This interview was done as part of the 2021 Staking Ecosystem Report by Staking Rewards.
The report was sponsored by StaFi Protocol.
Persistence: Protocol Enabling Exposure To Multiple Asset Classes
Q: How do we ensure and incentivize further decentralization within the staking ecosystem?
A: Proof-of-stake decentralization relies on the decentralization of assets staked through a chain’s validator nodes. This means there are two aspects to the decentralization – first is the distribution of assets amongst the stakers, and second is the distribution of stakes on the validators.
- To ensure a meaningful distribution of PoS tokens among stakers and prevent accumulation in a few wallets, several efforts have been made towards devising better token launch strategies. New token launch strategies like Initial DEX offering (IDO), Liquidity Bootstrapping Pool (LBP), Liquidity Mining etc have been evolving to provide token access to a wider audience, furthering the goal of decentralization.
- As an attempt to tackle this challenge Persistence launched its stakedrop campaign through which native tokens were allocated to be distributed to PoS stakers from seven networks – Cosmos, Polygon, Kava, Terra, IRIS, Tezos, Polkadot.
- Distribution of the stakes across validator nodes is also a big challenge which has invited multiple solution attempts. Currently for the Cosmos network, the top 10 out of 125 validators have more than 45% of the voting power. To make the Staking ecosystem more decentralized, an incentivization mechanism is required that promotes smaller validator nodes to compete with the bigger validator nodes
- A particularly interesting approach that has been evolving is the weighted voting mechanism. This approach decouples a validator’s voting power from the stakes by decreasing the voting power received per staked token with increasing stakes.
- Foundations can engage more with smaller validator nodes in order to promote their prominence in the ecosystem through higher delegations. Persistence, for once, has been actively working with smaller validator partners to foster their presence in the wider PoS ecosystem.
Q: What are the biggest challenges for Proof of Stake and Staking, that we still have to overcome or may still face?
A: While the Proof-of-Stake consensus mechanism effectively deals with the shortcomings of the Proof-of-Work mechanism, it has its own downsides. Some of the biggest challenges with for PoS and Staking are:
- Nothing at Stake: Since voting on a particular version of a PoS blockchain requires no additional resources, validators are financially incentivized to mine on every fork of the chain, unlike in PoW where the miners need to channelize their mining power to a particular chain. This makes the system more vulnerable as an attacker, in order to launch a successful attack, needs to overpower only those nodes who vote on only the correct chain.
- Long-range attacks: This is a problem closely related to the above mentioned Nothing at Stake problem. The attackers can try to create an alternative chain by circumventing the penalties introduced by a project for maliciously forking the chain. An attacker has to try to get as much stake as possible to grow the attack chain faster and with more deposit than the correct chain.
- Stake Centralization: The probabilistic selection of the next block miner in PoS chains leads to validators with larger stakes to be able to mine more blocks. This in turn leads to them earning higher returns. Those with larger stakes also have a higher voting power and are able to influence the network more than their peers. Bigger validators can also form cartels, concentrating the voting power in a few select hands. This can make the network not less decentralized but also less resilient.
- Decentralization and Speed: An increase in the number of validators on a chain adversely affects the chain’s finality as higher number of governance participants lead to a higher consensus time. Finding the right balance between security and speed has been a big challenge for the staking ecosystem.
- Token distribution: The initial token distribution is crucial for PoS chains to ensure the participation of a diverse set of active stakers, while avoiding bulk distribution to a few users. Relying on natural distribution can lead to accumulation of tokens in few accounts and can in turn cause centralization of voting power.
- Opportunity cost for staked assets: Assets staked to secure the PoS chains are locked up and can not be used in the DeFi ecosystem, which causes the stakers to incur a substantial opportunity cost.
