Web 3 for Beginners: Proof of Stake Infrastructure

Previously, I wrote about the basic blockchain framework from a high level. If you haven’t read that and don’t know what blockchain is, I recommend going back and reading that one first. Don’t worry; it’s nice and short. In this article, we’ll get into the weeds about different types of nodes, as well as what Figment does as a staking services provider and how both small and large token holders can get involved with Proof of Stake networks.

proof of stake

In the previous article, I wrote briefly about Proof of Stake (PoS). But as you start to get more crypto-curious, it’s good to know some of the basic building blocks of what makes different chains unique. 

Why Proof of Stake?

The cost of running the software to “mine” tokens is expensive, both in computational resources and natural resources. 

Additionally, Ethereum, a popular PoW chain that is migrating to PoS, has faced criticism because of the high cost of processing transactions on the network. Transaction fees and transaction processing time are high due to the network’s limited capacity to handle many users.

In PoW networks, when users transfer tokens across wallets, the transaction fee goes to the miners who processed it (known as gas). As more people use the network, transaction fees increase. Additionally, as more people use the network, the time it takes for transactions to be processed on the network increases, up to days or weeks.

There are three main participants of every PoS network: token holders, people who hold on to PoS tokens in wallets; Delegators, who lend their tokens to Validators; who run the software to verify and sign blocks. 

PoS networks don’t require as much computing power because verifying transactions is shared proportionally amongst the Validators on the network. Unlike in PoW, there isn’t a competition between nodes to create blocks. The protocol selects validators to create blocks based on the proportion of tokens that they have bonded to the chain. A validator that has 3% of the tokens can, theoretically, validate 3% of blocks. 

Validators can receive tokens from on the network who don’t run Validators. In return, Delegators also share in the rewards.

The more stake a validator has on the network, the more likely they will be selected to create a block. The more blocks created, the more rewards Validators earn.

Three main interactions happen on a Proof of Stake network between these three groups of users:

  1. Token holders can agree to delegate (also known as bond or lock-up) a portion of their tokens to nodes. 
  2. Validating nodes then verify transactions on the network and produce blocks. In return, the network distributes rewards to Validators for their work. Validation and creation of blocks require computational power and technical skill.
  3. Validators share these rewards with their Delegators. These rewards are the incentives to stake tokens. If token holders do not delegate their tokens, they do not participate in this process and don’t earn rewards.
proof of stake

Why stake your tokens? 

Initially, the token is staked to earn new issuance (also known as inflation) subsidies. That means that token supply will increase, and stakers will obtain the newly issued tokens by receiving rewards. Generally, you can earn around 8-20% annually on your staked tokens (APY). This depends on the protocol’s issuance rate and the percent of the network that’s been staked. Those two numbers change over time. We’ll talk a little bit more about what those are in a second.

Variations of Proof of Stake

People are developing more and different versions of PoS, such as Tendermint (from Cosmos Hub), Ouroboros (from Cardano), Tezos, and Dfinity. The Tendermint algorithm has the same general rules regarding rewards and risks, so networks that run on Tendermint will have the same rules at launch.

As the network grows, the individuals can change these rules’ parameters after the network has launched. Every participant in the ecosystem can get together to change the rules of the protocol through the community governance process. But usually, only token holders have the ability to vote and formalize these changes.

Nodes + Clients on Proof of Stake networks

As decentralized networks carry different types of value, they require different nodes to run on the network. If you’ve looked into different protocols in a communication channel like Discord or Twitter, or if you’ve read a whitepaper or two, you might’ve come across the words nodes or clients in reference to the underlying structure of the blockchain itself. Nodes and clients make up the architecture of a blockchain network. 

Basic Proof-of-Stake blockchains usually contain, at the very minimum, full nodes, validating nodes, and archive nodes. After that, it will vary based on the chain. Nodes are software that can run on a computer. Typically, there isn’t a cap on how many nodes can support a chain. 

  1. Full nodes carry the full copy of the blockchain and verify transactions on the network. So long as a computer has the bandwidth and space – any machine can run a full node. Although because of their requirements, they are usually stored on servers and bug computers. 
  2. Archival nodes will store the entire balance history of any account on the chain, including storing every state change in the network. These nodes do not process transactions or provide additional security the way that full nodes do. 
  3. Validator nodes are necessary for PoS networks. These nodes validate transactions and create blocks. In return for their work, active validating nodes receive rewards for their efforts. To be an active validator, nodes need a number of tokens (known as stake) that either the validator themself, or the token holders have bonded. It will depend on the protocol requirements.

Common Types of Nodes + Clients

While the previous nodes are necessary for running the chain, protocols may run other types of nodes depending on their service. Remember that nodes are just software on a peer-to-peer network. Some other common types of nodes out there that you might see include:

  1. Light nodes (also known as light clients) only carry parts of the blockchain. The exact number of blocks that are stored on the light node is protocol-specific. A month’s worth of blocks that have been produced can be stored on the light node. 
  2. Relay nodes connect validating nodes and other nodes in the network. They are responsible for keeping lines of communication open for transactions. A node needs to accept incoming connections on a publicly accessible port, and the node’s public IP address and assigned port need to be registered with the protocol’s network.
  3. Proxy nodes are nodes that function between the validating nodes and validating nodes. Sentry nodes protect validating nodes from attacks by shielding them from the public internet.

These nodes build up the rest of the chain. Different protocols will have other nodes depending on the chain’s structure or depending on the use. These aren’t fundamental knowledge to delegating nor interacting with the chain on a case-by-case basis.

Exploring the Network

By exploring the network using a UI/UX interface, we can see some of the metrics that matter to PoS networks. Hopefully, I can give a bit of background into what to look for in a PoS network and reveal some of the underlying infrastructure that makes PoS networks work.

