Reward Mechanism in different POS Networks

There are over 5,000 different cryptocurrencies, and Ethereum is the second most popular and valued cryptocurrency with a market cap of $17.1 billion.

The estimated market growth of global blockchain is USD 3.0 billion in 2020 to USD 3.9 billion by 2025, and this is the massive Compound Annual Growth Rate (CAGR) of 67.3% from 2022 to 2025. In recent times, nearly two-thirds of all cryptocurrencies employ the Proof of Work (POW) consensus mechanism to add new blocks to the blockchain network. Still, many cryptocurrencies are trying to implement and shift to more efficient consensus mechanisms like Proof of Stake (POS) to fill in the gaps left by POW, for instance, mitigating the security threats like 51% attack and energy consumption problem.

In this article, we’ll explore POS and its reward mechanisms concerning various blockchain networks. Let’s dive in!

What is PoS?

Proof of stake (PoS) protocol is a consensus mechanism of blockchain used in selecting validators according to the number of holdings in the associated cryptocurrency.

The mechanism of PoS depends on how many coins a person holds — the more coins a validator holds, the more power they have to get the chance to validate a blockchain transaction and be rewarded. PoS is the second most popular consensus mechanism after PoW. It was founded to fulfill the drawbacks of PoW related to its speed, energy consumption, scalability, and efficiency.

POS reward mechanism leading Industries

In this article we will discuss different PoS reward mechanisms in four leading PoS networks:

• Polkadot
• EOSIO
• Cardano
• Ethereum 2.0

Polkadot (DOT)

Polkadot uses the NPoS (Nominated Proof of Stake) mechanism for selecting a validator to secure the system. This system encourages DOT holders to nominate a validator. Validator produces a new block in BABE (Blind Assignment of Blockchain Extension). It validates the Parachian block and guarantees finality.

In Polkadot, it is not easy for everyone to become a validator. Polkadot competition is high because there is a maximum of 1000 slots for validators. The validator needs to fight for those slots in a disposal system and set a certain amount of DOTs as security while working for the network.

At first, the system equally distributes validation rewards to all validators without considering their stake. Then the staking reward is divided into stakers in a proportionate ratio after the deduction of validation reward amount. However, this lower-staked validator can produce an equivalently staked validator set.

Polkadot is a secure and reliable PoS platform, and its estimated reward offerings are 13.87% yearly, with a staked value of approximately $16 billion. Its market cap is up to $24 billion, and about 64.04% are being staked out of eligible tokens. Polkadot can be staked on major exchanges like Kraken and Binance or using a Ledger Nano via Polkadot-JS.

Staking Polkadot can bring token holders good returns, but it does not come without drawbacks.

• Polkadot staking is quite expensive, and the minimum stake amount constantly fluctuates, meaning that nominators can find themselves staking an insufficient amount in no time, no matter if they have already nominated their validators. This results in the concentration of rewards given to stakers who have large Polkadots holding. Smaller stakers will be marginalized over time.
• The staking reward can vary from time to time as it depends upon various factors, i.e., number of nominators, validators, inflation, transaction fees, and inflation.
• If any validator misconducts, then the nominators are also punished along with validators without doing anything wrong. They are penalized by slashing, which means that they can pay some proportion of all staked DOT to the network.

EOSIO (EOS)

EOSIO is the software that allows you to create scalable decentralized networks using smart contracts, and EOS is the first (of many) networks to use it. It is a blockchain protocol based on EOS cryptocurrency. The smart contract platform guarantees to execute millions of transactions per second while also excluding transaction costs.

In EOSIO, Delegated Proof of Stake (DPOS) is used to elect the validators who are active enough to approve the valid block in the network. The other part of EOSIO is asynchronous Byzantine Fault Tolerance (aBFT) which is involved in finalizing the block, and this algorithm verifies a 100% guarantee of irreversibility within 1 second.

Block producers (BPs) are one of the most innovative concepts of EOS. BPs control the EOS blockchain, where they create the blocks. BPs are selected by the number of votes they get, and the voting power of an individual depends on the number of tokens they hold. EOS staking requires only 1 to 2 EOS; per EOS, the cost is $5.86 on 6 June 2021.

• The annual inflation rate is 5%, which is distributed in such a fashion that

1% is being used for free transactions, and 4% is reserved to fund initiatives. The 4% rate remains unused because initiatives have never been funded till now. Therefore, the annual inflation rate is not being employed appropriately.

• Protocol updates (i.e., any change in blockchain protocol) are approved by only 15 block producers out of 21 selected block producers.

Cardano (ADA)

Cardano is a public blockchain platform, which is open-source and decentralized. Its consensus is achieved by using proof of stake. With its own cryptocurrency ADA, it supports peer-to-peer transactions. The current price of one ADA is equal to $1.63 on 06 June 2021. It requires a minimum of 5 ADA for staking, which means $8.15 is required for staking in Cardano.

The Ouroboros proof-of-stake protocol permits ADA holders to receive rewards by choosing their stake to the third-party stake pool or by establishing their stake pool and by contributing some of all stake. Ouroboros decides who will add a new block to the blockchain and receive the reward for doing so.

• While staking ADA, when a stake pool reaches the saturation point (i.e., maximum capacity), the delegators acquire lower rewards.
• In another case, If a stake pool goes offline and misses a block, delegators get lower rewards. But you won’t even know about it for about two weeks. Hence the importance of trusting your stake pool operator who knows how to maintain servers and ensures uptime.

Ethereum 2.0

Ethereum 2.0 is the upgraded version of Ethereum, which is more secure, scalable, sustainable, and energy-saving. Ethereum was initially started as a proof of work blockchain, which is now migrating to a PoS blockchain named Ethereum 2.0.

As a result of this process, Ethereum’s current mining methodology will be replaced with a staking mechanism. ETH is converted to ETH2 when the validator stakes it. The price of ETH2 is the same as the price of ETH, and it will return to ETH once the Ethereum network update is complete.

Validators can get annual returns between 6% to 7% depending on the ETH they stake. The more validators join the network, the lower the annual return will be. You need to deposit 32 ETH to activate a validator software, and one ETH is equal to $2,827, so it will require $90,469 for Ethereum staking. Validator responsibility is to add a new block to the blockchain, and they need to manage those blogs. Through this process, the validator earns a new ETH.

• The downside of the Ethereum staking model is that the reward will shrink as more people join the staking. This is normal economic behavior, as the pool for rewards gets spread over more and more nodes.
• You will get penalized or get slashing if you accidentally validate an invalid transaction or if your computer goes offline for any period and your stake reduces below 16 ETH. In the worst case, you’ll be kicked off the network entirely.
• If the market value decreases, then the value of your stakes will reduce significantly; you can not withdraw ETH until the project is fully deployed, which is estimated to be in two years.

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