Several projects have taken steps to address these challenges:
- Casper handles nothing at stake problem through a ”wrong-voting penalty” to the protocol, where users can submit evidence of voting on the wrong chain by miners in order to penalize that miner for wrong-voting
- Peercoin introduced ‘coin-age’ mechanism to tackle stake centralization
- NXT chain attempts to tackle the long-range attacks by introducing the 720-block limit for chain re-organization attempts
- Persistence introduced Stakedrop campaigns to distribute native tokens in order to ensure optimum decentralization while involving the most active staking participants in the PoS ecosystem
- Liquid staking protocols like pSTAKE, Lido have attempted to unlock liquidity of staked assets and allow stakers to access the wider DeFi ecosystem
Q: How can smaller Staking-as-a-Service companies differentiate themselves from large players like exchanges providing staking services (e.g. Binance, Kraken, Coinbase)? Is there a danger of centralization?
A: While it can be difficult to compete with larger staking service providers like Binance, Kraken, Coinbase, etc., smaller Staking-as-a-Service providers can indeed differentiate themselves to secure a prominent position in the staking ecosystem. Persistence has developed multiple insights into the Staking-as-a-Service operations through its validator arm AUDIT One:
- Developing a robust infrastructure to ensure high uptimes and low latency for the validator operations is the most important aspect of building a good track record in the PoS ecosystem. This helps build a reliable reputation and trust amongst the stakers
- Geographical decentralization of nodes can be appealing for foundations as it compliments their overall decentralization efforts
- Engaging with foundations to support their development activities is one way to establish domain-expertise and in turn invite foundation support
- Leveraging validator’s local community to help the foundations expand their community presence is a good way to attract delegations from local stakers
- Competitive commission rates can also help attract delegations
Given the above points, there still is a fair amount of centralization of stakes across prominent PoS projects. All stakeholders across the ecosystem, including the bigger staking service providers need to take necessary steps to ensure decentralization in order to maintain chain security.
Q: What are your thoughts on the permissionless nature of staking from a legal standpoint? (due to no sign-up, or verification process, delegators cannot be explicitly forced to agree to the terms of service)
A: Permissionless nature of staking comes with both advantages and disadvantages.
A permissionless ecosystem can be more difficult to regulate from a legal standpoint since building a well-defined governance structure on the basis of accountability of actors is challenging in such a scenario. Permissionless ecosystems can also be slower and less scalable than their permissioned counterparts.
However, the accountability and scalability in a permissioned ecosystem comes at the cost of decentralization and security. A permissionless ecosystem ensures anonymity, is more transparent, and is more reliable in terms of chain security. This is because the chances of collusion amongst bad actors is minimized by the presence of a higher number of validator nodes and delegators. Measures like slashing, jailing etc. also act as fail-safes, by disincentivizing malicious behaviour in a permissionless ecosystem.
Different stages in a project lifecycle may allocate varying importance to these parameters, which leads to several projects starting with a permissioned environment to ensure scalability and accountability of initial participants. They slowly evolve into permissionless as the project matures, in order to build security through decentralization.
Q: There is a winner-takes-all sentiment emerging around staking derivatives. What do you think about this thesis?
A: The yields generated from a particular staking derivative are heavily dependent on availability of liquidity across various DeFi protocols, which associates a network effect to a particular derivative.
While this argument tries to justify the thesis of a winner-takes-all sentiment emerging around staking derivatives, there is an important additional aspect that needs to be considered here. The TVL in PoS ecosystem is about twice that in the DeFi ecosystem and these staked assets are siloed across multiple ecosystems, largest being Ethereum followed by Comsos, Polkadot, Cardano etc.
Multiple factors including the growth of PoS market cap with increasing chains adopting PoS consensus, increase in staking rations due to reduction in the opportunity cost for stakers, and rise in interchain assets flow, create ample opportunity for multiple market participants to capitalize in the staking derivatives space.
Q: Since the overall space is not matured yet, at which point, do you think, should governments and central banks move to regulate the staking space?
