Understanding the Staking Ecosystem
I am a community leader in the Livepeer community, as well as Head of APAC at The Reserve researching, investing and working alongside integral early-stage crypto networks. This piece is a deep dive into the emerging staking ecosystem and its impact on the future of participation in stake based networks such as Livepeer.
Over recent years, we have seen an increase in the development of Proof of Stake (PoS) networks and staking participation. Interest in PoS can be seen most clearly by the rise of capital that is locked in PoS networks. To serve the number of new PoS chains coming to market, an entire ecosystem of service providers have sprung up to provide staking services to the crypto industry -with the goal to eventually serve the masses too.
In this post, we will take a look at PoS networks, the staking ecosystem that has been built around them and what it means for the future of crypto.
Source: https://www.theblockcrypto.com/2019/04/04/mapping-out-the-staking-ecosystem/
Proof of Work (PoW) vs Proof of Stake (PoS)
PoS is an alternative consensus mechanism to PoW, which a number of today’s largest public blockchains rely on. In a PoW network, miners compete to solve mathematical problems using physical hardware. Alternatively, in layer 1 PoS networks, a select group of validators all stake their tokens to participate in the validation process. In simple terms, PoS networks achieve consensus by selecting parties who will validate blocks based on their proportion of staked of tokens within the network.
What is Delegated Proof of Stake (DPoS)?
DPoS works functionally in a very similar manner to PoS, the key difference between the two being the addition of a delegation mechanism in dPoS networks. By enabling delegation, a dPoS network enables all token holders to participate in the validation process. Token holders can make a decision whether they would prefer to become a validator themselves or delegate this responsibility to a third-party provider. Critics of dPoS networks argue that dPoS is in many ways less secure than traditional PoS and can centralize network stakes amongst fewer validators.
What are the other advantages of different PoS based networks over PoW networks?
One of the more common criticisms of PoW blockchains is their inefficiency in terms of energy consumption. PoS chains are much less energy-intensive, as a larger portion of the work that is completed is utilized for validating blocks. PoS chains are also less wasteful than ASIC or GPU mining in terms of hardware as less of the work is being repeated to reach consensus. PoS can also be helpful for layer 2 networks using staking as a mechanism to facilitate alternative forms of work. As a layer 2 on the Ethereum network, Livepeer uses staking as a mechanism to coordinate the transcoding of video and FOAM uses staking to support the creation of a crowdsourced geospatial map, with token holders staking tokens to contribute map entries.
What are the common criticisms of PoS?
Firstly, PoS is considered by certain groups in the industry, to be far too unproven to be truly relied upon. Conversely, PoW based public chains have had the benefit of 10 years in a live adversarial environment. Furthermore, Bitcoin has provided one of the largest effective bug bounties in history, providing a massive financial incentive for attackers to find vulnerabilities in the security of the network. Another common criticism of PoS networks generally is the centralization of validators in the validation process. Networks with fewer validators are generally considered more centralized, increasing the risk of collusion between validators.
Source: LongHash Newsletter
While PoS networks in practice are designed to prevent centralization of voting, in many cases we see a select few validators controlling a significant proportion of the voting share.
Proponents of PoW argue that PoS creates gatekeepers who benefit from their oligopoly rewards, preventing hobbyist validators from reaching enough stake to be active in the validation process. Within live PoS networks, there have also been instances of validators engaging in price wars and attempting to gain market share or simply to stay competitive in a competitive fee market. These types of natural competitive market dynamics, paired with the scale benefits of running a validator, can create a centralizing force within PoS networks.
While many of these criticisms are correct, similar centralization problems can be seen within PoW networks as well, across ASIC mining hardware manufacturing and mining pools.
Source: LongHash Newsletter
The key driving force behind centralization within PoW networks is the scale benefits that come from achieving economies of scale in what are in many cases industrial businesses with high barriers to entry.
Why have PoS chain’s gained popularity?
PoS chains and staking, in general, has received increased attention this year due to the number of high profile network launches — most notably the launch of Cosmos. In preparation for the launch of their PoS network, Cosmos held their “game of stakes” competition, creating a hostile testnet environment with real tokens on the line for the winning validators. The game of stakes competition provided both excitement and a foundational testing environment for the Cosmos network, thereby showcasing the many technical challenges in running a secure setup.
To add to the excitement around PoS networks, there are a number of launches on the horizon that have captured the enthusiasm of the crypto community including Polkadot, Edgeware with its recent lock drop and of course the long-awaited ETH 2.0, in which Ethereum will gradually transition to PoS.
Why should I care about PoS?
Many active within the crypto industry are excited about PoS networks due to the scalability benefits PoS can bring, while potentially enabling advanced sharding architectures and potentially lowering the barriers to achieving interoperability between chains. While PoS is simply an alternative consensus mechanism, we see many new PoS chains also experimenting with bleeding-edge cryptography, novel scaling architectures and some chains even conducting their own on-chain governance experiments.
PoS chains represent a paradigm shift in terms of the way token holders can interact and even participate in the validation process. Traditionally in PoW networks, token holder’s percentage ownership of the network is being diluted away over time with most or all of the block rewards being given to the miners. Alternatively, in PoS chains, token holders can participate in the mining or validation process and — subject to fees — those not staking their tokens are most exposed to the impacts of the network dilution.
Why is Staking important?