Like with PoW, users need to access a wallet (and obtain some cryptocurrency in the process) of the network in question. This isn’t a necessary step to exploring the network, but it is a helpful one. You’ll also need to track down a block explorer for the network. We list all compatible wallets and block explorers for all the networks we’re running nodes for on our website.

Anyone can build these tools. In fact, teams often rely on community members to build them. Because anyone can build wallets and block explorers, it’s good to double-check with the network in question. They may have the block explorer and wallets they’ve endorsed on their website or in their discord channel.

To explore the Cosmos Hub (ATOM) chain, we recommend using the Keplr wallet and the block explorer, Mintscan. Mintscan looks like this:

Mintscan is particularly helpful because it includes information from CoinGecko about the price of Cosmos’s token, the ATOM – including market cap and 24 volume. 

Block explorers will include the following: 

  1. Block times – the measure of time it takes to create a new block. Faster block times equal the quicker transactions are processed. 
  2. Block height – the number of blocks that have been created until this point. The larger the number, the healthier the chain. 
  3. Bonded tokens or percent staked – the number of tokens that have been bonded to the network. 64.43% of the existing ATOM tokens, or 174 million of the 271 million tokens, have been delegated to Validators to secure the chain.
  4. Inflation rate – the rate that tokens are scheduled to be issued, currently at 7.01% a year.

Not included on this block explorer but what is relatively common in these networks are epochs. Epochs are a measure of time where a certain number of blocks have been produced. 

If we navigate to the Validators or staking interface, we’ll see some of the statistics specific to PoS networks. 

Searching for Figment’s validator, we can see some information that’s good for Delegators to know. Voting Power refers to how much sway Figment has when we vote on proposals on network changes through a system of governance. On Cosmos Hub, voting power is proportional to the amount of stake we have bonded to the network – currently, 2,982,138 ATOM = 1.71% of stake on the web. More stake = more say in network decisions.

This also includes uptime, the number of blocks that we are available to sign. Uptime signals how often our validator is online and ready to work (100% of the time). Our commission is 9%. When the network distributes rewards to Figment, we take 9% of the rewards distributed to you. Validators take a bit of commission to offset the costs of running the infrastructure to secure the network.

There are some technicalities with staking tokens; now some of these questions are protocol specific, so if you want to start staking with a network that Figment doesn’t support, these are some good questions to find out before you start. 

How long does it take to stake & unstake the token?

Sometimes it takes a bit of time before your delegated tokens can start earning rewards. On the Cosmos Hub, if you start delegating, you’ll instantly start earning rewards. But, when you want to withdraw those tokens, exchange them, switch Validators, or just stop staking, it will take 21 days. 

Staking and un-staking usually rely on the number of epochs that have passed. After a certain amount of blocks have been created, the protocol will box those up, send out the rewards, and start a new epoch. Epochs can be days, weeks, or hours – it depends on the protocol.

Can my staked token be slashed (seized or destroyed)?

Validators are penalized for their bad behavior. Common behaviors that can get a validator slashed are downtime and double signing. Validators may also be slashed for violating the rules of the protocol. Downtime means that if a validator is offline for a certain amount of blocks, the network will automatically take a portion of their stake away. Double-signing means that if a validator signs a block twice, they might also be slashed. 

For example, on the Cosmos Hub, and often other networks that run on Tendermint, slashing happens in two ways. 1) If you delegate to a validator that is offline for over 20 hours (assuming a 7.22s block time), you will lose 0.01% of the tokens you have delegated to that validator. 2) If you delegate to a validator that signs the same block twice with the same key, you will lose 5% of the tokens you have delegated to that validator.

Is staking income liquid or automatically staked?

When rewards are distributed to Delegators, they’re either liquid, meaning they will be able to be withdrawn, or they will be “re-staked,” where the rewards are automatically added to your stake. If they are “re-staked,” they are subject to the same unbonding period as the rest of your stake. This depends on the protocol. 

For example, On the Cosmos Hub, staking income is liquid, which means you can withdraw your rewards to use at any time, but you will need to delegate them if you want to add them to your existing stake. Reward income is not automatically staked.

How are rewards disbursed? Do I have to re-delegate rewards for compounding?

Rewards may be given out on a per-block or per-epoch basis. Sometimes the protocol will automatically pay them out to Delegators and Validators simultaneously. Sometimes, Delegators need to claim their rewards, and sometimes the Validators need to claim rewards and distribute them to Delegators.

It’s good to keep track of how rewards are paid out because there are protocols out there where if Delegators don’t claim their rewards within an epoch or two, they will lose them. If the protocol dictates that validators are supposed to give out rewards, and you haven’t received any, consider switching Validators. 

Can I lose potential staking rewards?

Sometimes a protocol will have additional penalties for Validators outside of slashing. If they are offline for a significant amount of blocks or have actively engaged in malicious behavior, they can be kicked out of the active set or “jailed,” and Delegators will not earn rewards. In the Cosmos Hub, this is roughly 20 hours.

Picking a validator to delegate to may require you to ask questions like: have they been slashed recently and what’s their uptime? If Validators have an identity on the network, you might be able to find them on Twitter or get on a mailing list to receive information from them.

We have previously written about the relationship between the rewards of staking and the inflation rate. It’s a good breakdown of how rewards are calculated and how rewards change over time. It’s not technically a part of this series, but it’s the logical next stop for token holders looking to understand rewards’ underlying economics (and Cosmos Hub).

There are some risks to staking as well, which will be the following article to look forward to. In the meantime, you can find me on Twitter.

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