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In my previous story, I covered the specificity, advantages and issues with Proof-of-Work secured cryptocurrency blockchains.
In the near future, if things proceed smoothly, the currently second biggest cryptocurrency by marketcap, Ethereum, should make a switch from Proof-of-Work model to Proof-of-Stake. Therefore, getting to know more about PoS (and Delegated Proof-of-Stake) and and looking at blockchains already relying on such model is particularly relevant.
What is “Proof-of-Stake”?
On blockchains, transactions are broadcasted to the whole network in a peer-to-peer communication between nodes, simple computers. Those nodes must fulfill those tasks:
- validate the integrity of the previous block
- collect the transactions
- compose the next block with the transactions
- (and if the node is “lucky”:) sign and broadcast the new block, and earn a reward
Those principles are the same on PoW and PoS blockchains, but the conditions differ:
- in PoW, to be able to “sign” out a new block, the node has to provide a mathematical solution to the previous block, thus proving having done the required calculations (the work, typically referred to as “mining”)
- in PoS, to be able to “sign” out a new block, the node gets a random selection based on amount of bonded tokens, it’s “stake” in the network
The more tokens a node has staked (bonded, dedicated to the network securing), the more likely it “wins the lottery” against other nodes and gets to sign out a new block, generating rewards for itself (a percentage of their bonded tokens, plus transaction fees paid in transactions in the newly signed block).
But what happens if a node “cheats” and tries to send out a block without having been selected, or “double-signing” a block? Well: the blockchain algorithm punishes such behavior with “slashing”: the misbehaving node sees a certain amount of it’s bonded tokens burned away. The losses being usually huge, node operators are highly discouraged to attempt disrupting the blockchain integrity.
On principle, such model has no limitation on amounts of nodes securing the blockchain, but unless the protocol has a built-in bias to “boost” chances for minority nodes to sign blocks, only the nodes with the biggest stakes ever get rewards (that’s particularly true if the blockchain didn’t had a “ramp-up period” in which many nodes could enter the network with zero or low stake, and with the first blocks generating zero or very low rewards, so all nodes get a chance to increase stake gradually and proportionally from the start). Some blockchains use that model in a centralized way, such as Stellar.
And there’s an improvement on that model:
Nominated Proof of Stake
NPoS, as seen notably on Polkadot ecosystem, sees a selection of validators by nominators make it into the active pool. It differs from DPoS as seen below as there’s a “rotation” of which validators secure the blockchain, based on the amounts of nominations they receive BEFORE era start. Otherwise, the general principles are the same ↓
Delegated Proof of Stake
More and more blockchains use a DPoS model, and indeed this component introduces very interesting functions.
In DPoS we must consider two participants in the blockchain:
- validators, who are the nodes as described before
- delegators, who are token holders
A DPoS blockchain usually sets a fundamental parameter: the amount of validators (nodes) is limited, only the validators with the most bonded tokens are eligible to signing blocks on the blockchain and thus generating rewards.
But while node operators can bond tokens to their own validator, validators derive the most bonded tokens from delegators.
Delegators are, simply, token holders who choose which validator(s) they want to delegate their tokens to. In return, they receive a portion of the rewards generated by that validator, minus a commission kept by the validator (in this, it’s somewhat similar to pooled mining on PoW blockchains).
But there’s a catch: since the total number of validators on the network is limited, the network needs the validators to be faithful AND highly available.
If a validator is offline, itself AND the delegators suffer a slashing penalty. Not too hefty, but hard enough to really ensure the node operators do their best keeping their validator online, and the delegators do proper research about the validator and it’s operator before delegating their tokens to it.
And of course, in case of more grave infringements against the blockchain such as double-signing, the penalty is very hefty.
Also, to prevent validator-hopping and chain-split events, most blockchains set a minimum amount of time for undelegating tokens: usually between 7 and 28 days, during which those tokens can’t be redelegated or spent, and don’t make a portion of rewards the delegator might get.
The tasks of the delegators
To avoid seeing their bonded tokens slashed and suffering losses, it is highly recommended to delegators to carefully pick which validator(s) they delegate their tokens to. They may pick a single validator if they trust it’s operator will run it faithfully and with proper measures to ensure it will remain online 24/7 available for the network, or they may pick multiple validators to compensate the failure of one.
