Human economic relationships have been based on the same basic principles for thousands of years.
An over 4,000 year-old tablet discovered in Mesopotamia, present-day Iraq, depicts an arrangement about the payment of corn, the currency of that era. This is the first recorded history of what we call a surety bond today.
Portrayed on the tablet are three parties: the first party is the obligee, who is expecting a payment of corn at some later point in time. The second party is the principal, who is supposed to fulfill this obligation. The obligee requires a guarantee from a third party, the surety, should the principal fail to meet their obligation. This guarantee is called a surety bond. Surety bonds are commonly requested to ensure contractual promises are met. They are usually obtained in exchange for annual premiums to account for the risk of the principal failing to meet their obligations.
But what does all of this have to do with Proof-of-Stake (PoS)?
In some sense, stake in a PoS network is a type of surety bond:
By staking tokens with a validator, a token holder is providing a surety bond to the protocol that this validator will meet his obligation to stay online and to faithfully validate transactions. The token holder provides this surety bond in expectation of future premiums; the staking rewards. In PoS networks with slashings, the protocol can claim a part of the surety bond should the principal (the validator) fail to meet his obligations, e.g. by going offline or double-signing. The difference between common forms of a surety bond and a PoS protocol is that premiums aren’t paid by the principal, but by the obligee (the protocol) itself.
Let’s fast forward a few thousand years and find out how these fundamental economic principles made it into the world of distributed systems and digital assets.
Pro tip: from here on developments in PoS can be followed along in the Staking Economy newsletter ;)
I hope this article helped you to understand the key milestones in the history of Proof-of-Stake!
Even though there is already a rich history of work around Proof-of-Stake, we are still at the very beginning. The pace of innovation is rapidly accelerating and many interesting experiments are and will be conducted. Some examples include: Polkadot’s Nominated Proof-of-Stake algorithm, anti-correlation penalties, exchange staking, as well as designs that will allow staking positions to unlock their full economic potential (e.g. delegation vouchers).
The next few months and years will show which PoS design will help enable a secure, decentralized, and performant blockchain network.
We will see the staking and decentralized finance space merging and hopefully will be able to avoid some of the outcomes that made so many fall out of love with the legacy financial ecosystem. I remain hopeful that the crypto community can solve this puzzle and create more sustainable systems for human collaboration.
Follow Chorus One on Twitter and give our podcast a listen (there’s an episode dedicated to this article)!
Originally published at https://blog.chorus.one on August 9, 2019.
This week we witnessed the first slashing on the Cosmos Hub. A misconfiguration of one of the validators led them to double-sign a block, which the Cosmos Hub punishes with a 5% slashing of staked Atom deposits:
While in this case, the slashing was neither the consequence of an attack on the network nor the result of a compromised validator key, it demonstrates that slashing is real and that validators should carefully design their infrastructure to mitigate the risk of losing their own and their delegators’ funds.
We have already published a high-level overview of our architecture earlier, as well as carried out an audit to test if our architecture is at risk to be compromised by outside attackers. Today, we are following the practices of some of our fellow validators (notably Iqlusion, Certus One, and Figment) and release a comprehensive (19-page) overview of our complete validation estate:
We hope that this document will prove helpful to those eager to learn more about building and running validator infrastructure. Our architecture was designed following common security best practices without compromising the ability to scale and onboard new networks and upgrade node software swiftly, even as a distributed organization. In case you are left with questions or suggestions after reading this document, don’t hesitate to contact us on Twitter or through our Telegram community channel!
PS: Some of you that have checked out the document may have wondered why there’s no blurry pictures of our server racks; sadly, our vendor doesn’t allow mobile phones on the datafloor, so have a picture of Roosevelt, our platform engineer’s cat instead:
Originally published at https://blog.chorus.one on July 4, 2019.
Cosmos Bonded Proof-of-Stake is the first major implementation of a permission-less BFT protocol. The well thought out protocol features many nuances ensuring that the Cosmos Hub blockchain is performant and that the security of the system is economically guaranteed even in the presence of malicious actors. Yet, in our view, the design space of Bonded Proof-of-Stake has barely been scratched. It’s important to explore alternative designs that can improve the user experience and the economic potential of Proof-of-Stake.
