For Whom is This Article Written
The content of this article is a follow-up to an article I released previously (and can be found here) concerning a high-level perspective of the tokenomics for the LTO Network. If you haven’t read it yet, please check it out. It will really help in digesting what we are discussing in this article.
Node operators in the LTO Network are given an incentive for holding an amount of LTO Network tokens proportional to the transactions originating at their node. This is a fundamental component of the LTO Network tokenomics and yields some interesting system-level economic dynamics.
This article focuses on the system engineering and economics of LTO Network’s consensus algorithm — Leased Proof of Importance (LPoI).
If you’d like to be able to better assess token utility and dynamics in a particular token’s network/platform, this article is for you.
The Shortcomings with Traditional Economic Assumptions
- People Respond Positively to Incentives — LPoI assumes node operators will respond positively to incentives. That is, node operators will actively pursue an optimal raffle factor in pseudo-real-time. While theoretically, this should be true, it probably isn’t. Some node operators will become complacent and will not dynamically adjust their raffle factor to an optimal position. Rather, some node operators will be content on hosting as many lessees as possible or having the best payout percentages, or any other differentiating criteria. For whatever reason, not all node operators will optimize their raffle factor.
- People are Rational — People are not rational. As mentioned above, some people will not seek to optimize their raffle factor. Some people will become negligent on operating their node, particularly if the reward payouts process is automated.
While these shortcomings of traditional economic assumptions are well-documented (great read), it is extremely difficult to model these qualitative aspects. As such, the modeling will ignore these types of influences. Bear in mind, however, that these types of things do exist. In any case, most people respond positively to incentives and most people are rational (so I’m told).
Wait, Isn’t This Article About LPoI?
You might be wondering how to build some intuition for how the LPoI consensus algorithm might affect the LTO Network dynamics. Let’s just keep digging.
Current Network Statistics Snapshot
To better understand where LPoI will lead the network, we need to first understand how the LTO Network exists today.
The following network snapshot is based on data acquired for the month of March 2019 (Special thanks to whoever made this.).
- Consensus Algorithm: Leased Proof of Stake (LPoS)
The chart below is a graph of a hashing power distribution for the Bitcoin network. Never mind the fact that BTC consensus algorithm is proof of work, let’s just focus on the percentage allocation. AntPool, with 18.8% of the hashing power will, — on average — receives a mining block reward for ~19 out of 100 blocks generated on the Bitcoin network.
LTO Network operates exactly the same way, but is based on a node’s percentage of staked tokens relative to the total number of staked tokens — per block — on the LTO Network.
What’s the takeaway?
Currently, node operators are rewarded based solely on a probability distribution proportional to the node’s number of staked tokens; nothing else matters.
So, what is the LTO Network Block Reward? Where Does it Come From?
The block rewards on the LTO Network are the transaction fees. This is the net total of all transactions during the block multiplied by the per-transaction network fees (currently 0.25 LTO tokens for anchoring).
Why Does LTO Network Want to Change the Consensus Algorithm from LPoS to LPoI?
Before we dive in, let’s recap. Proof of stake allows users to be rewarded for validating and verifying the network-based exclusively on their holdings. Leased proof of stake is the same system but allows smaller holders to dedicate their holdings to larger pools in order to be rewarded. So, what is Proof of Importance?
LTO Network defines importance — in part — as the number of transactions an entity participates in on the LTO Network (Remember the previous bit about token velocity). That is, the entities (nodes, wallets, etc.) which contribute transactions to the network more frequently are more important.
Transactions Aren’t the Sole Basis of Importance
Spamming transactions is a means of network attack (which LTO have called out, addressed, and motivated solutions for). LTO Network assigns importance based on the size of the holdings an entity holds also. Importance is a combination of network transaction origination and LTO token holdings, with transactions being the most important characteristic.
Being the Most Important — Optimizing the Raffle
Importance on the LTO Network derives from a combination of transaction origination and token holdings. As Importance is a dynamic and real-time qualification, LTO Network built a quantitative definition of Importance called the Raffle Factor.
Calculation of the Raffle Factor
- Minimum Stake — The Green Dot — It is possible to stake — at a minimum — 1000 LTO Network tokens and still earn rewards if the entity is originating transactions on the LTO Network. The raffle factor in such a scenario remains relatively high at a value of approximately ~1.3 (the minimum raffle factor is 1) — a 30% gain in raffle factor, which is the likelihood of receiving a reward, based purely on transactions.
- S/T Ratio of 1 — The Red Dot — An S/T ratio of 1 is the optimal position for increased likelihood of earning rewards (The raffle factor optimization does not increase the block reward, but rather increases the likelihood of receiving the reward as a result of network validation). This is the point at which the raffle factor is maximized.
