Staking Rewards Revisited

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It’s been three months since I last wrote on the subject of staking rewards, and a lot has happened since then. Avalanche post-consensus was launched on September 14, and already more than 84 billion XEC have been staked across 22 different Avalanche peers. That’s nearly $3.5M worth of XEC helping to secure the network and represents a strong vote of confidence by people with actual skin in the game. I’m proud to be able to say I’m one of those people, and having gone through the practice of running my own staking node, I now have a better understanding of exactly what that entails.

Over the past few months multiple people have shared their opinion on how staking rewards should be handled. I’m glad to see that members of the community are having meaningful discussions about this important but complicated issue, and I wanted to contribute to the discussion as well.

Before I continue, I want to state that my understanding is staking rewards is not something that’s going to happen anytime soon. Bitcoin ABC’s goal is to launch Avalanche Pre-Consensus first, and staking rewards will only come afterward. There is no clear time table of when that might be. But with that said, I see no harm in thinking about the matter and trying to determine what the best solution might be for the future.

For me, the purpose of staking is to make the eCash network more valuable by improving security, usability, and scalability. Staking nodes help the network quickly decide what blocks and transactions are valid so no one can 51% attack or double-spend the network. This makes the chain more secure and functional because once Avalanche is completed, eCash transactions can be considered final within two or three seconds and gone will be the days of having to ever wait for another block confirmation again. Avalanche also helps in terms of scalability because it reduces the amount of work that miners have to do when a block comes in. In other words, it reduces the max system load for a given transaction throughput.

Certainly these are value adds to the network that come at the cost of people willing to lock up their coins as well as run their own validating nodes.

As of right now, people who stake their coins get nothing in return other than the satisfaction of knowing they are helping secure the network and protecting the value of their coins by making it more difficult for a malicious actor to attack the chain. But is that enough? When Bitcoin was first launched, in order to incentivize people to run mining nodes, a block reward was offered to those willing to expend computing resources to keep the network running. This is what’s known as proof of work. You perform work, and in return you get rewarded for it.

But technologies evolve. For example, while Bitcoin has never had a built-in funding mechanism to pay developers, eCash implemented a new rule whereby miners have to send 8% of their block reward to a developer’s fund in order to mine XEC.

When Bitcoin ABC decided on the percentage for this fund, it made sense for them to come up with the number since it was their services that were being paid for. If you’re a business owner, you aren’t required to ask your customers what they want to pay, you get to decide what you want to charge. Fortunately, it looks like the 8% seems to have worked out, but how do we determine what the reward should be for staking?

This isn’t an easy question to answer, but having now gone through the exercise of staking my coins and running my own node, I don’t think the answer should be zero.

You might argue that as an XEC holder, my incentive for running my own node is simply to help secure the chain. But I don’t think that’s enough. It leads to a situation where only a handful of people would be contributing to the network out of the goodness of their hearts while everyone else benefits at no cost to them. This is the classic free-rider problem. The truth is I’m here because I want eCash to enrich my life, not the other way around. And while running a node isn’t nearly as expensive or difficult as running a mining farm, there is a cost to do so as well as a cost to locking up my coins.

Yes, I believe in economic freedom, I want to help build the lifeboat that will protect us against CBDCs, but I’m not here to lend out my money for free solely for the benefit of others.

It’s also been argued that staking rewards could be paid voluntarily by miners. But in my experience, miners are only interested in mining what’s profitable, not in making things more complicated. I don’t see them competing with one another to offer the highest staking reward, nor do I see how it benefits them to do so. Besides, this still leaves us with the issue that holders like myself would have no incentive to run a staking node myself.

While I understand how some may think activating staking rewards is a mistake, the only mistake I see would be doing it in the wrong way, which begs the question, what is the right way? What would bring the most value to the eCash ecosystem without causing unintended or damaging consequences?

Another way of posing the question is what would be acceptable to miners, developers, and holders alike such that everyone involved will be in consensus? Perhaps this is where the original idea of the GNC could have helped. Originally the GNC was supposed to include both large stakeholders as well as the largest miners. A meeting that included both groups could have resulted in discovering what would be agreeable to everyone.

Maybe that’s what’s needed now. Bitcoin ABC has said they are in contact with most of the miners so it would be possible to ask miners what they think is best while the GNC could speak on behalf of some of the largest stakeholders to state what that contingent thinks is best.

I don’t have any answers at the moment, but what I want first and foremost is to do whatever it will take to increase the value of XEC in the long run and maximize its chances for success. That means more miners mining the chain, as well as more Avalanche peers validating transactions and blocks, and a higher price to pay for more development and infrastructure.

I think it’s safe to assume that the reward will have to come out of the existing block reward, so what percentage of it will lead to the best outcome? Lowering the mining reward can lead to miners leaving the chain, while adding a staking reward could bring new participants and a higher demand for the coin. There’s also the fact that a hybrid approach would have the added benefit of reducing the energy consumption of the chain making it more environmentally friendly, which could lead to a higher price, which could offset the decrease in the mining reward.

