Proof of Stake & Validators: An Overview
Why is a blockchain a blockchain? Consensus. An immutable, distributed, tamper-proof agreement that things are as they say they are. A way for human social constructs to operate to parameters that are not violable.
When Bitcoin was created, it was the revolutionary use of Proof of Work mechanisms (which already had history in cryptography) to create a unit of value. Proof of Work, also the consensus mechanism of the Ethereum chain, is a way to make it too difficult — mathematically — for any individual agent to destroy the shared work.
Why Most New Blockchains Don’t Use Proof of Work
Proof of Work has criticisms though. As the network becomes larger, correspondingly larger and more powerful mining operations are needed to compete effectively. Bitcoin miner pools are now huge infrastructures, with warehouses guzzling fuel, hydropower (and even volcano power) with rack upon rack of specialised ASIC mining computers (so specialised as to create electrical waste) needed to have a chance to mine the next block and thus earn rewards. It pushes power of the network into the hands of a few colossal operations, and requires a faith that enough miners are competing, or are able to compete, to ensure its validity. Four large pools currently account for over 50% of bitcoin’s hash rate, which some perceive as a threat, as it’s an entente cordiale that users hope lasts to ensure the sanctity of the network.
Moreover, there is the risk of a ‘Tragedy of the Commons’ scenario where, because mining rewards are not eternal, continued upkeep is disincentivised because the fees eventually become the only source of revenue. The abundance of miners by that point means people will pay less fees to transact and, then, in turn, mining operations will wind down. This then leaves the network vulnerable to a 51% attack. In Proof of Work consensus, a 51% attack is fatal, as that agent could begin to falsify the blockchain and render it useless.
All that said, Proof of Work (in Bitcoin’s case) hasn’t failed once to produce consensus — the key to all this — and there is negligible indication it ever will. Yet for the reasons above, Proof of Stake is seen as a more economically and environmentally efficient approach to blockchain consensus, with even more security implied. This is why Ethereum has long mooted to shift from its current Proof of Work model to a Proof of Stake mode.
Why Proof of Stake Is Sound Consensus
Proof of Stake is now considered the regulation consensus mechanism for state of the art blockchains, and is the consensus mechanism we use at Onomy Protocol. In it, holders of the token validate and guarantee the network and the transactions taking place within it. The central idea is that any compromised network would lose value, and hurt everyone within it, so everyone is incentivised to maintain good faith. An individual’s power in a Proof of Stake blockchain is based on the number of tokens out of the total supply they hold, thus, the idea of performing a 51% attack on such a system is economically unfeasible due to the amount of tokens a user would have to own. However, even if it did occur, that user would have vested interest in not collapsing faith in its network in order to maintain the value of its investment.
How Does Proof of Stake Work?
Proof of Stake, in general, works as follows. Rather than giving the first node who solves an arbitrary problem permission to create a new block, instead proposers (or miners) of new blocks are selected from a pool of full nodes who meet certain requirements, called validators. They are already invested token holders and are selected by the protocol in varying ways. These blocks are then signed by other validators to ensure consensus.
In Proof of Stake, the algorithm pseudo-randomly selects a validator every time a new block must be proposed, and that validator can create a single block that points to a previous block. Over time, most blocks converge into a single chain. In BFT-style proof of stake, validators chosen to propose the new block are assigned completely randomly and the cohort of other validators agree that block is the correct one. It means that consensus can be achieved within a single block, rather than needing an entire chain of blocks to ensure validity.
It’s faster (most of the time), more efficient, and more community-oriented in the way it invests power in a wider group of collaborators including individual token holders.
Full Nodes and Light Nodes
Validators must run full nodes, and it’s true to say that the always-on nature and strict criteria for these means they are usually the preserve of big organisations or individuals with very sophisticated setups. The exact criteria for being a full node varies from blockchain to blockchain, ranging from a powerful systems infrastructure to a simple laptop.
Of course, a blockchain whose code requires full nodes to only have a laptop runs the risk of too many of its validators being ineffective at upkeep, and consistent failure occurring. Still, projects like Ethereum 2.0 would allow a common user with a very good individual setup to run a validator, but they must also make a 32 ETH staking investment to do so, and when that extent of investment is involved — specialised setups are a necessity.