A: There have been multiple talks about regulatory intervention by Governments and central banks in the broader blockchain industry lately. This was specially triggered with an increase in potentially malicious actors in the space, which were inherently a cause of the increase in participation from a diverse audience and realisation of multiple use cases generating a lot of value. Parallels can be drawn to the DeFi ecosystem as well, which has been able to capture a lot of value through multiple use-cases for the cryptonative audience and hence, has led to an increase in fraudulent activities.
The staking industry is still evolving and the true potential of the staked assets has not yet been realised. As the staking ecosystem evolves through the transition of the Ethereum DeFi ecosystem onto PoS, unlocking of the staked assets through staking derivatives, and ease of interchain asset flow across PoS networks through efficient bridges, industry’s market cap and monetary opportunities will expand at an explosive pace. This will naturally attract multiple attack attempts within the ecosystem. At the same time, as the industry matures, an external catalyst can also help direct further growth and mass-adoption.
Government interventions like that seen from El Salvador can serve as this catalyst. The governments and central banks should intervene to protect the ecosystem participants from exploitation and also provide the necessary push to the ecosystem to be accepted by a broader audience. Participation of regulatory authorities in the staking activities would open gates to a huge capital reserves that can be deployed for then-realized use cases. The scale and nature of intervention will also be crucial so as to bolster the natural growth of the ecosystem, while putting in regulatory safeguards to prevent attacks.
Q: An increasing portion of miner income on the current Proof-of-Work Ethereum comes from ordering transactions (often referred to as Miner Extractable Value). It is likely to assume that this will also continue into the Proof-of-Stake world. How do you think this will impact the staking market? Do you think the existence of MEV bears risks for the network? Do you think this can be mitigated?
A: Miner Extractable Value (MEV) is the profits earned by miners in the current Proof-of-work Ethereum ecosystem through their ability to freely select, omit and order transactions within the mined blocks. Majority of the MEV is currently being exploited from the traders/bots competing to realise arbitrage opportunities by paying increasing amounts of gas fees (the bidding war is called a Priority Gas Auction) to have their transactions included in the blocks on priority.
With the evolution of Eth2.0 and the growth of Defi in the PoS ecosystem, MEV is likely to stay as the validators will now take on the responsibility of ordering transactions. This shall have multiple possible implications on the staking market, some of which are highlighted below.
- Since MEV is exploited majorly by the block proposer, there is a possibility of increase in the income gap between the bigger and smaller validator nodes as the bigger nodes with higher stakes are more likely to be selected as block proposers and earn MEV incomes. This will add to the stake centralization challenge already faced by PoS networks.
- Validators can also be incentivized to re-mine blocks that contain the arbitrage transactions. This can lead to frequent forks and chain re-organizations, which can harm the network’s stability. These are also called time-bandit attacks.
- The validators themselves can start exploiting the arbitrage opportunities for themselves that can risk the trader’s positions.
- With an increase in average validator incomes through MEV, the number of market participants running validator nodes is likely to increase, which can increase network security.
Some mitigations steps that can be taken are:
- Better design for dApps to decrease the MEV opportunities created
- Enhance finality to make time-bandit efforts more difficult
- Stricter slashing measures for validators who attempt to maliciously re-org the chain for MEV
The existence of MEV does bear risks for the network’s security and stability that can be difficult to mitigate. Attempts to prevent validators from accessing this revenue stream can trigger creation of secondary markets and also incentivize collusion between validators and traders to execute certain transactions at priority. Hence it can be a tricky problem to solve.
Q: Which network or protocol has the most sophisticated staking mechanism or staking use case that is not a Proof of Stake Layer 1?
A: When it comes to Layer 2 solutions, Polygon has grown to be one of the most popular networks, aiming to target some of the major challenges faced in the current Ethereum ecosystem like heavy fees, low TPS and poor user experience.