During the Cosmos Hackathon (Hack4Atom) in Berlin, the Chorus One team in cooperation with Sikka implemented changes to the staking logic in the Cosmos SDK that would allow stakers to increase utilization of their staking positions and additionally allow for a more user-friendly delegation process. These changes will open up a wide range of use cases that, in the current implementation, can only be achieved through custodial counterparties (e.g. exchanges).
We achieve this by creating a representation of staking positions we call “Delegation Vouchers”; validator-specific fungible tokens that can be traded and used in decentralized finance (DeFi) products. The following post aims to lay out the details of our implementation, its advantages, and potential use cases. You can find our implemented hackathon code on Github and a recording from the hackathon presentation itself on YouTube.
We implement a delegation pool for each validator on a Cosmos SDK chain. Instead of directly delegating to a validator, delegators transfer their Atoms to their desired validator’s pool. The pool automatically delegates to the respective validator and accrues rewards on behalf of the collective of delegators. Delegators receive delegation vouchers representing their share of the pool in return. These vouchers are fungible tokens that can be redeemed with the pool to receive their share of the pool’s updated holdings (a fraction of the delegated Atoms + accrued rewards — slashings). This is achieved by tracking a conversion ratio (Atoms/vouchers) between delegation vouchers and bonded Atoms for each validator pool. Accruing rewards increase the conversion ratio, while slashings decrease the conversion ratio.
All staking operations can be modeled using delegation vouchers. The user experience of staking on such a Cosmos SDK chain improves because rewards don’t need to be manually claimed by delegators anymore. Instead, rewards accrue for each validator pool on a per block basis. Unbonding is modeled as the burning of vouchers and receipt of underlying Atoms (calculated as vouchers times conversion ratio) after the unbonding period. Redelegation is modeled as the burning of vouchers combined with the issuance of new vouchers corresponding to the validator that received the redelegation. Newly issued vouchers resulting from a redelegation are non-transferable (frozen) for one unbonding period to make sure delegators remain accountable for infractions that were committed by the validator they redelegated away from.
Delegation vouchers could be traded at a discount bringing liquidity to staked Atoms, e.g. allowing delegators to sell vouchers on a decentralized exchange instead of unbonding. Additionally, delegation vouchers can be used in decentralized finance applications, e.g. as collateral in a DAI-style stablecoin system or in a Compound-like money market protocol. In addition, we believe delegation vouchers could allow for a market-based mechanism of ranking validator quality because delegation vouchers will need to be priced based upon their liquidity and the slashing risk associated with validators. Pools of delegation vouchers can be implemented allowing the creation of diversified tokenized delegation indices such as a Decentralization Index (pictured below). An example would be a Decentralization Index voucher tracking the delegation pattern of the Interchain Foundation. Holders of the Decentralization Index voucher will be able to foster geographic and voting power decentralization without requiring them to pay the mental cost of researching and evaluating validators. These are just a few of the possible use cases. Since one will be able to easily transfer delegation vouchers to other chains via IBC, they will enable permission-less and unbounded innovation.
While delegation vouchers may increase the security of a PoS system because there is less need for unbonding or holding liquid staking tokens, there may also be emergent types of attacks, e.g. a validator shorting his own delegation voucher and double-signing. Implications of this model need to be researched in detail. The model also raises concerns about systemic risk that could potentially arise from multiple usage of collateral. It remains too early to definitely comment on the second and third order effects of such a design.
We will do a more detailed write-up and explore extending functionalities to enable products like staking indices. In the medium term, we would like to explore a proposal to change the staking model of the Cosmos Hub to increase the utilization of staked assets. If you have feedback on our design, please let us know! Reach out to us on Telegram with your comments or if you are interested in collaborating.
Originally published at https://blog.chorus.one on June 20, 2019.
This is Part 3 of a series of posts on the Chorus One blog. Part 1 and Part 2 can be found here and here.
In Part 2 we discussed network effects in the context of the Cosmos Hub. In this post, we will focus on a key innovation in Proof of Stake networks: a mechanism that creates incentives for communities to build network effects.