Proof of Stake consensus also includes delegation systems, where any token holder holding any amount of the token can submit their vote (in the form of the token) to a validator and by doing so earn a portion of the rewards they earn from their network upkeep.
It means that rather than a small, central cabal of established and well-funded miners reaping all the rewards from something like Bitcoin, instead the rewards of network security are given to everyone who participates in holding and staking the token. Proof of Stake throughput is dependent on the amount of active validators in the pool, as each must sign each new block that is produced. A low number of validators creates faster throughput, which is immensely beneficial to application-specific blockchains.
Inside the Mechanics of PoS on Different Blockchains
Every Proof of Stake blockchain has a different implementation of Proof of Stake concepts. At Onomy Protocol, we are building with Cosmos Tendermint, a BFT-style consensus architecture that follows the Proof of Stake model. Ethereum’s Casper will be chain-based. Both types must select validators from their validator pool and decide how that validator pool is selected.
What Is a Validator?
The role of validators is to run a full-node and participate in consensus. A full node is simply a program that validates the transactions and blocks of the blockchain. They vote by sending out cryptographic signatures using their private key. They also commit new blocks to the blockchain and receive fees or staking rewards — in the native token — in exchange for their work.
For the Cosmos chain, for example, validators also must participate in governance proposals, and failure to vote on them can result in rewards being fined. This governance aspect is essential, as validators must be incentivised to stay at the cutting edge of community proposals and be long term supporters of the project. Governance pressure is not always incumbent upon validators. Again, it depends on the blockchain and their own specific requirements.
How Validators are Chosen
The same is true for how many active validators are chosen. On the Cosmos chain, validators are the top 125 token holders in the network who have also put themselves forward for validation duties (by broadcasting their intent to take them on). On the BSC, the top 21 token holders are selected as validators.
Until they have enough bonded (staked) tokens to put them in the active set however, they can’t sign blocks or earn rewards. Yet they can receive delegations, which incentivises new validators to impress token holders with their setups, community contributions and competitive commissions and thus garner enough support to enter the active set.
This has the knock on effect of keeping established validators at the top of their game so they remain in the active set. As said, the amount of validators in the active set through this process is specified by each blockchain, as is the time interval for promoting and demoting validators into the active set.
Once they have enough tokens, their status is updated to bonded and they can begin to sign blocks, receive rewards and propose new blocks. For each new block, a proposer is chosen from the active set ‘at random’ based on their proportion of the token staked.
However, to stop such randomness leading to unfair outcomes — one thousand times the roulette wheel lands on red — balancing factors can be coded in (e.g how recently a validator last got selected) to ensure that every validator is eventually selected, as is the case with Cosmos. Other blockchains strive for ‘true random’, but how they implement it differs, as the deterministic nature of computers means that random selection is actually pseudo-random and will always produce the same results with the same seed.
Once a validator is chosen, they get to generate a block, and the rest of the validators sign off on their work. They then get to reap the rewards of the block provision, and this is the incentive that underpins all validator actions and also helps guarantee network security.
What Must a Validator Do?
The onus on validators is quite steep, as perhaps they should be. They must always be on, as (On Cosmos, for example, new block proposers are chosen every six seconds). Failure to sign a block will result in a corresponding reduction in rewards, and after being inactive for too long, their status as a Validator can be removed.
As a result, they must have systems architecture resistant to hacks, failure and other forms of malpractice. There must be excessive redundancy in their set up so that they are insulated against power failure and other infrastructure breaches, as well as ensuring they have enough human capital to maintain operations at all times.
They must also ward off DDoS attacks, and this would include running sentry nodes and other effective monitoring systems to protect against it. They must of course also have superlative key security. Tendermint is Byzantine Fault Tolerant, meaning that although it can only tolerate up to 33% of false behaviour, that behaviour can be entirely random, flawed and malicious and the system would remain fully functional.
Validators will of course penalised for poor behaviour, whether deliberate or unintentional, and false reporting through a process known as slashing, wherein bonded tokens are paid in fines to the network. The requirements for validators means it would not be a task worth taking on if one’s own tokens were the only ones counted. This is where delegation comes in.
The Role of Delegators in a Proof of Stake Model
Standard holders of a network’s token can choose to delegate their vote to validators by delegating their tokens with them, and thus increasing that validator’s amount of bonded tokens and thus improving their chances of being selected to propose a new block, or become part of the active validator list.
