles move further towards calls. Despite the strong anticipation, however, realised volatility remains very close to historical lows. This leaves the volatility ratio of both BTC and ETH options at its highest since 2019, a spread that we believe cannot be attributed entirely to ETF speculation.

Weekly crypto-derivatives market analytics, spanning futures, options, and perpetuals.

This week's edition of our DeFi Analytics report.

Weekly crypto-derivatives market analytics, spanning futures, options, and perpetuals.

The Ethereum network's pivot to a new consensus mechanism in September 2022 caused a dramatic shakeup to the reward system available to blockbuilders. Maximal extractable value, previously merely a popular side project for Proof of Work miners, has now become the most attractive reward stream for validators, and understanding its nuances is key to a profitable validator operation.

The Ethereum network boasts the biggest Decentralised Finance ecosystem of any blockchain, an ecosystem supported by a network of smart contracts that allow for composable blocks of code to be executed by validators in the form of onchain transactions. The computation required by a transaction is performed by the validators (analogous to Bitcoin's miners) who create new blocks on the chain and is paid for in ETH by the sender.

In mid-September 2022, Ethereum’s blockchain completed its long-awaited merge into a Proof of Stake chain, deprecating the Proof of Work system that has found consensus for the network since its inception in 2015. The Merge marks the most significant event in crypto to date, as the community has never seen such a drastic change to such a high-profile chain, and with such unpredictable consequences. It represents the culmination of many years of research and testing by both the Ethereum foundation and its community and is just one step on a long roadmap of planned upgrades.

Weekly crypto-derivatives market analytics, spanning futures, options, and perpetuals.

Ethereum has emerged as a prominent and transformative force in the world of blockchain and decentralised finance, revolutionising the concept of digital currencies and paving the way for countless innovative applications. With its robust infrastructure and vibrant ecosystem, Ethereum continues to captivate the imagination of developers, entrepreneurs, and investors alike with an evolving ecosystem. As part of that evolution, the Ethereum Foundation has released a roadmap of planned upgrades, intended to enhance the network’s scalability, security, and sustainability. The transition from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) model in the Merge was the first (and maybe most ambitious!) of these upgrades. Completed in mid-September 2022, the shift required a stunning feat of blockchain and community engineering to put an end to Ether mining and instead derive the blockchain’s security and reliability from staking. After over two and a half years since the genesis block of the Beacon Chain, and ten successful months of PoS-powered blocks post the Merge, Ether staking has grown from infancy to an established & maturing practice.

In this second part of our examination of Ethereum staking rewards we will perform a deep-dive analysis of execution layer rewards, describe and assess the contribution of Maximal Extractable Value (MEV) to a staker’s income, and review the drivers of MEV and its link to price volatility. We hope that you enjoy the full report, from which several key findings are outlined below.