Delegators can delegate tokens any time and in any amount directly from their compatible wallet, can reinvest rewards to the same validator, can undelegate the tokens back to their wallet, or redelegate their tokens to a different validator (this operation, like undelegating, usually coming with a 7–28 days minimum time).
It is also quite recommended for delegators to keep in touch with the validator operators, may it be by following them on their website, Twitter, Telegram, Discord or any other communication channel where the operator might publish announcements regarding the validator node (for example: scheduled maintenance during which the node would be offline and potentially leading to slashes, or changes in the commission rates). Or even explicitly ask what measures the operator puts in place to ensure the good function of the node, hardware used, human supervision,…
Additionally: delegators get to vote for governance proposals on the network, their vote weighting according to the amount of tokens delegated. Such proposals can cover a variety of subjects such as changing the limit number of validators, creating a compensation fund in case of bugs, changing the inflation parameters, introducing upgrades to the blockchain…
Sidenote: on ownership of delegated tokens
In this post, I assume people who delegate their tokens do so by themselves using a proper non-custodial wallet, being in control of the private keys. That’s on-chain self-staking, people remain in ownership of their tokens, even of tokens that have been delegated. But there are other situations.
As per the motto “not your keys, not your coins”, people should be extra careful when they delegate their tokens through an exchange or staking service: they effectively loose control over their tokens.
On-chain custodial staking usually refers to exchanges or staking services taking control of the tokens, and actively using them to validate on the blockchain. This is for example the case of Kraken, Binance or Huobi, validating on the KAVA blockchain with their user’s tokens bonded. While users of their services might enjoy a few benefits like zero-wait unstaking or autoreinvest, they tend to get significantly less rewards than if they delegated themselves through a wallet. And: they become ineligible to possible airdrops or governance voting.
Off-chain custodial staking is basically just a proprietary interest rate on deposits on an exchange or other service, regardless if the token’s blockchain actually uses PoS.
The tasks of the validator operators
Validator operators have the responsibility to maintain a network node and do due process to ensure their delegators don’t get penalized by slashing, may it be by insuring them with a reimbursement (either paid out directly, or integrated as “slashing compensation fund” fed by a portion of the reward commissions.
Operating a validator node is maintaining a server or cluster of servers but on steroids: only people with solid expertise in system administration and high-availability protocols should operate a validator node.
Maintaining an online presence and providing transparency to delegators is always appreciated.
Validator nodes consume way less electricity than Bitcoin miners, and they are a limited quantity of them, but it’s always good if infrastructure can be reused, for example operating validator nodes for several blockchains on the same hardware, or using optimized cloud computing instances.
The staking rewards
Blockchains differ in their parameters, but usually there are a few principles:
- the amount of delegated tokens should be high, so no “rich adversary” can disrupt the blockchain by delegating to (or operating) a mischievous validator
- to reach high proportions of delegated tokens, token holders should be incentivized with high reward rates
- to be able to get tokens to stake, users should benefit from airdrops, sales, event rewards, faucets, or exchanging other tokens or fiat
It is not uncommon for early blockchains to provide quite high reward rates to delegators, the rates gradually decreasing as more and more tokens get delegated and secure the blockchain. One common figure for PoS is > 80% of tokens staked. Additionally, reward rates are also affected by inflation rate.
The aristocracy issue of PoS
Proof-of-Stake introduces some level of trust in a blockchain ecosystem, with delegators having to trust validators will do their job properly to avoid slashing. It’s a sidestep from Nakamoto’s ideal of zero-trust digital money.
Delegators, by risk management, might pick only the most reliable and insuring validators, therefore concentrating the “validation power” in the hands of a reduced amount of validators. While PoS don’t exactly suffer a risk of 51% attacks like with PoW, the concentration shifts commissions resources away from smaller or newer validators. A big validator can easily cover their costs or buy the best hardware with just a 1% commission, while a smaller validator would struggle to meet ends with a 10% commission. It comes down to the community to ensure a monopole/duopole/tripole of validators don’t prove detrimental to small validator health, and that failure of one big validator doesn’t start a ripple effect on blockchain stability and security.
For a more technical dive into Practical Byzantine Fault Tolerance in a Proof of Stake context, here's an excellent blog post on Cosmos.