On the 19th of January 2023, Anthony Sassano, the founder of the Daily Gwei, went on Twitter to explain the components that make Ethereum’s staking rewards 7.5%
1/ ETH can be deflationary while still earning stakers 7.5% APR because that 7.5% isn't ETH's yearly inflation rate.
Let me explain.
The 7.5% APR consists of:
– Protocol issuance: 4.1%
– Tips (aka unburned fees): 2.3%
– MEV rewards: 1.1%
All of these %'s are variable.
— sassal.eth 🦇🔊 (@sassal0x) January 19, 2023
Ethereum’s staking rewards are issued in accordance with how much ETH is validated and what rewards the network is offering at that time period. The official rewards rate is currently around 4.1%. So why do validators receive as high as 7.5% for their staked ETH?
Due to Ethereum’s burning design, the value of ETH is deflationary. As users stake their ETH, they currently receive 7.5% APR which consists of three components. The official 4.1% reward, Tips worth 2.3%, and MEV rewards which is 1.1%. And according to him, all of these rewards are variable.
The official 4.1% is usually made up of issuance and fees. When the Ethereum network issues new tokens, the tokens are only shared with the staked portion of ETH. Currently, only 13% of ETH’s supply is staked. Thus, out of the 120.5 million, only 16 million are staked. And they are the only ones that receive issuance rewards.
The inflationary rate is set at 0.6% based on the new ETH assets issued yearly. Thus the issuance protocol is 7.5x, which is the total supply divided by the staked value. 7.5 multiplied by the inflation rate is 4.1%.
Official rewards aside, during periods of network congestion and slow processing, the Ethereum network has added features that allow users to tip validators that staked ETH to prioritize their transactions over others.
On the other hand, MEV rewards are for validators that reorder blocks on the network. If a user wants a specific block arrangement, they can pay the validator to arrange the blocks in their favor.
Add the official 4.1% to the 2.3% tips for validators, and MEV 1.1% would total 7.5% rewards on ETH-staked assets. Since the issuance of new assets on the ETH network is on the consensus layer, it’s the only one that directly affects inflation. The tip and MEV rewards are from the already existing asset supply, thus, are considered part of the execution layer.
Thus to maintain the deflationary nature of the network, only 0.6% are burned to counter the 0.6% issuance. And ETH stakers get 7.5% APR, which are used to conduct activities on the network.