Staking and DeFi: Can They Coexist? Part1

Staking Rewards in Proof of Stake are Economically Flawed

Ryan Park
Ryan Park
Aug 29, 2019 · 6 min read
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Economic analysis of Proof of Stake

To Stake or to Not Stake:

The Introduction of a Central Interest Rate

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Staking and DeFi products compete with each other

1. Disincentivizes Ecosystem Development

Some might argue that this is natural and the ecosystem will reach an efficient equilibrium due to market effects. However, though it is likely that an equilibrium will be reached, it is highly doubtful that it’ll be efficient (in a way that it maximizes user utility). Two examples (Compound and Uniswap) are used to give a more in-depth explanation.

Compound on Post-Casper Ethereum

In contrast, in post-Casper Ethereum, a blockchain which we assume will have an staking reward rate of 2% APR from now on, ETH holders are incentivized to stake instead of pooling ETH to Compound. The supply of loanable ETH in Compound will decrease until the APR of lending goes above 2%. This will cause a rise in the borrow interest rate to 4% and above, forcing loaners to take higher interest rates, thus causing a decrease of social utility.

Uniswap on Cosmos

2. Disincentivizes dApp Usage

MakerDAO on Post-Casper Ethereum

Kava on Cosmos

3. Opportunity Cost of Interchain Transfers

Ethereum-Cosmos Peg

Therefore, since by moving one’s ETH to Cosmos holders basically miss out on potential staking rewards, the incentive to move ETH to Cosmos is reduced.
In order for the Ethereum-Cosmos ecosystem to grow, transfers to ETH to Cosmos should happen regularly, but the above problem adds hurdles to this from happening.

The Inflation Rate Dilemma

High Inflation Rate

However, since in current models tokens can only be either staked or invested/used, this reduces the total amount of assets that can be used to develop the ecosystem. This negative effect is further deepened since potentially useful applications that offer returns lower than the staking reward rate are neglected by those that can help improve them.

Low Inflation Rate

A Potential Solution

Our proof of concept implementation on Cosmos, bATOMs (bonded ATOMs) was made during the 2019 Cosmos Seoul Hackatom (which we won the 1st prize). Our aim is that ATOM delegators could generate bATOMs from their delegation positions and use those bATOMs to invest/use in various Cosmos dApps (e.g. provide liquidity to a Cosmos version of Uniswap, Open a CDP on Kava etc.). We believe by doing this PoS blockchains can achieve a higher level of security without hurting developments in the ecosystem and also help achieve higher security with a lower inflation rate.

For people who are interested in knowing the insides of Everett Protocol, the usecases and the benefits that can arise from it, we have written a follow up article. (Click here to view the article)

For folks interested in finding out more about our Hackatom entry please click here.

Everett Protocol

Generalized Liquid Staking Protocol

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