State of staking: observations of a validator
stake.fish has been in operations for approximately 6 months now. We’ve made some rapid progress during this time: adding a block producer on EOS, becoming a genesis validator for Loom Network, participating in the final testnet of Cosmos, and launching the Cosmos Hub as a genesis validator. We are working on adding support for Tezos now and have been conducting due diligence on a few additional protocols that use staking.
Wang Chun launched bitfish in the summer of 2018, which has since inception grown into a project with bigger ambitions than supporting PoS blockchains. In order to streamline our operations, we spun off a brand called stake.fish that handles all businesses related to staking. The current team is working with the thesis that PoS based projects will constitute at least 40–50% of coin market cap in the next 2–3 years.
The initial phase of stake.fish is to create the security backbone for staking based projects. Chun has built one of the biggest mining pools to date. It was a natural progression for us to build out staking pools (or validators) that play a similar role in Proof-of-Stake blockchains. We have learned a lot while spinning up our validators and talking with different project teams, validators, and token holders.
We have been openly sharing our knowledge to teams and individuals that had reached out to us, and now I want to share our observations and approach in a more general format with any community member interested in staking.
Exploding interest in staking
Our initial thesis that protocols using PoS will boom has been holding up. Outside of projects that were planning to migrate over to PoS (namely, Ethereum), most of the newer projects that are now just fundraising have plans to use staking. For example, let’s take a look at projects that have conducted an Initial Exchange Offering (IEO).
There are not that many data points to forecast how much of the circulating coins within each protocol would be locked in for staking. However, the initial results show a lot of potential. The average staking ratio (total coins staked / total circulating coins) shows that coin holders see value in helping secure the network and protecting themselves from dilution even while giving up liquidity.
Now, looking at the total amount of capital actually locked up in staking, I estimate that at least $5 billion have been staked so far. This is around 3% of total market capitalization of the top 50 coins. The total amount staked has potential to increase to around $30 billion within the next year once taking into account all the new blockchains that are launching their mainnets, older blockchains that are migrating to PoS, and potential increase in staking ratios with more awareness.
Some problems (or potential opportunities)
Fair token distribution: Decentralization on PoS blockchains should not be measured by stake power distribution. Token distribution is by far the most important metric to measure decentralization. Switching costs on selecting validators are close to zero. Even if validators hold a lot of network power, the true owner of that power lies with the token holder who can easily switch validators to shift the stake power distribution. Therefore, more so than Proof-of-Work protocols, token distribution is key to achieving a healthy decentralized network on PoS blockchains.
Sustainability of validators: Fees for the services provided by validators are entirely paid out in each protocol’s native coin. The biggest two costs of validators, server hardware and payroll, are still (alas) paid in fiat. Hence, in extreme price volatility, many validators may have difficulty sustaining their operations. In the face of price decreases, on PoW blockchains, miners would exit and cause a downward adjustment to difficulty. Similar dynamic adjustments are currently non-existent on PoS blockchains.
Regulatory unclarity: Blockchain has not been around long enough for regulatory bodies and lawmakers to actively provide guidance around them. Staking itself is an even newer field. So, it is no surprise that there is not much discussed around staking. It is unclear how the rewards from staking should be recognized, how these rewards should be taxed, what sort of compliance delegators and validators would need to abide by, etc.
Governance transparency: Validators spend a considerable amount of time proposing, reviewing, and debating governance. Depending on each protocol, the coin holders are proxying their governance votes to validators or are required to vote on their own. While it is debatable whether all coin holders should be required to vote on every single proposal, it is crucial that information on each governance topic should be transparently communicated in layman’s terms.
- One of the key narratives that needs to change around staking is that staking should not be considered as a method to purely earn interest. Staking protects coin holders from being diluted from new issuance or additional coins being added to circulation. Coin holders are able to maintain their share of the network’s power by staking early on.
- The coins staked are not the only thing “at stake” for professional validators. These validators, including stake.fish, have reputation at stake. Any slashing event could prove to be devastating for any validators’ operations. Even more so if said validators had validators on multiple chains as the reputational damage from one will carry over to other chains.
- Protocols have been doing well to make slow upgrades or changes to parameters on staking. I hope this pace continues and both the protocol teams and community members do not make hasty changes, especially on the PoS economics. It will take time for markets to play out. It will be key for these communities to determine what the priorities are before chasing one issue after another.
- Security is not nearly as appreciated as they should be. First, it is extremely difficult to get validators to disclose their entire setup. Arguably, discussing infrastructure setup can create more opportunities for malicious actors. Second, even if validators do describe their infrastructure setups, there is no clear way for one to go assessing them. There is no industry standard or widely accepted metrics to do a comprehensive comparison that can serve as reference for delegators to determine who to stake with and for validators to decide whether they need to further invest in security.