In order to make the staking and governance mechanism more decentralized, the network has taken multiple steps:
- Polygon Improvement Proposals to discuss and decide upon various network attributes and activities. One interesting feature
- Auction mechanism to replace underperforming validators in the active set
- Weighted stakes mechanism to adjust voting powers of validators and prevent centralization issues
While building a sophisticated staking mechanism is a challenge that still requires more research, Polygon has taken multiple steps towards doing justice to the trust acquired by the network from the staking ecosystem.
Q: Which network or protocol in the market has so far proven to have the best “product-market-fit”? And why?
A: Talking about product-market-fit, Terra has been aggressively driving its vision to lead a decentralized finance movement through its product suite catering to both crypto-native and retail audiences. Terra is a stablecoin platform that has built a suite of products around its stablecoins.
Terra’s approach was unique and exceptional in the sense that they simultaneously built out the use cases for their stablecoins, specifically UST instead of relying on third party applications to integrate with their stablecoins (UST, KRT, SDT, etc). Terra’s Anchor protocol and Mirror protocol both utilize UST, giving users the ability to generate yield by minting and using UST in Terra products.
- E-commerce payments platform, Chai, helped in bootstrapping the network’s adoption. The network’s exposure to the booming payments market in East Asia helped the platform reach 2 million users and $1.2Bn annualized transaction volumes
- Mirror protocol was the next feather in Terra’s hat. The synthetic assets platform allowing users to gain exposure to equity market and leverage price actions without owning the underlying assets helped Terra penetrate the cryptonative market
- Finally, Anchor protocol catered to the requirement of a stable yet attractive yields in the DeFi space, especially during given the rapidly fluctuating market sentiment
All these steps together led to an explosive growth in Terra’s user base and adoption of UST and LUNA, helping the network achieve product-market-fit in the staking industry.
Q: What could be done to increase overall awareness and participation in protocol governance?
A: The idea of a perfect protocol governance seems to be a little ill-conceived in the current staking ecosystem.
Drawing parallels to the real world, there are always multiple attributes up for discussion in a democratic setting that people can provide their opinion/vote on. In absence of an effective incentivization mechanism, it is unrealistic to expect all potential governance participants to vote on a proposal. This is due to a variety of reasons:
- The decisions to certain proposals affect some stakeholders more than the others
- Some actors like to actively participate in discussions and governance while others prefer to take a back seat and not get involved in the decision making process
- There is a lack of foresight amongst stakeholders while evaluating long term effects of certain decisions
PoS protocols attempt to address this complexity through incentive alignment. However, PoS networks today do not incentivize participation in governance. A protocol where a user is made eligible for additional incentives in the form of voting rewards (this could be similar to staking rewards) by voting on governance proposals, can attract a lot more participation. There can be a lot more thought put into designing a voting rewards mechanism, but this would definitely incentivise people to do some research and participate in governance.
Furthermore, expecting most token holders / stakers to participate in governance is a wrong approach to governance. As long as stakers with enough domain-expertise and alignment with the project’s long-term vision vote on proposals by doing enough research, protocols should move in the right direction.
Q: Do you see staking yields competing with DeFi yields? What are the implications of this on network security? How to balance these?
A: Staking yields and DeFi yields can not be seen to compete because of the yield farming opportunities available in the DeFi ecosystem.
PoS stakers participating in network security and governance have to lock up their assets that can’t be used anywhere else. This incurs a substantial opportunity cost for those contributing to the PoS ecosystem’s security. Hence, the attractive DeFi yields can draw stakers to exit their staked positions, which can compromise the network security. An effective balance between network security and yield generation is being sought through staking derivatives, which allow PoS stakers to use the liquid representatives of their staked assets in the wider Defi ecosystem to generate additional rewards.
The TVL in the PoS ecosystem is twice that in the DeFi ecosystem, which has led to an increased demand for additional yield on the staked assets. At Persistence, we witnessed the increasing demand for additional yield on the staked assets during the Stakedrop campaign, which led us to build the liquid staking solution pSTAKE.
