Overview of Cardano
Cardano is touted as a third generation blockchain, focusing on scalability, sustainability and interoperability. Launched in 2017, Cardano aims to be the most sophisticated of all blockchain projects by adopting a scientific, peer-reviewed approach. This philosophy was the foundation of Cardano’s research into what a provably secure blockchain protocol actually is, and how it achieves consensus across thousands of independent parties in a decentralized way. Answering this question resulted in Ouroboros, a family of academic papers designed to guarantee safe and secure network consensus for Cardano in the long run. Over the course of three years, this research was engineered to build a provably secure blockchain protocol which achieves the same security guarantees as Bitcoin but at a fraction of the energy requirements. The result was the dawn of Cardano’s Shelley era in 2020. This transitioned the blockchain to a Proof of Stake (PoS) system, rather than the federated model which was previously run. This shift meant that blocks were no longer minted by a small number of fixed entities, but rather block production would be controlled in a dynamic and decentralized manner by the community and Cardano token holders themselves. The result today is that Cardano is the most decentralized of all PoS blockchains, while minimizing environmental impact. Cardano’s sustainability is second to none, as the energy requirements amount to that of a large home to sustain an entire financial operating system. In this post, we’ll be looking at how staking works in Cardano, and what the key features are.
Cardano’s ADA Token
Cardano’s native ADA token acts as a medium of exchange, store of value and also gives holders the right to participate in Cardano’s consensus. Ouroboros, the algorithm responsible for ensuring Cardano’s continued decentralization, allows anyone to participate in consensus by participating in staking. This is because Cardano’s ADA grants people the right to mint the next block in the blockchain. Rather than relying on an external resource such as electricity to decide who gets to mint the next block, as is the case with Proof of Work networks, Cardano relies on the ADA token as the internal resource to decide who gets the right to advance the network. The algorithm achieves this by randomly selecting ADA token holders at fixed intervals to forge the next block in the chain. Time occurs in slots, with a group of slots known as an epoch, which roughly equates to every five days. Although token holders may be chosen to mint a block by holding ADA, not every person would have the time, resources or skill to do so. This is why Cardano’s network is divided into delegators and validators.
Cardano’s Validator Ecosystem
Delegators are normal ADA token holders who can earn ADA rewards by delegating their right to produce blocks to the validators of the network. These validators can run stake pools, in which numerous token holders may delegate their stake in order to increase their chances of minting a block. Validators who have large amounts of stake delegated to them have a greater likelihood of being chosen to mint a block and advance the network. A simple analogy to understand this would be that token holders own farmland, yet they delegate their right to farm the land to a farmer with the necessary equipment and skills to do so. In return for this service, the farmer is rewarded while the landowner receives compensation as well. The larger the farmland allocated to the farmer, the greater the rewards.
In order to preserve a decentralized ecosystem, Cardano was designed to ensure that no single validator receives all of the stake. Sticking with the farmer analogy, Cardano does not want all of the farmland farmed by a single entity. Ensuring this is necessary to the long-term success of the blockchain, as networks such as Bitcoin are dominated by very few, powerful validators who have the resources necessary to afford expensive Bitcoin mining facilities. This stands in contrast to Bitcoin’s original spirit, in which anyone in the early days could participate and be a validator with a simple computer. Cardano overcomes this dilema by having a saturation parameter baked into the protocol. This is where validators who have a certain amount of stake allocated to them receive diminishing returns after this point is reached. The idea here is that delegators are incentivized to maximize their financial returns by spreading their stake across multiple validators, all of them working independently to maximise return on investment. Therefore, no single farmer can attract all of the farmland to their control.
What makes a good validator? Key considerations
Good validators are those who perform well consistently, put up a healthy pledge and contribute to the health of the network. Here is an outline of the key considerations for what makes a good validator:
- Financial Parameters
Validators on the Cardano network have the ability to set varying fees to cover their cost of operations. The fee parameters include the fixed fee and pool margin. Fixed fee (also known as cost per epoch) is skimmed from the total block rewards generated that epoch and allocated to the validator. The cost is meant to reflect the need for covering the cost of operations. The minimum this can be set to is 340 ADA. Regardless of a pool’s size and amount of delegated stake, a pool that produces one block or one hundred blocks will receive the same fixed fee if they both have their fee set to the minimum.