Within PoS networks, staking provides a crucial role in the validation process, helping determine the likelihood of different validators being selected to produce blocks. Token holders delegation decision, whether off-chain in a traditional PoS network using third-party staking services or on-chain in a dPoS network, plays a critical role in the political process for the network and also provides a critical role in the security of the network. Within a PoS network, one of the greatest attack vectors for the network is the risk of a bad actor acquiring ⅓ of the staked tokens within the network. Therefore, the cost of acquiring and controlling ⅓ of the staked supply is the cost to attack the network. As a result of this, one of the most effective ways to increase the security of a PoS network is to increase the staking participation rate. By increasing the percentage of the network staked, this significantly increases the dollar cost of attacking the network.
How to participate in staking?
The process to participate in staking within PoS networks varies across different networks, but generally involves locking up tokens in a bound staking wallet, and thereby preventing tokens from being transferred while staked. Within most PoS networks, the largest validators are staking pools, which allow users to delegate their tokens to participate with their tokens in the validation process, passing on the inflation rewards (less a fee) for providing the service. Token holders can generally stake themselves using a staking interface provided by the project, or teams releasing tools to make the staking process easier. Livepeer, for example, provides an explorer listing all of the registered transcoders listing their inflation reward cut and fees (Livepeer explorer).
Example: Staked.us Livepeer Staking guide
Staking Marketplaces
One new staking solution for those less familiar with staking are staking marketplaces. Staking marketplaces aggregate staking pools and staking service providers into one easy-to-compare interface. While some dPoS networks provide easy to use user interface, many do not, which can make comparing the different operator’s reliability and fees difficult. Staking marketplaces aim to aggregate these options in some cases providing their own services or enables others to perform other forms of work on your behalf.
Examples: Union.market, Staked.us
Staking-as-a-Service
For those who would prefer to outsource staking, there are also a number of new Staking-as-a -Service providers who can perform the role of staking within a PoS network on investors’ behalf. Staking-as-a-Service providers are largely used by institutional investors, crypto funds and high net wealth investors who would prefer to rely on a professional third party to stake on their behalf.
Examples: Bison Trails, Chainflow, Figment Network, P2P Validator
Staking on Exchanges
For those newer to crypto, it is important to lower the barrier to entry to participate in staking within PoS networks. One interesting way in which the industry is doing this is by enabling staking on exchanges. The key player providing support for this at this stage is Coinbase building support for staking Tezos on Coinbase.
Governance within PoS networks
Due to the ideology of PoS networks, many crypto enthusiasts believe that PoS networks are better suited to on-chain and decentralized governance experiments. Two of the most well-known examples of on-chain governance are Tezos and Cosmos. Within both Tezos and Cosmos, token holders are given the opportunity to vote on key decisions such as protocol changes or upgrades, within some cases token holders deciding when these changes are ready to be rolled out to the mainnet. Within the decentralised governance space, we have also seen Aragon and Decred experimenting with decentralised treasury management, with Aragon allowing token holders to vote on whether the project treasury should participate in Polkadot’s latest fundraise. The Decred project goes one step further entirely decentralising management of their treasury allowing token holders to vote on how treasury funds should be spent.
New Inflation Funding Models
An interesting new approach we have seen within stake based networks is the birth of inflation funding models within inflationary crypto networks (see Inflation Funding in Practice). While on many existing dPoS chains we have seen operators building value add services to drive adoption, in the Livepeer ecosystem we have even seen some projects actually using the transcoder role itself to fund their projects. The transcoder role within Livepeer, performs a similar function to a validator in a traditional layer 1 PoS network, although instead of securing the network, the transcoder transcodes video which is the process of taking an input video stream and converting it into many different formats in a timely manner for low latency distribution.
Interestingly, during the initial stages of the network where the requirements of running a transcoder node have been lower we saw a number of projects using the transcoder role as a way to fund or subsidize the development of their products, while adding the benefit of their product or services on top of the protocol to drive adoption. While this new strategy may not be viable on these networks long term, it creates an interesting flywheel for both the network and projects helping them both bootstrap each others network effects simultaneously.
Examples: Video DAC, Stake Capital, Telegram Watcher Bot, Scout.cool
New Financial Products
More recently we have also seen what may be the beginning of a wave of new financial products. “Cambrian Technologies” project “Vest” aims to build staking futures contracts to allow stakers to hedge out the market exposure of their future staking rewards while providing speculators with a new way for speculators to get leveraged exposure to the asset. While some proponents might argue hedging tools removes the inherent skin in the game staking aims to provide, it also may provide infrastructure for a more mature market for staking services over the long term.
Some additional points to consider
One of the most important factors to remember when staking is the impact of inflation and fees on network dilution. There is some level of network dilution in almost all crypto networks, however, it is important to understand that not participating or paying excessive fees can have a considerable impact on what percentage of the network the token holder maintains over time. Many PoS networks also have an unstaking period which tends to vary between anywhere from a few days to multiple weeks, which adds additional liquidity constraints to consider.
Conclusion
We are in the early stages of experimenting with PoS networks and the entire industry has considerably more to learn about the role they will play in the future growth of the industry. As more token holders learn about staking and Proof of Stake, there will be considerably more experiments conducted, which could have far-reaching implications on the future of the crypto industry. For token holders, it is an exciting time to learn more about PoS networks, watch the many experiments happening across the industry and to become more actively involved in PoS networks.