Q: Are Staking Lock-Up times any good for protocols? Or unnecessarily overthinking protocol security?
A: Staking lockups are necessary for the PoS networks to ensure network security. The locking up of staked assets and the unbonding periods imposed on exiting the staked position together keep the network security relatively decoupled from the market events. In absence of the staking lock-ups, sudden changes in market sentiment can trigger a lot of stakers to exit their staked positions which will adversely affect the security. However, the staking lockup also leads to a downside where the stakers have to incur the opportunity cost of not being able to use the staked assets anywhere else and settling with the fixed yields earned on these assets. While this problem can be solved through liquid staking, the locking up of assets is essential to maintain security.
Q: We have seen a lot of talk about PoW’s energy consumption in recent months. How important is energy efficiency for PoS’ case when it comes to long-term adoption?
A: Optimizing energy consumption is extremely important for ensuring the mass adoption of the blockchain technology. With a global focus shifting towards tackling the environmental problems and devising sustainable processes, PoW has faced a lot of criticism pertaining to the increasing amount of energy that the network’s miners consume in order to mine the next blocks. This energy consumed per block keeps increasing with an increase in the size of a chain, which can limit the chain’s scalability and efficiency.
PoS networks’ energy consumption is orders of magnitude less than the PoW networks. This has been a key selling point for the advocates of the staking ecosystem. Even though there are increasing efforts towards building sustainable energy sources, the energy-footprint will be a very important factor when it comes to building the case for mass-adoption of PoS.
Q: What is your vision of the staking economy/industry in 5 years?
A: Proof of Stake is seen by many as a future-proof mechanism that is secure, efficient, cost-effective and can serve as a suitable solution for both large-scale cryptocurrencies like Ethereum as well as small-scale institutions. Although it has certain drawbacks also, the staking ecosystem has seen multiple advancements to solve major challenges faced by the PoS mechanism. Multiple derivatives of the PoS consensus like Delegated PoS, Bonded PoS, Liquid PoS, Hybrid PoS have been developed as an attempt to make the PoS algorithm more suited for mass-adoption.
The staking industry is surely evolving at a tremendous pace and, within 5 years, is set to become the market leader against alternative consensus algorithms. Having said that, we might also see governmental interventions in the coming years with an increase in the staking market cap, which might lead to some unforeseen reforms within the ecosystem. But it can be safe to say that the staking industry is here to stay.
Q: Ethereum 2.0 – What are you most excited about? What are you concerned about?
A: Ethereum 2.0 marks an important milestone in the evolution of the staking industry, and comes with multiple benefits as well as challenges. Ethereum, unlike other major PoS chains, is not a dPoS chain (stakers cannot delegate their assets to other validators).
- Exciting things
- Tackling the MEV challenge
- Liquid staking around ETH2: utility of staked ETHER derivative would decide how much ETH2 chain could be centralised
- Validator deactivation time: A queue formation when ETH2 withdrawals are activated. Stakers might rush out to withdraw staked ETH and stake with liquid staking protocols to earn additional yield on staked Ether. This queue could be potentially long and would be exciting to see how it plays out
- Validator activation time: which can cause misalignment of incentives among active validators and validators in the activation queue.
- Centralization in staking pools, which can be be more attractive to stakers because of lesser activation times
Q: With an increasing market-lead for proof-of-stake based networks. Is there a future for proof-of-work besides Bitcoin?
A: Despite the constant comparison between the PoW and PoS algorithms, and an increasing market-lead for PoS networks, there can be a balance achieved between the two. PoW networks fail to serve as a sufficient solution for use-cases which require faster transaction throughput. Furthermore, the expanding energy-footprint, increased strain on the environment, adverse media coverage, and centralization of mining operations, together make it difficult for PoW to continue as the algorithm of choice for several use-cases other than a currency serving as a store-of-value. While Bitcoin is perceived as an effective store of value, the PoW’s future seems bleak as far as mass-adoption across multiple use-cases is concerned.