A Preliminary Study on Staking Business Model

introduction

1.1 Overview of PoS consensus

The PoS (Proof of Stake) consensus mechanism originated in 2012. The proposal of PoS is a change in the economic concept and incentive model of the PoW consensus mechanism rather than a technological innovation. In this consensus, all nodes (validators) in the blockchain can obtain the right to produce blocks according to the size of their stake. The stake here is determined by the number of tokens owned by the node or the corresponding rules. The key to this type of consensus lies in "stake". The function of stake and its importance to the consensus mechanism have led to a variety of PoS types, including voting rights, income rights (interest), verification rights, on-chain governance rights, etc.

Compared with the PoW mechanism, the biggest advantage is that it reduces energy consumption. Instead of introducing external resources, it uses the value and penalty mechanism of the token in the network to prevent attacks and ensure the security and stability of the PoS mechanism. However, this mechanism still leads to increased development costs and complex network security mechanisms that increase the performance of the consensus chain, and the development progress has not been as expected.

The economic model in PoS is basically based on the inflation model. Why do we say that? The equity corresponding to the validator node is its equity reward, which can also be understood as a mining reward - Staking. For example, investors deposit their tokens into a designated digital wallet or mining pool to verify transactions in the blockchain network. This process will generate new digital currencies, thereby increasing the number of investors' tokens. This process is more like our daily economic thinking.

1.2 Staking Mechanism

If you don’t understand the Staking equity reward model above, then we can also understand it this way: we all deposit money into the bank (money-equity), and the bank will also pay us a certain amount of interest (interest-equity reward), and the amount of money you deposit will determine your interest or the cycle of your financial products, etc., and the bank will use your money to lend to companies or individuals in need (equity of production blocks). Isn’t this explanation much easier to understand?

The birth of the Staking mechanism connects and mobilizes the orderly network and infrastructure in the blockchain with the nodes (people) in reality. Staking seems to be the soul of the entire PoS consensus.

1.3 Comparison between Staking Mining and PoW Mining

So what is the difference between Staking mining and the “traditional” PoW mining model?

In the PoS mechanism, nodes, or miners, are mainly responsible for packaging transaction information, maintaining network operations, participating in community governance and other activities. However, there is no block reward in this process, and it often requires investing in node hardware and maintenance costs in advance. The income that a node wants to earn depends on the number of tokens pledged in the network. Generally speaking, the more tokens pledged, the more income it earns.

Retail investors in staking mining can obtain considerable returns at a relatively low cost through staking, voting, entrustment, locking and other behaviors. Retail investors generally need to pay a 5%-25% handling fee to a third party.

In terms of energy consumption, the Pow mode requires a large amount of hash power, so the energy consumption is much greater than the PoS mode, which does not generate useless resource consumption; in terms of token/passport distribution, the Pow mode depends on the size of the computing power, and the reward rules are determined by the algorithm at the beginning of the design and cannot be changed. PoS depends on the number of pledged tokens for additional rewards, but it is decided by the community and has a certain degree of modifiability; in terms of security, 51% computing power attacks ensure the security of Pow, while PoS uses the validator node pledge margin and stipulates a series of penalty conditions. When it is found that the node has taken the actions listed in the penalty conditions, the node's pledged margin will be confiscated. The behaviors that will be punished usually include malicious behaviors such as producing blocks on two chains at the same time and not producing blocks at the latest height. In terms of computing and usage performance, both are low due to their mechanisms. In the comparison of decentralization, Pow will lead to centralization due to the concentration of computing power, while the PoS model will lead to centralization due to the concentration of token chips.

2.1 The Current Staking Business Model

At present, due to market demand, many players have participated in the Staking industry. We can take a look at the changes in the total market value in recent years. As of November 19, 2019, according to the data on the official website of Stakingreward, the total market value of Staking projects has reached 12.21 billion US dollars, the locked market value has reached 7.06 billion US dollars, and the average rate of return is about 12%. From the table, we can see that since 2019, the market value has risen against the trend from the bear market in 2018, and has gradually stabilized at more than 10 billion US dollars in recent months. In the rise of market value, the launch of the main network of projects such as Cosmos and Algorand has also contributed to the development of the Staking industry. Among the many projects at present, we found through the Staking asset table that EOS has ranked first with 1.75 billion US dollars, but the locked value has dropped by about 50% compared with before. Tezos, Cosmos, Algorand, Dash, etc. followed closely behind and divided the Staking market.

Staking Market Value in 2019

Assets of major staking projects

What is the market value of the staking industry in the current digital asset market?

I have selected several key time points in the digital asset market value from 2018 to date and made the following chart. We can find that at the beginning of 2018, when the digital asset market value was at its highest, the market value of Staking assets was 70.64 billion yuan, accounting for only 8.7% of 813.8 billion yuan. At the end of April 2018, when the Staking market value was the highest, the market value accounted for 11.3%, and the lowest was at the end of 2018, accounting for only 4.7%. As of November 19, the Staking asset accounted for only 5.5%. Looking back at the changes in the market value share over the past two years, at present, Staking assets still have room to double their growth compared to the highest point at the beginning of 2018, and are also lower than the average level of 7.5%.