Another thing to consider is that if Bitcoin ABC were to announce that staking rewards are going to be removed from their roadmap, I’m guessing many stakeholders would reconsider their investment in the project. Just as miners would leave the chain if too much of the block reward were to be taken away from them, I think it’s safe to assume some long-term holders would dump their XEC if staking rewards were taken off the table.

As you can see, this is a complicated issue with many moving parts, and we’re still just barely scratching the surface.

For example, let’s take a look at some numbers to get a better sense of what we’re talking about. First, I will present some back of the envelope math to see what a hypothetical miner potentially earns by mining XEC. Keep in mind that I’m not a miner so this is purely speculative based on some light internet research. As a result there could be significant flaws in my calculations below. With that said, here’s some numbers just to give you some food for thought:

  1. Current hash rate on eCash: 420 PH/s
  2. Antminer S19 can produce 110 TH/s at 3.2 kW but we’ll use 105 TH/s to make the numbers easier
  3. 40 S19s would produce 4.2 PH/s, or roughly 1% of the total hash on the network
  4. 5.75M XEC per block x 144 blocks per day x 365 days x 1% = 3B XEC mined per year
  5. At current price that’s $125,000 per year
  6. If you can get electricity for $0.10/kWh, the cost of running 40 S19s year round is $112,128
  7. New Antminer S19s cost $4000 with an average life expectancy of 3-5 years
  8. Amortizing the hardware costs of 40 S19s over four years is $40,000 per year
  9. Plus you might have some additional costs such as the commercial space where you’re running the miners, a person who runs and maintains the machines, etc.

What this makes clear is that mining isn’t easy. In the above example, if you factor in all the sunk costs, there’s a good chance you’d be mining at a loss unless you can secure cheaper electricity or get a good deal on the hardware. The point is that all of this must be taken into consideration before moving forward with the decision to reduce the miner’s reward as they are an essential part of the eCash ecosystem.

Now let’s compare this to staking. Since we still don’t know how rewards will be distributed based on factors such as staked amount, node count, up time, etc., let’s assume that staking rewards will be roughly based on total amount staked. I’ve created a little chart laying out what the annual yield would be depending on how much XEC ultimately gets staked and what % of the block reward is allocated to staking rewards:

Note: This is all purely hypothetical and for comparison purposes only. We don’t know how much XEC will actually be staked, or what the reward amount will be.

At the moment, less than 100B XEC is staked so even a 4% reward would result in a material return. But it’s safe to assume that much more than 100B XEC will be staked once rewards go live. It’s hard to say how much more, but considering the three largest wallets alone add up to nearly 5T XEC, it wouldn’t be hard to imagine that trillions of XEC could be quickly added to the staking pool shortly after rewards go live.

Another thing to think about is that in the distant future, if a significant amount of eCash is being used in daily commerce, that means a large number of coins can’t be locked up for staking. There’s also the fact that the coinbase subsidy will be reduced by 50% with each additional halving and the only way to make up for it is by increasing the amount of transaction fees collected in each block. These are but a couple of examples, and I’m sure there are plenty of other aspects to this that need to be carefully considered beyond simply choosing a number and seeing what happens.

For the purposes of this article let’s assume 5T XEC gets staked shortly after rewards go live. If you’re someone who is staking 100M XEC (~$4,150) and the reward was the same 8% allocated for the developer’s fund, you’d earn 500K XEC per year. At the current price that’s roughly $20/year. Running a node using a VPS will cost you about $120/year so this doesn’t seem like a profitable endeavor. Even with a 46% reward, you’d barely be breaking even. For someone staking 1B XEC (~$41,500) running your own node would earn $200/year at the 8% level, or $1,200/year at the 46% level, both of which would cover the cost of your node but hardly make you rich. As such, smaller stakes might have to rely on a staking pool or centralized exchange in order to make it worth their while, though that would also mean giving up custody of your coins.

I don’t know what the future holds, but I think what these numbers show is that no one should expect to be able to just sit on their coins and get rich. The only way that’s going to happen is by continuing to build and making XEC more valuable. Just as miners have to put in work to earn a profit, the same is going to be required of everyone who has a stake in XEC in order to make it succeed.

The goal is to make it so that eCash benefits everyone and makes the world a better place, not only the early adopters, or miners, or developers. We want to build a system that incentivizes good behavior, not reward people who expect to get something for nothing.

We are still early. There’s still a ton of work to do and many problems that need to be solved. But I hope you found this information useful and I hope it can lead to more meaningful discussions regarding the future of this project. If you have any thoughts on staking rewards or see something I’ve missed, please feel free to ping me on Twitter and let’s continue the conversation.

As always, thank you for reading.