Delegators who stake their tokens receive a proportion of the fees the validator generates, with validators able to set their own commission rates to attract new delegators to their operation. The rewards for this are myriad from chain to chain, and are a large part of the excitement and the uptake of the Proof of Stake model as, alongside its ecological and economic advantages, it also rewards average token holders who believe in the network and its potential growth.
This is the fundamental source of ‘income from staking’ that retail holders receive when they stake their crypto either in a blockchains ecosystem or through a centralised exchange’s rewards program. Give a man a steak, he’ll eat for a day; teach a man to stake, he’ll eat for a lifetime.
Typical Rewards for Validators
Avalanche, for example, offers roughly 9.34% to its stakers. Solana, 6.1%. Ethereum 2.0 plans to offer 5.05%, Polkadot 13.95% and BSC 19.46%. Cardano has recently entered the spotlight after it was unveiled that validators are rewarded 100% yearly.
Note roughly. These rewards, their frequency, amount, and distribution process, are all subject to change as a blockchain evolves and governance takes place. It also varies depending on activity on the network, vesting periods, and much else besides. They can also vary considerably based on which validator you stake with, as with Cosmos, for example, validators can unilaterally set the rewards sent out to their delegators. There is something of an arms race about which network can provide the most superlative rewards and attract new investors to a blockchain ecosystem.
Excessive rewards have a counterpoint, however. If much of the token supply is still locked away to be awarded to validators and delegators, then this inflationary pressure forces downward price action. If inflation is too steep, and validators and delegators accrue too much for their work, it can undermine the health of the project. Careful calibration of these rewards and their process over time is fundamental to the success of a Proof of Stake blockchain.
At Onomy Protocol, we have opted for a dynamic inflation reward to validators based on the number of NOM staked, ranging from a few percentages up to 100%, and back again — depending on the number of coins in circulation. This decision was made after thorough consideration in regards to tokenomics that assure long-term value, and particularly to incentivize liquidity onboarding into the Onomy Network in conjunction with the Bonding Curve Offering and other incentives.
The Importance of Delegators
The delegator system ensures healthy competition through a combination of competitive commissions — with different validators offering a larger cut of their rewards for running the full node — hack bounties on large validators to keep them frosty, and community common sense. It’s important to ensure there are no excess of delegators to one single validator who then reaps too large of a share of the network rewards or even begins acting malevolently. By letting delegators unstake and restake without penalty to different validators, healthy community competition can be maintained.
Delegators whose validators have been penalised will also lose a portion of their rewards, as both are subject to fines imposed by the network, which ensures delegators think wisely about who they trust to validate. This is doubly important for governance, especially with a model like Cosmos, where delegators are free to participate in community voting but, should they not, their bonded tokens are inherited by their validator who can use them to vote. In other blockchains, delegators’ only voting choice is the validator they send their vote to.
It’s natural that most delegators won’t vote or even think about voting every governance proposal, but validators must, so delegators are advised to vote with the ‘party’ whose goals for the ecosystem most closely align with their own. This two-tier system of validators and delegators gives all token holders in a Proof of Stake system a meaningful voice depending on their personal investment in the project and is one of the core attractions behind Proof of Stake.
Validating for the Onomy Network (ONET)
Onomy Protocol is building a layer-1 Cosmos SDK / Tendermint BFT proof-of-stake (PoS) blockchain network, aiming to serve as the infrastructure powering the Onomy Exchange (an inter-chain DEX with a hybrid AMM/orderbook design, Onomy Reserve (a decentralised stablecoin minting system), and Onomy Access (a cross-chain DeFi access wallet for crypto, stablecoin, and NFT management, with staking and governance functionalities).
Together, these components provide the foundation to a fully cross-chain ecosystem facilitating seamless, yet advanced trading of Forex pairs and crypto assets deployed across multiple blockchains.
To achieve these goals, Onomy has opted to maintain a high standard in operational performance and sustainability, which requires a strong validator set upholding cutting-edge hardware specifications for the bettermint of Onomy Protocol.
While the OVG is open to validators only, delegators are welcome to assign their NOM holdings to their favourite validator groups in order to obtain their share of the staking APY automatically obtained by validators who are securing the network.