What a week it’s been in Crypto. Bitcoin is trading at $5000/coin. Elon Musk revealed his greatest achievement to date in shepherding humanity into the future as the former CEO of Dogecoin. And Coinbase just announced a staking service for its institutional clients, starting with Tezos. If you’re new to crypto your probably asking a few questions: “Bitcoin isn’t dead yet?”, “What’s Dogecoin?”, “Elon Musk is in crypto now?”, and “What is staking and how does it work?” To start: no Bitcoin is not dead yet, although it has ‘died’ over 350 times according to different analysts. As for Elon and Dogecoin, the short answer is no, but there is too much historical information surrounding the meme, crypto in 2017, and otherwise for me to unpack succinctly in this article. If you are unfamiliar and feel like learning more or want to relive the good old days of 2017 you find a brief history here or can even order a paperback book detailing it for $9 on Amazon here.
Now for the staking question. When people talk about staking, they are referring to how users and ‘miners’ achieve consensus on a proof-of-stake (POS) network. In proof-of-work (POW) networks, like Bitcoin, miners on the network are rewarded based on their ability to solve algorithms which is generally equivalent to the amount of computing power they contribute. POS, on the other hand, replaces computing power with a ‘stake’, or essentially an investment, as a means of network participation to ensure users and miners have ‘skin in the game’. Structuring the network in this way aims to reduce the cost of running a blockchain protocol and improve scalability. There are numerous articles detailing the ideological differences, pros, and cons of those two consensus mechanisms. We’re going to take a deep dive into POS networks and the different roles people play in them. Deeper comparisons between these two network types can be found here, here, and here.
So how does staking work in practice, and what are the different ways people can participate in these networks? POS has been around slightly over half of a decade, at least conceptually. Until recently, with several POS protocols launching in the last couple months, many had wondered if the higher transaction rates and lower block times POS promised were actually achievable, or just the next wave of ‘crypto hype’. However, with over a dozen POS networks already active and many anticipating launch this year, 2019 is shaping up to be the ‘Year of Staking’ in the blockchain world. Regardless of the market gains or losses this year, it appears that POS is here to stay and you should know the different roles in these ecosystems and how they work together before you jump into the market to ride the bull, or bear, or cryptokitty, or some other animal spirit. Understand though, that actual POS networks are far more nuanced in practice than I’ll cover here. Some networks will have other actors involved in the ecosystem as well and you should understand how they all work together when assessing a protocol. With that said, time to transition to the first layer of the POS networks: the protocol.
As with any other blockchain protocol, the protocol layer consists of the team of developers and entrepreneurs building out the functional components of the network. The ecosystem members here define the purpose and rules of the protocol, the network architecture and design, the tokenomics of the protocol, and create the associated software to carry this out. This layer is the actual blockchain protocol made by the team. They have the ecosystem vision and are trying to build it out, but are not necessarily the ones building the infrastructure to support it. While these teams often do run several core nodes on the network, due to the distributed nature of blockchain and the ecosystems they hope to create these parties rely on third parties to help maintain the network and participate in governance. Thus we move onto our next role in the ecosystem: the node operators.
The Infrastructure Providers (Node Operators):
Node operators go by several different names depending on what network you are on. Tezos calls them Bakers. IoTeX calls them Delegates. LivePeer calls them transcoders. The list goes on and on, but regardless of their name, these parties serve much the same role. Node operators run nodes on the network, process blocks, and ensure that the network is running as intended. Hence, node operators are responsible for several key technical aspects of the networks they support like: ensuring their nodes can handle transaction volumes on the networks they support, maintaining constant uptime, are secure, and administer network updates as needed. Essentially, they are the backbone of the protocol they support. Without quality node operators, POS networks cannot operate at scale in a practical manner.
For taking care of the technical heavy-lifting and costs of maintaining their server, node operators are the ones who receive block rewards for adding blocks to a POS blockchain. The exact mechanics of how block rewards are distributed to node operators differs across networks, but the basic premise is that the greater the amount staked to a node, the more likely the node is to be selected to produce blocks. Nodes may also have greater functionality that just processing currency transactions in blocks. LivePeer’s transcoders, for instance, will soon be processing streaming video.
Node operators also serve as a form of investment vehicle for other participants in a POS ecosystem. If someone wants to participate or invest in a POS network without having to set up and maintain the infrastructure needed to run a node effectively, he or she can stake to another node in the network. When that node is selected to produce a block, the rewards that a node operator receives will be distributed to those staking on their node proportionately to the amount the person staked relative to others on the node. Here enters the remainder of the network participants.
Now suppose you’re an investor, crypto-enthusiast, or developer who sees a protocol they like and wants to participate without having to go through the hassle of maintaining a robust node or investing thousands of dollars onto your own node to have a shot at being chosen to produce blocks. POS networks allow you to still reap the rewards of producing blocks by staking to one of the node operators. You can look through the list of node operators and decide which operator or set of operators you would like to support based on the node operator’s rewards distribution plan, technical expertise, ideology, and projects they are interested in supporting. It is really a matter of personal preference which node or nodes you would like to stake to. You then stake some amount of the protocol’s crypto to that node and every time a rewards call is made you will receive a payout that is proportional to your stake on the node.
For example, suppose you stake to a node that promises to distribute 80% of all of the rewards it receives. Let’s also suppose that prior to the rewards call there was 1,000,000 total tokens staked to the node, of which you had staked 100,000, and the reward was for an additional 100 tokens. For the purpose of this example we will assume that there are 0 fees collected. The node operator has to fund operations and upkeep for their services so they keep a rewards cut, which is in this case 20% of the rewards or 20 tokens. This leaves 80 tokens to be distributed to everyone staked on the node. Since you contributed to 10% of the total stake on the node prior to the rewards call you will receive 10% of the rewards being distributed, or 8 tokens in this case.
What you do with the tokens you receive is entirely up to you. You can reinvest them back into the node you are staked to in order to increase the rate at which you meet your ROI. You can keep them in your wallet and use them to fund development projects and transact on the network. You can even liquidate them to fiat if you so choose. Similar to picking your delegate node, the world is your oyster in terms of what you do with your rewards cut. However, as you can tell, the incentives are such that it is likely more advantageous for you to continually reinvest in one node so you keep receiving a larger portion of the rewards and your stake is not diluted down. With that said, if at any time you do not like how your node operator is contributing to the network, you are free to remove your stake and move it elsewhere. Freedom rules in POS and network participants can stake to whomever they would like for as long as they want.
Blockchain protocols are complex beasts made out of next generation information technology, economic theory, and political ideologies. Consequently, every single protocol has its own intricacies and finer details. Hopefully you gained more insight into what some of the commonalities across all of these protocols are and have a clearer picture of how they interact with one another. Thanks for reading and we will be back with more content soon! As always, let us know your thoughts, if you have any more questions, or any other topics you are interested in hearing more about! Find us on telegram or twitter and let us know how you feel about POS and where you see it going in 2019!