50 Shades of Staking: Part III. Validator — a Bank, Mining Pool, VC, or Exchange?
This is Part III of a series of posts dedicated to exploring the topic of staking and validation (Part II here). In this series I will argue why I see validators of a certain blockchain protocol type as future financial hubs, able to combine and capture value from several business models simultaneously, evolving into new Bitmains, Binances, USVs and Goldmans. I will be exploring various validator, masternode and block producer concepts of various projects.
Since we have covered the basics of Cosmos Network in Part II, its finally time to dig a bit deeper into the validation topic. Here is a great article describing the economics of Cosmos, their native token Atom and Validation (highly recommended read).
Despite a quite insightful article, the benefits of validating within Cosmos Network are not limited to the block rewards from own token staking in Atoms (and possibly receiving Photons) and the fee taken from the delegators.
Running a validator provides incentives which go beyond the ones above. Validator is a new crypto-native business model, which I believe has combined in itself a Mining Pool, VC Fund, a Bank and a Crypto Exchange.
Let’s look into each of these one by one:
1. Bank
Why would anyone stake tokens at the first place? In Mining 2.0 as individual investor you earn block rewards (or shares of these) not by setting up hardware rigs for CPU/GPU mining but rather than taking your assets to another party (e.g. Validator) who is one of those in charge of block creation and receiving rewards for it. This is the case with Cosmos Validators, who accumulate a certain number of Atom tokens in addition to providing a secure infrastructure, which enables them to receive block rewards. Block rewards are paid out proportionately to the delegates minus the fee.
This is very similar to taking hard-earned fiat to the bank, putting it on savings account and receiving annual interest rate. With one major difference — interest rate itself. Even though at its current stage it’s hard to estimate the annual ROI on staking Atoms due Cosmos not being on the mainnet yet and other projects like EOS just recently having launched. Estimates are in the range of 7–20% of ROI per year, which compared to any traditional savings account is a dream come true. Given the tokens at least not to be losing their fiat value on year to year basis, this offer is way better alternative to current interest rates in the EU or any other country (with possible exceptions of Venezuela and alike). Thus any rational tech savvy household instead of having fiat money in the savings account with <1% interest, should be taking part in Mining 2.0.
Thus I believe in the long term either traditional banks would feel the need to join the game to provide their clients with more lucrative savings opportunities or they would lose a great deal of a market share.
2. Mining Pool
In case of ETH mining, anyone could mine using an own GPU rig, but doing this without joining a pool is not wise since the chance of mining an Ethereum block alone with one rig are literally zero. Joining a pool guarantees a relatively stable periodic revenue flow for a fee to the pool operator. Mining pool operators typically also own and mine with own rigs due to economies of scale as well as hardware industry connections.
In case of Cosmos, one can’t stake Atoms on their own, but these have to be delegated to one of the Validators, which would charge a fee to pay for the infrastructure. This creates an incentive for Atom holders (those who want to stake their tokens) to delegate. The Validator can also use own Atom tokens to stake, using the infrastructure in place.
“Old crypto” which gets it: Bitmain got into this business as well, becoming recently one of the 21 EOS bock producers.
3. Crypto Exchange
In case of “application specific blockchains (ASBs)”, every dApp will be an own blockchain, which in case of Cosmos are called Zones. These have to be connected to the Cosmos Hub. Being connected to the Hub ensures interoperability and thus trading of the asset in question against the rest of the assets connected to the Hub.
Despite connecting to the Hub being permissionless, it requires a substantial amounts of gas, with validators being the end beneficiaries of it.
This is very similar to a crypto exchange like Binance adding new token and new trading pairs. It has been rumored Binance listing to cost anywhere between 0.3–3 million USD. CZ has since denied this, however listing on a major crypto exchange and access to large liquidity pools is very valuable event for any token. Many projects are incentivized to pay for listing in order to increase the price of the tokens held in their reserves, not to lose token holders, provide liquidity to the pre-ICO investor and so on. The numbers mentioned is the value projects are willing to expense to get connected to a large liquidity pool, most of which would in our case land with validators in form of tokens.
This shows the importance, value and thus money involved in this type of activity. Validators (or a cartel of a few of them) of all the cross-chain protocols can become the next Binance and Coinbase. This also goes well in line with Cosmos’s original vision of becoming the fastest decentralized exchange.
“Old crypto” which gets it: The exchanges themselves are in the game and want to maintain their power and are setting up own validators and block producers (EOS — Bitfinex/EOSfinex; Cosmos — Coinone, etc.)
4. Venture Capital Fund
Building up on the previous point, I think many opportunities will emerge for the funds which are planning on active network participation. Validators are the entities, which are deeply networked in a given ecosystem with close contacts to the protocol developers. They also possess a lot of capital due to their activity, fees and block rewards.
This makes them an attractive point of contact for both global and local projects building on a given protocol. I would expect not only VC running own validators, but validators themselves setting up own VCs.
Mythos Capital is also good example of a next generation crypto fund with “active investment approach, which means participating in the networks through governance and by leveraging the assets to perform services within the network.” Figment Networks is doing a great job on the same front, supporting such networks like Cosmos, Livepeer and zencash.
“Old crypto” which gets it: I am not yet aware of any VCs and large crypto funds setting up validators, but some like Coinfund are actively looking into it (please let me know of any examples you know in the comments).
Conclusion of Parts I, II and III
As I have hopefully shown in the post, the validator business model is a very promising endeavor and business concept, incorporating in itself the features of a bank, mining pool, crypto exchange and VC Fund. Companies running validators and being deeply involved in a given protocol and having a say regarding its development, are turned into multiplicators, attracting opportunities both locally and globally before the market.
Amazon Web Services and Microsoft Azure are rumored to be approaching various stakers and validators trying to cater to their needs since they see the potential and money involved.
We have seen a rise of mining pools and mining companies like Bitmain, branching out into VC buisness. We have seen a rise of VCs like Polychain, 1Confirmation and alike. We have seen meteoric rise of Binance, evolving into an exchange behemoth. I strongly believe next few years we will witness the rise of Validators. With crypto going mainstream, and blockchain standards emerging, I do see the role of validator as the enabler around it. These are going to become financial hubs of blockchain of tomorrow. These, especially since this is a closed circle of developers and entities, might even put the decentralized nature of the networks to threat and evolve to be the new intermediaries and rent-seekers.
We have barely scratched the surface and here are many nuances and components to Validation business. It is not all sunshine and rainbows as it might have seemed on the first glance. Running a Validator requires a large upfront investment as well as confidence in the protocol’s mid-to long-term success.
In my future posts (Part IV) I will go deeper in the topic of what it takes to run a validator, risks and investments associated with it. As promised, in future posts, I will also look into newer (and thus less competitive) protocols enabling similar business model like Elastos Arbitrators and Waltonchain Supermasternodes.
About the author
As a blockchain analyst at ASTRATUM, I am involved in a wide spectrum of activities, analyzing blockchain ventures and ICOs, applying cryptoeconomics and mechanism design to engineer tokens, conducting due diligence, developing blockchain strategies as well trading and investing into crypto-assets.
I am passionate about:
- Novel business models like masternodes, staking, validating/delegating
- Crypto-asset analytics and valuation
- Crypto-asset management
- Token engineering and mechanism design (game theory view)
- Smart contract platform research and analysis
- ICO/STO consulting
- Blockchain “deeptech” research
ASTRATUM is a Berlin-based blockchain venture studio, developing blockchain strategies, solutions and ventures. Besides corporate innovation in mobility, fintech 2.0 and real estate, we develop together with partners our own ventures. We are a founding member of German Blockchain Association.
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