Overview of the Staking Industry Ecosystem

The gradual increase in the market value of the Staking industry corresponds to the gradual layout of enterprise projects in various sub-sectors of the industry. If we say that the traditional mining industry ecosystem has chip manufacturers and mining machine manufacturers in the upstream, mining farms and mining pools in the midstream, and miners in the downstream, there are sub-sectors such as exchanges, wallet service providers, and digital asset management outside the upstream and downstream. Then corresponding to the Staking business model, we will find that except for mining machines and mining farms, other sub-sectors will correspond one by one. Because the industry still has certain emerging attributes, the corresponding enterprises in various sub-sectors are still in the stage of investing money and encircling the land, but Stakingreward is already relatively leading in data services, and the competition among third-party service providers is fierce. There are Stake Capital, P2P Validator, Stake With.Us, etc. abroad, and Cobo, Wetez and HashQuark, etc. in China, all of which obtain income by serving as project nodes or node service providers. According to the comprehensive ranking of global staking service providers listed on the Staking Rewards website, My Cointainer, an Estonian staking service provider that supports 18 tokens, tops the list, while Grin Platform, which ranks second overall, supports up to 130 tokens.

What exactly do third-party service providers provide?

In the PoS mechanism, there are two main types of nodes: verification nodes and proxy nodes. Verification nodes usually refer to verifying transaction information. Proxy nodes can be regarded as a commissioned dealer, which collects votes from investors and then sends them to a verification node for verification. Third-party service providers are also third-party node operators, namely Staking-as-a-Service (StaaS) service providers, who verify on behalf of token holders. Therefore, the general public holders pledge their digital assets to third-party service providers, who manage the assets and use these nodes to exercise the above rights to share the benefits. The service providers charge a certain commission and obtain higher returns through their own technical accumulation and comprehensive operational capabilities, thereby reducing the risks and thresholds of the general public holders. Therefore, the third-party service providers play the role of "bank" here, and for the traditional mining circle, they play the role of "cloud computing power, mining machine hosting, etc.", which naturally becomes the most competitive "track".

What is the real rate of return?

As mentioned in the previous article, the average rate of return in the current Staking business model can reach about 12%. In fact, there is another point that we cannot ignore, that is, staking in exchange for income also reduces liquidity and cannot resist the fluctuation of currency prices. From the perspective of currency standard, users make money, but considering the fluctuation of currency prices, if the final income is measured in fiat currency standard, a large number of projects will suffer losses. If we use the income calculator on the Stakingrewards.com website to roughly calculate the projects with a relatively high market value in fiat currency, and if we pledge in a three-month cycle and randomly select Staking projects for 90-day income measurement, the main factor affecting the final real yield is still the change in the currency price (the correlation coefficient between the two reaches 0.98), which means that no matter what the Staking yield given by the project party is, the final real yield is still dominated by the change in the currency price, and the income obtained by most projects cannot keep pace with the decline in the currency price. In this process, users cannot stop losses in time and can only bear the risk of asset shrinkage after the pledge period ends. Therefore, I suggest that when investing in such projects, you must consider the change in the currency price, the project party, the difficulty of operation, the project return rate and other angles, and invest cautiously.

2.2 The Future of Staking Business Model

Here are some of my thoughts on the future Staking business model:

1. Huge growth space and promising future

Compared with 2018, the current market value of tokens is only one-third of the highest market value of 813.8 billion US dollars. Blockchain technology is regarded as a national strategy in China. Looking at the world, developed countries such as the United States, Singapore, the United Kingdom, and Australia have a high degree of recognition of blockchain technology, with more initial investment companies and higher investment amounts. The market development space is huge. With the gradual improvement of technology and the gradual implementation of various application scenarios, PoS consensus will break the current dominance of POW consensus in various forms, enrich industry application scenarios, and exert its huge potential for the development of the token economy in the entire industry.

2. The competition in the field of third-party staking service providers is fierce, and the real rate of return is the key.

As a service field facing the general public, it is undoubtedly the sub-field with the strongest ability to attract money. At present, many domestic and foreign companies have invested in it. The core competitiveness of third-party service providers is the real rate of return, and the rate of return is a comprehensive reflection of the company's multiple capabilities: the reputation of the node team itself, security capabilities, community influence of different projects, asset disposal capabilities for fluctuations in the rate of return of different projects, etc. Third-party service providers are like overpasses, connecting project parties, users, and PoS mining pools. This service nature is the overpass in the Staking business model. The more cars running on the overpass, the more convenient it is, the more roads there are, and the higher the cost-effectiveness, the more "tolls" the company will collect.