The economics of Ethereum’s Casper
As Ethereum inches closer to a hybrid PoW/PoS rollout with Casper FFG, we’ve begun our internal analysis of running a Validator node. It’s the first time we’ve put serious thought into the economic incentives of ETH’s first iteration to Proof of Stake, and we felt our findings are strong enough to share.
The proposed economics of Casper FFG:
For an ETH stakeholder who wants to participate in the Validation process under Casper FFG, there are, conceptually, two points of access. The first is through operating a private Validator node, with a minimum deposit size of 1500 ETH. The second is to join a PoS “pool”, where many users pool their ETH deposits to reach the 1500 ETH level, and split the related income (minus a pool fee) on a pro-rata basis. With these two choices, the barriers to entry for small ETH holders has been removed.
Once acting as a PoS Validator, the stakeholder is now entitled to their pro-rata share of an issuance schedule, dependent upon how many ETH are staked, over time. The currently contemplated schedule is:
In this schedule “Deposit Size” refers to the total amount of ETH staked (network wide); “Annual Validator Interest” is the approximate reward, in pct ETH, payable to all stakeholders per year; and “Funding Crunch” is the amount of time the network can operate PoS at certain Deposit Sizes, with the initial 1.25MM ETH Casper Balance, before another fork is required.
The most important non-payment aspect associated with these economics is the “Withdrawal Delay” — after a Validator successfully logs out of the Casper FFG PoS smart contract, their funds are held for a period of 15,000 epochs (approximately 4 months), before being released to the Validator’s wallet address. Under a pool, one would assume that this condition passes through to each participant.
Sample Economics with 100 ETH stake:
Let’s assume that a stakeholder joins a PoS Validator pool with an initial deposit of 100 ETH. Let’s also assume that the network wide contract balance is 10M ETH. The first year participation would yield:
5.13%. This looks like a great interest rate just for depositing an asset. If this were a liquid deposit structure, that might be the case. Unfortunately, the 4 month Withdrawal Delay seriously changes the risk/reward of participating in the proposed ETH PoS process.
What are the REAL economics of Casper FFG PoS?
To understand the real risk/reward of staking ETH in a deposit instrument, let’s break it down into two parts, the 100 ETH Deposit and the 4 month Withdrawal Delay.
Part 1: The plain vanilla instrument is the deposit. We’ve already seen what that looks like under our assumptions, it pays you 5.13% (without pool fees) per year. For our 100 ETH demonstration, the value of Part 1 is 5.13 ETH.
Part 2: Under the 4 month Withdrawal Delay, you are effectively removing your liquidity for a 4 month window. On an expiry payout basis (meaning, the revenue stream received on the day of the Withdrawal Delay expiration), you have synthetically sold an at the money European put option on your 100 ETH stake. Unfortunately, you’ve sold it to no one, it can’t be used, and you haven’t been paid for it. We can value this, crudely, using the following assumptions:
So, the real income stream of depositing 100 ETH in a PoS pool looks more like:
For this structure to be BREAK EVEN, the interest rate paid by the Casper FFG contract would need to be ~26% per year. What rational participant would ever want to enter this structure?
This might be something that small investors or fans of the network would be interested in doing, but we do not believe a sophisticated participant will choose to enter this type of contract. This leads us to a number of follow-on questions:
Question: What is the plausibility of a Proof of Stake system with a required Withdrawal Delay?
Question: Can Ethereum attract enough participants at the current economic incentives to meet their minimum threshold in deploying Casper FFG?
Question: Does this deposit instrument immediately bring about regulator scrutiny, putting undue pressure on the network from centralized government consumer protection watchdogs?
Question: Does the operation of a PoS pool breach the threshold for the unlicensed selling and distribution of a security?
Question: What are the true goals of Proof of Stake? Is it only to reduce energy consumption and inflation of the network? What are those true numbers? Has a relative assessment of true energy consumption been done?