The Proof of Stake (PoS) ecosystem has grown very quickly over the last two years with increased retail and institutional interest as yields have made participating in these networks attractive for newcomers. Blockdaemon operates nodes on over 20 different Proof of Stake blockchain networks for customers all over the world as well as our own company owned validators which are publicly available for delegation.
While PoS networks gain in popularity, it’s important to recognize that each of these blockchains are very different and should be considered on a one-by-one basis. The purpose of this blog post is to give a high level overview of what sort of similarities PoS networks have in terms of their general mechanics and how to think about the potential yields one might expect by staking.
What Is Proof of Stake
If you’ve heard of Proof of Work (PoW), the consensus protocol made famous by Bitcoin, you likely have heard of its requirements regarding hardware and electricity to secure the network and provide “miners” rewards when they are able to produce a new block on the blockchain. The more mining hardware is run with enough electricity, the more of a share of the rewards operators can compete for.
Alternatively, PoS is a consensus protocol that relies less so on hardware requirements as it does individual token holders on the networks and operators, known as validators, to cooperate on producing new blocks in a secure manner. For our purpose, the term “stake” is defined as:
“an interest or share in an undertaking or enterprise”
“something that is staked for gain or loss”
In most PoS blockchains there are validators within the network who are running some type of computer machinery, either physical or in the cloud, which will work to secure the networks. Validators are a critical component of PoS systems and are rewarded for their participation similarly as PoW miners are. A main difference is that the capacity for earning rewards is often based on how much stake, or native tokens, from that specific network is delegated to them.
In permissionless systems, people who hold a native token from a PoS blockchain can delegate their tokens to one or several validators. This signals that the token holder trusts the validator to operate in a way that is aligned with the network and not be caught acting nefariously in their own interests. In return for a validator doing its job well in a PoS network, they are paid for their work from the network and their delegators will benefit by receiving their full rewards as well.
PoS blockchains allow for individuals, groups and/or businesses to directly participate in the operation of a blockchain network and in some cases the governance surrounding how decisions are made.
With each PoS blockchain type being different, the yields one can expect from staking can vary greatly depending on factors such as validator performance, network adoption and how (and if) rewards are compounded.
1. Network Adoption
Early on in a network’s life cycle the staking yields may look very different than when the network reaches maturity. Sometimes networks are designed to specifically reward early participants, providing for higher rates of return for early stakers that tapers off as the network grows in adoption and usage. Unlike with one of Bitcoin’s primary attributes, which is the fixed inflation rate and supply cap of 21,000,000 Bitcoin, the rate of return estimated on a specific network is almost never static.
2. Validator Performance
One of the most important factors of yield to an individual staking any amount on a PoS blockchain is their choice of validator. A validator’s actions and reputation directly affect the health of the network, their own financial interests and the interests of all those who delegated to them.
Validators who establish and maintain both technical prowess and social reputation can often attract high levels of delegation, raising their profile in the network and thus increasing their own income as well as the stating yields to those delegating to them.
On the other hand, validators which engage in nefarious activities intentionally or unintentionally put the network, their own reputation and funds, and the funds of those staked to them on the line. Regardless of whether a network engages in some form of slashing or monetary penalty.
3. Strategic and Tactical Staking
Other factors that may change the rate of staking returns whether you’re running a validator yourself or delegating is how funds are managed and monitored. Regularly reviewing rewards is necessary to keep on top of expected returns as well as outlying irregularities noticeable in your balance. With most networks there are little to no established tools which enable users to get alerted if a slashing event or something abnormal happens to their accounts. With Blockdaemon we guarantee against any slashing risks which would be associated with issues on our part and reimburse against those events, however it’s crucial that each individual staking address be monitored by the owner.
Another important detail to remember is that during un-bonding periods an address will not typically continue to accumulate staking rewards which is important to take into consideration from the perspective of opportunity cost. For example, with networks that allow instant re-delegation it’s better to use this option rather than un-bond and then re-bond after the funds are available.
Let Us Help You Earn Optimal Yield
Blockdaemon’s staff of protocol experts are always willing to chat with customers regarding the most ideal approaches to securing and maximizing staking returns. We always focus on non-custodial solutions and empower our customers to set up and maintain high secure staking configurations that they are in control of at all times. Let us know how we can help!