- Stake Larger than Transactions — The Blue Dot — As stake size begins to outpace transactions, the likelihood of earning rewards for validating transactions on the network decreases. This is indicated by a lower (~1.18) raffle factor.
Takeaways from the Raffle Factor and the S/T Ratio
- The LTO Network places greater importance (remember, LTO Network consensus algorithm is Leased Proof of Importance) on originating transactions on the LTO Network than on holding tokens. This is evidenced by the fact that — even with zero tokens held — transaction originators have a raffle factor of 1.3 (30% more than passive staking).
- The raffle factor incentivizes entities originating many transactions to buy more LTO utility tokens. As transactions originated by the entity increase, to continue to optimize the raffle factor (likelihood of being rewarded), entities will buy more LTO tokens.
- Entities will be disincentivized from holding more LTO tokens than the entity can justify, from a transaction origination volume perspective. It simply does not make sense to hold more tokens than proportional to the number of transactions being originated by the entity. This has the effect of encouraging decentralization.
- The cream rises to the top. The entities originating the most transactions are incentivized to buy more LTO utility tokens in an effort to continuously optimize the raffle factor. This dynamic system creates a real-time importance scheme for the most active (and presumably largest stakeholders) entities to hold the most weight in terms of network validation and verification.
Why Not Just Go to LPoI Right Away? Why Start with LPoS?
When you think of changing consensus algorithms, you usually think of hard forks. Why would the LTO Network team make the choice to have their network dynamics change after launch?
Going to LPoI Now Would Impose Significant Influence Toward Centralization
The LTO Network statistics for the past 30 days are shown above. There are 4 significant players: Legal Things (The founding company), SingRequest (a.k.a. Engager #3), Capptions, and Firm24/ OnlineFlexBV.
As LPoI disproportionately rewards wallets that originate transactions (as opposed to passively stakes LTO Network tokens), the founding team and the early active network users would be due a large majority of all block rewards. Similarly, the public leasing pools that have thus far benefitted from the LPoS consensus algorithm would begin to demonstrate diminishing returns (notice Liquid Leasing, the premier public leasing pool on the LTO Network, has generated 11 transactions in the past 30 days compared to Legal Things nearly 120,000.).
Under LPoI, public leasing pools would need to actively find ways to generate many transactions (this is a job for a sales team!) or accept that their node rewards — in LTO Network tokens — are going to take a hit. As possible, the relatively few wallets generating the majority of the transactions would become attractive for passive staking and leased LTO Network tokens may migrate to the wallets generating the most transactions.
This persuasive forces toward decentralization would be two-fold. Relatively few wallets would be receiving nearly all block rewards and passive stakers would be inclined to move their tokens away from public leasing pools in search of better staking rewards.
Legal Things, Signrequest, and Capptions
Looking at the wallets responsible for generating the most transactions provides some information concerning the distribution of transaction origination across the network.
The top two wallets shown above, over a 24 hour period, are responsible for ~90% of the LTO Network transaction origination. The LTO Network team have offered a glimpse of how the transaction distribution might look once the LTO Network becomes mature.
Though the LTO Network has seen tremendous growth since going live, and the integrators that have joined have brought significant transaction volumes, the LTO Network has a long way to go to reach maturity.
So, why not just switch to the LPoI consensus algorithm now?
The Network is not yet ready and will not be until the reward mechanism can be confidently applied without undermining the decentralized nature of the LTO Network.
Public Leasing Pools
A Case Study: Liquid Leasing
Of the total ~30 million staked LTO Network tokens, the Liquid Leasing public leasing pool accounts for approximately 19% of all staked tokens (recall: Bitcoin network’s Antpool accounts for nearly the same proportion of hashing power, often motivating claims against decentralization), which is a significant portion.
However, in the past 30 days, the Liquid Leasing public leasing pool is responsible for 11 transactions.
The S/T ratio for Liquid Leasing over the past 30 days looks something like this:
This isn’t intended as shade on any public leasing pools! Rather, the purpose of this article is to underline the changes that will take place when the consensus algorithm changes. As such, it is important to recognize that the passive staking of LTO Network tokens — by design — will become less profitable over time.
Don’t be upset.
Without adoption (what LTO Network have prioritized) LTO Network tokens would be based solely on speculation. Wouldn’t you prefer to invest in substance rather than speculation?
Can’t I Just Spam the LTO Network and Inflate My Importance?