The NFX venture fund estimates that 70% of the value created by technology startups since 1994 was driven by network effects! So it (a) pays to understand how they work and (b) pays for all stakeholders to go to every effort to nurture them. But network effects are notoriously hard to build. That is why successful startups are known as unicorns: the failure rate is extremely high. For every Uber, there are tens of thousands of “Uber for X” startups that never achieve critical mass, where they can match supply and demand across geographies, offerings etc. When a network effect scales to its full potential, hundreds of billions of dollars of value can be created. But the probability of this happening is very low. The good news is that the expected value across a well-chosen portfolio of networks can deliver great returns (just ask Union Square Ventures).
So what is the connection between Proof of Stake (PoS) networks and network effects?
Last week when I explained the staking economics of a Proof of Stake (PoS) network to a banker friend of mine, he was a little bemused. His intuition of money comes from the “time value of money”. It is the basis for almost everything they do. For bankers, money is created as debt. The person who borrows pays interest. The person who lends gets interest. Money today is better than money tomorrow. So to find out what a future income stream is worth today, you “discount it” by a factor based on the risk involved i.e. by how likely are you to actually get the money. This is at the heart of trillions of dollars of trades every day: bonds, treasuries, repos, CDs, etc. Even stocks are priced based on future income discounted back to today.
The banker’s intuition told him to find out where the interest payment is being made (or more specifically what interest rate — the price of money — was being paid), as this would explain the nature of the transaction and shine some light on the risks being exchanged. But this worldview doesn’t work for a Proof of Stake network and the intuition of the “time value of money” is fundamental to this misunderstanding.
To see why let’s shift back to the tech investor mindset above. Here money is earned based on a principle that we might call “the network effects value of money”. In this worldview, money is not created as debt, nor is the value captured as interest. Wealth is instead created by building a network that provides value to its users and capturing some of that value. As network effects grow according to the square of the user base (or maybe n log n at scale, see Metcalfe’s Law) the best way to build wealth is to scale a network globally. This effect is most mostly clearly visible with centralized networks, e.g. Google Adwords connecting publishers to advertisers, Uber connecting commuters to drivers, and so on.
The reason why crypto is getting so much attention in technology circles right now is that it has the potential to meaningfully reduce the high failure rate of these networks. As we have seen, scaling networks is hard. Anything that reduces this failure rate will increase the expected returns of investing in this space. If it turns out that crypto-powered networks are easier to scale than a typical (non-crypto) two-sided markets like Uber or Airbnb, then crypto networks will out-compete (and eventually take over from) non-crypto networks.
Proof of Stake networks utilize rewards to build network effects. Recognizing that network effects are hard to build, they reward community members that contribute to the network. They ask token holders (aka delegators) to make decisions about who runs the network nodes, via the validator marketplace we discussed in Part 2. By engaging token holders in this way, they incentivize attention through the mix of rewards and slashing. This is interesting from a psychological perspective: ongoing dopamine hits as gains accrue, loss aversion associated slashing risk, an IKEA effect as they are now actively contributing to the running the network. Together these things create a deeply engaged community, who then wants to spend more time on governance, evangelizing the network and contributing to the codebase. Validators, aware that they are being measured by these highly engaged delegators, now compete on the value they can add. So they write blogs and research reports, record podcasts, organize events, and get involved in governance. They build Dapps and tools like block explorers and wallets and contribute to the codebase and protocol specifications.
That is why trying to map crypto rewards in a PoS network to banking terms like interest is doomed to failure. It misses where the value is created and how it is captured. Inflation of PoS token supply is not about interest or yield. Instead, it creates a mechanism to fund public goods and community building on a massive scale. As the value of a network grows faster than the number of participants, this can have a very significant impact on the probability of success. It allows decentralized networks to grow faster with much lower failure rates than any other business model we have seen before.
This is the reason why smart investors have stayed in crypto. With 70% of the value created in the last quarter of a century being attributed to network effects, there are many reasons to believe that crypto-powered network effects will drive much of the growth in the next 25 years.
Stay tuned for more insights into the Internet of Blockchains in Part IV.
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