Pool margin is the percentage of rewards generated that are taken by the validator before rewards are distributed. These can vary from 0% upwards. There is no minimum parameter baked into the protocol. Selecting a validator requires considering what amount of funds they will receive for performing their services.
- Staking performance
When ADA holders delegate their stake to a validator, they’re doing so to contribute to network decentralization and to be rewarded for doing so. It is for this reason that performance is critical, meaning validators should not miss the opportunity to mint blocks which are allocated to them. Each time a block is minted rewards are earned. Missing one means that delegators don’t get rewarded for placing their trust in the hands of a validator. It is important to pick a validator who will perform to a high-standard on a regular basis. A good indicator of future performance is to look at the operator’s history of produced blocks.
- Healthy pledge
Pledging is the mechanism required to prevent Sybil attacks. Simply put, pledging is where a validator pledges some amount of their own personal ADA when registering a stake pool. Doing so rewards the pool with a greater likelihood of rewards. A healthy pledge is necessary for ensuring the pool operator does not create multiple pools in order to try and seize control of a majority of the stake in the network. Achieving this would defeat the purpose of decentralization. The value of pledge is that validators are less likely to spread out their stake across multiple pools, but instead are incentivized to consolidate their resources. When choosing a validator, it’s important to look for one who contributes a healthy amount of pledge. The larger, the better.
- Network contributions
While staking itself is important to the continuation of the system, Cardano relies on the contributions of stake pool operators to add value to the network in other ways. Many people delegate to stake pool operators who create valuable content, have mission-oriented goals or promise to use the profits of their stake pools towards charitable causes. For example, a few pool operators contribute towards the development of Pooltool.io, a useful tool to monitor the validators in a network. As an open-source community, these people advance the reputation of the network and help improve the use, utility and adoption. Financial rewards may be the main incentive towards choosing a validator to act on your behalf, it can be valuable to support the ones who have a wider vision or purpose which you are aligned to.
For a normal token holder, anyone can participate in staking through the many Cardano wallets available on market. These wallets are available through a web browser and mobile apps, and support hardware wallet functionality. Exploring pools can be done through Pooltool.io, a handy website and mobile app that can be used to browse the many different validators available on the market.
Rewards are issued at the end of each epoch. These rewards are automatically re-delegated to the pool that one is delegated to. Cardano ensures that these rewards are distributed directly to the delegators via the protocol, rather than relying on the validators to distribute rewards themselves. This would create a point of trust which would jeopardize funds where malicious pool operators may exist. Rather, this creates a safe way in which delegators can guarantee rewards proportional to their stake in the system.
What are the risks?
Staking in Cardano is risk free. Ouroboros was designed so that token holders only delegate their right to mint blocks to a validator. They do not delegate the funds themselves. This ensures that the value of the funds allocated to a stake pool is not at any risk of loss or theft. For validators, there is no slashing built into the protocol to put validators’ pledge at risk for poor pool performance. Cardano was designed to incentivize participation and good performance, while minimizing the risk of funds being lost.
Cardano’s peer reviewed approach to protocol design has resulted in one of the most performant and secure blockchains on market today. The Ouroboros algorithm is the first of its kind to guarantee the same level of security as Bitcoin without the trade-offs of energy consumption. This results in an ecosystem that converges towards more decentralized block production over time, rather than converging towards more centralized block production, as is the case with Bitcoin. Cardano has extremely low barriers to participating in consensus, meaning getting involved in staking is a low risk way of ensuring financial returns. While easy to get involved, picking the right validator is important to maximise profit. This means choosing one which has a proven track record of performing well and maximising the amount of blocks minted by them.