No. The LTO Network team, prior to choosing a raffle factor, determined the upper limit on the raffle factor that would discourage spamming the network in an effort to inflate performance. See below:
At present, the maximum raffle factor is 1.5 (as shown above). While the S/T ratio may change (e.g. not 1:1), I don’t believe the maximum raffle factor will change. If it does, however, the community can be confident it will not exceed or equal 2. The network dynamics, with a raffle factor less than 2, do not provide incentives to spamming the LTO Network in an effort to inflate importance.
Optimizing Network Dynamics
Optimizing the LTO Network dynamics implies there is some preferable outcome associated with LTO Network evolution. The LTO Network team have been clear from the beginning concerning their opinions concerning optimal LTO Network makeup.
Where Does the LTO Network Team Want the Network To Go?
- Strong Passive Stakers — public leasing pools are to be kept to a minimum as these types of entities do not contribute appreciably to the adoption of the LTO Network nor do they provide liquidity pools for token velocity. The tokens in these pools, for all intents and purposes, are dead. It’s true these staked LTO Network tokens provide some level of decentralization, but a decentralized network with no transactions is useless.
- Passive Stakers — Notice that the LTO Network team has prioritized small trustworthy validators over large staking pools. Why would they do this? The LTO Network team want decentralization on the network. The concept of many small nodes validating the network is preferable to one or a few very large pools validating the network.
- Passive Clients — Clients that wish to subsidize the costs of integrating their workflows on the LTO Network may choose to purchase and passively stake LTO Network tokens. This has been designed to lower the barrier to entry to interested parties and create a hedge against price fluctuations in a very notably volatile digital asset market. Many clients, based solely on price instability, will avoid taking advantage of superior automated technology. LTO Network have thought of this and have made it a priority to offer these clients the peace of mind of being able to generate network cost subsidies simply be generating transactions on the LTO Network.
- Joint Business Builders — Capptions and Signrequest are some examples of these types. We have already seen surges in the number of transactions originating from these wallets. These are entities that have incorporated the LTO Network into the fabric of their business workflows. These entities are thought to be the most trusted entities as they have the most to lose in the event of maleficence on the LTO Network. These entities have been given the top priority.
How Do We Get There?
The LTO Network incentive mechanism has been designed to persuade the LTO Network to evolve in the following manner.
The above time evolution of the LTO Network is relative in nature. That is, there are no timelines or deadlines. This is important!
Let The Market Decide!
By definition, the LTO Network is decentralized. The LTO Network team do not intend to meddle in the market dynamics any more than is necessary to safeguard and ensure its success (which includes waiting to change the consensus algorithm when the network is sufficiently stable and diverse).
At the beginning of the article, we discussed the shortcomings of many economic models. People aren’t always rational and do not always respond positively to incentives. Sometimes people are lazy, forgetful, or careless. As such, a model based purely on theory is destined to miss the mark to some extent.
I was not surprised to discover the LTO Network team are aware that purely theory-based models and associated assumptions are inferior to sampling market dynamics to gain a better perspective on optimizing the network dynamics.
How Will the LTO Network Team Sample and Characterize Network Dynamics?
The LTO Network team, later this year, will begin to sample the network dynamics by experimenting with a manual raffle factor. The choice to sample the actual real-life network (as opposed to creating theory-based assumptions) is motivated by the very shortcomings many economic theories rely on.
What other crypto project does this?!?!
To sample the network dynamics in search of an optimal raffle factor, the LTO Network team will lease foundation funds (for free) on the LTO Network. This will allow the team to better understand how the network responds to incentives and organizes according to changes imposed on the network dynamics.
Life (and relevant) lesson: The future is not knowable. Deal with it when you get there. Have a plan. Be willing to be wrong.
LPoI is going to incentivize decentralization on the LTO Network. The LPoI variables have yet to be fixed and determined (maybe they won’t be fixed?), but the process of migrating to the LPoI consensus algorithm is underway. When the LTO Network is sufficiently mature, the LTO Network team will begin sampling various raffle factors in an effort to establish how the network actually (instead of theoretically) responds to incentives.
By design, the evolution of the LTO Network will become more decentralized and reward active participants on the LTO Network.
Many times, crypto projects make claims of decentralization but have no such means of which to secure that outcome. The LTO Network team have the LPoI algorithm — and they’re willing to tweak it — to get the right level of decentralization and network dynamics.
The LPoI consensus algorithm in many ways encapsulates how I see the LTO Network project. This is a novel approach to old problems and isn’t over-committed to the solution to the problem in advance.
LPoI is glorious.
What Doesn’t Make Sense?
Please feel free to ping me in the comments section if you want to discuss anything. You will get a thoughtful response! If I don’t know the answer, I will find it!