Staking Logbook — Kickoff

Intro

In July last year, I decided to devote as much time as possible to the crypto space. I realized that doing a master’s degree, working at a company builder and at the same time trying to wrap my head around all the amazing stuff that is going on in the crypto space is just too much to take in at once. So, I joined Staking Facilities — a Munich based Staking-as-a-Service provider for public Proof-of-Stake (PoS) Blockchains — as a working student.

Ever since, I constantly get asked by my “non-crypto” friends what the heck we are doing, what this staking thing is all about and how one can participate in all of this. After explaining our business, blockchain, proof-of-stake and a bunch of other mind-boggling topics over and over again, a friend from the Munich crypto scene, Victor von Wachter, gave me a great idea. Why not take people on a “staking journey” with me so that they can experience and get to know staking first hand?!

I want to take advantage of the turn of the year and post about my personal staking operations throughout 2020, so that you can get a better grasp of what staking is all about, how it works and what you can expect from it. So without further ado, welcome to my “Staking Logbook”!

What you can expect

These posts are for people who are only slightly familiar with blockchain — therefore I want to retain from using too much crypto-lingo as well as technical details and keep things as simple as possible.

On January first I bought two PoS crypto-assets, namely ATOM & XTZ, for a Euro equivalent of ~100€ each (see pic. 1). Immediately afterwards I staked them with Staking Facilities.(More on all of this in later posts)

Throughout the next months I will keep you in the loop of how my staking operations evolve. Additionally, I will sporadically post about anything that is staking related — always with reference to my staking operations as to make things relatable and illustrative.

Please note, that these posts are not an investment advice. They simply serve the purpose of familiarizing you with the staking space. Also, all opinions expressed in this or the following posts are my own and do not represent Staking Facilities’.

Before we dive in, let’s go over some basics:

Proof-of-Stake

Proof-of-Stake (PoS), just as Proof-of-Work (PoW) can be thought of as a mechanism to align the incentives of the parties operating the infrastructure and maintaining the blockchain.

Operating the infrastructure and taking care of the blockchain’s maintenance means, amongst others, that you provide computing power (such as servers), propose new blocks and validate transactions. Parties engaging in this process are called Validators in PoS blockchains (they are very similar to so-called “miners” in PoW blockchains). They are “special” nodes in the blockchain network. Validators get rewarded for their services in the form of block rewards (newly created tokens by the network) as well as transaction fees (paid by the users of the blockchain).

Since there is no central authority that ensures that all operations are done correctly and that no one is trying to cheat the system (e.g. by validating false transactions), a mechanism is needed that protects the network from malicious behavior. Additionally, there is a need for a mechanism that determines which validator is allowed to append the next block.

Aligning incentives — PoW & PoS

Just like in PoW networks, in which miners compete for the right to add the next block by solving a complex, computational complex “puzzle”, you have competing validators in PoS systems.

Solving the PoW puzzle leads to costs for the miners in the form of energy consumption and specific hardware. These costs are incentivizing a miner to act honestly, because the miner only gets to collect the block reward and transaction fees if the network (other miners) confirms that all the transactions included in the proposed block are valid (that is why you have to wait a little before you can be sure that your transaction is final, e.g. in Bitcoin ~ 1h). Given the transparent & distributed nature of blockchains, other miners will find out should a specific miner try to cheat. In that case, the cheating miner would not get remunerated whiler still having to bear costs. Hence, the miner is very much incetivized to act honestly.

The stake

Now in PoS networks, the same incentive is achieved by validators having to put up “stake” — capital in the form of the respective network’s native currency (e.g. XTZ for Tezos) — that is forfeited by the protocol in case of malpractice. The stake can be thought of as a security deposit that gets locked up. The size of a validator’s stake as well as other metrics such as pseudo-randomization determine the validator’s likelihood of being allowed to add the next block. This approach avoids the detour through hardware and energy that you find in PoW systems and is therefore a lot more environmentally friendly.

Incentivizing validators to act honestly increases the network’s security tremendously, which is why PoS is often referred to as the network’s security mechanism. The network’s total stake can be thought of as the network’s security budget.

You and PoS networks

Ok by now you probably grasp the main mechanics behind PoS, but you still might wonder where you come into play within all of this, right?

Well, there are some sub-forms of PoS, such as delegated, liquid or bonded Proof-of-Stake. Tezos and Cosmos utilize such sub-forms for their network’s security (more specific info about the projects in later posts). The cool thing about these sub-forms is that they allow every token-holder to participate in the network’s security and get rewarded for doing so without having to run a validator themselves.

As a token-holder, you can back a validator by delegating the right to append blocks and validate transactions (a right contained in every PoS token) to a validator of your choice. You are a delegator, Staking Facilities is a validator. This process is referred to as staking. Token holders staking with a validator ultimately raise the validator’s stake and increase the likelihood of the validator getting to append the next block.

Delegators get a share of the block rewards and transaction fees earned by the validators they are staking with. The share they receive is proportional to the size of their stake and the validator’s total stake. Validators earn money by charging a commission fee on the delegator’s rewards.

The networks have a built-in, variable inflation rate that serves to incentivise token-holders to stake their token and thereby increasing the network’s security. The less tokens staked, the higher the inflation rate in order to get people to stake their tokens. A high inflation rate means higher block rewards for people engaging in staking. People that do not engage in staking see their funds getting diluted over time.

Helpful resources:

I know this is a lot to process all at once, which is why I added some helpful links with more info on the main concepts mentioned above :

Blockchain:

https://www.youtube.com/watch?v=yiRCdMgkkFY&t=476s

https://www.youtube.com/watch?v=bBC-nXj3Ng4

PoW:

https://www.binance.vision/blockchain/proof-of-work-explained

PoS:

https://www.binance.vision/blockchain/proof-of-stake-explained

PoW & PoS:

https://www.youtube.com/watch?v=Dbe_BE8fVJ8&t=41s

https://www.binance.vision/blockchain/proof-of-work-vs-proof-of-stake

Smart Contracts:

https://www.binance.vision/blockchain/what-are-smart-contracts

Personal note: why blockchain?

To me it is fascinating that blockchain combines so many interesting fields such as finance, economics, technology and mechanism design. I see it more as an institutional rather than a pure ICT innovation (check out the work by S. Voshmgir & P. De Filippi for more on that). It is still fairly early but the big promise here is that blockchain could disrupt the internet and institutional world as we know it today. This is just too exciting to not pay attention to. With the log book I want to encourage people to learn more about and maybe even get involved with blockchain. I think that small financial incentives such as earning passive income through staking is a good way to achieve just that.

I hope that you enjoyed my first post and obtained some knowledge about blockchain and staking. Feedback is highly appreciated and in case you have any questions, feel free to comment them below.

Hope to “see” you for my next post — in which I will explain my personal staking experience of Tezos in more detail.