Is Staking Truly Profitable? Robert Koschig and Angela Kreitenweis

Transcript

this is like in web 2 you have to explore how to be successful big part of the token engineering work is understand where certain mechanism might break and and this is about risks and handling risk and and rating risks and then adapt uh the design but I think this that perspective is something that protocol designers or like Founders should should keep in mind that okay then end of the day it's like okay how much Capital you want to raise with a depth that the debitor can cash in at any [Music] time I'm here at staking Summit in

beautiful Bangkok and I'm here with Robert who's a researcher at 1kx and Angela who is founder at token engineering Academy thanks for being on vas thanks for having us so you guys just uh gave a talk about uh profitability in tokenomics um which I thought was really interesting and um there's sort of lots to dissect here but you know maybe first uh starting with a bit of background for both of you and how you uh became interested in tokenomics and being profitable uh with staking okay I started in in 2017 2018 uh when I realized that the design space

for tokens is so rich and so exciting because we can design mechanisms we can Define new roles of contributors in an ecosystems um we can reward them we can align incentives and there's so much to explore then I realized to together with a bunch of other people active in this space um okay you can study nothing that really equips you well with the skills and knowledge needed and in 2020 we launched uh T fundamentals a first course to educate people in this um crossover cross disciplinary field that combines computer science game theory

mechanism design systems engineering behavioral economics and this is token engineering Academy and since then we have um 5,000 students in road now collabor ating with optimism uh with nosis with ethereum um big players in the field um checking or seeing what challenges we have how the space is evolving when it comes to mechanism design and this brought us together talking about okay they're staking one of the most the best explored mechanisms we have in the crypto sector um and and how can we have the problems the

challenges we saw on this brought us basically to to uh this to together yeah yeah so yeah I'm from one early stage Venture fund uh I joined a couple of years ago um my background is ma Finance which first brought me to like okay can you help us understand like the def5 space better and then to like oh you can do all this simulation and data science and machine learning stuff um can you actually help our portfolio companies in their token design which then expanded to like okay it's not just a simulation it's the whole process of like legal marketing the design itself the implementation um and then besides that also to you know stay on top of like okay what's the latest

and greaters on all these different mechanisms what works what doesn't work um yeah where you keep following the discussions of like latest is about staking emissions staking rewards what's good what's bad what's sustainable what's not and yeah we we noticed um that nobody's talking about profitability I before staking networks I was more narrowly looking at deepens and and trying to understand profitability in the deepens sector um because the say there the cost basis is just even bigger relatively speaking um but yeah we we can get get into that more but that's basically how we how we came into it um and look more into it so when thinking about profitability I

think there's like different ways to think about profitability you know as a as a validator uh obviously like if you're running nodes you want to be profitable you don't want to be you know losing money running infrastructure I think as as um as a delegator the question is less you know you ask yourself that question less right because you hold tokens you delegate those tokens you get rewards typically uh you you you you don't get like negative rewards there's also like protocol Prof profitability which I'd like to talk about as well but you guys are focused primarily on profitability when it comes to staking and uh looking at the differences between running your own nodes and and delegating tokens so at a high level what what did you research um f there so yeah I mean it it

was a starting point to basically say okay as in any token design you start with like okay what's the objective function here where it's like profitability is like a good good measure to to to keep keep track of um and then different stakeholders how does look like right in staking networks the core stakeholders are the ones that stake which is two parties it's either the guys running the notes or if you have delegation enable the guys to delegate to to the notes and obviously them um with with different profiles as you alluded to um and even there you can dissect even further right like if you look at the delegator space um right you have like guys like me like okay I have some E I don't want to run a

validator I'll put it into rocket pool or wherever ever because you know I'm too I'm too lazy to do it and and I'm happy to them take a commission and then you know I I I get the remaining yield um whereas then you know us as the fund or like other other institutional investors they have my different criterias right like talk talking about like not losing the money uh there's Al the whole point about like co-mingling of funds and all these regulatory requirements um so you have all these different requirements on each of them um and that obviously affects then the the profitability as well because it sets sets constraints and uh interesting thing is like seeing this across all the different networks is uh yeah was quite unexplored or is still unexplored and

and that's why we pooped into that yeah and the the token design I think and sort of the staking mechanism design between chains plays as well in your talk you focus quite a bit on eth and soul but then there's all of the tenderman um polka dot type type chains uh that have entirely different economic um mechanism behind staking where you you know you have delegators and you the question really is pretty clear right like most people are just holding tokens are going to delegate they're never going to run their own noes just because they can't get in the um in the in the top like 1 150 or whatever in the in the sticking um so

what are the different types of considerations that protocols you know should consider in terms of design yeah I think there are several steps protocol should take to design for example a staking mechanism but generally this applies to any mechanism designed to reward contributors to secure your ecosystem to um contribute data or transactions to generate fees and sometimes I think people assume that as soon as you have a smart mechanism um and some you know certain can have a certain promise on on rewards uh that

contributors can make and gain um this this is enough but I think what's highly underrated is that you have to solve a problem or find product Market fit in staking we the situation is very clear compared to many other mechanisms we we try to find out many other um problems that we try to solve like with data storage or with deep bins um for scking um it's about validations we have well defined roles we have service providers we have delegations many uh routes to onboard token holders to make them participate

lsts in in other areas this is much much more immature and then the first step is what is actually the value um people can benefit from what's the offer and how to then Define roles so that contributors can participate and profit and this is the first steps you have to take and this can't be done on a on your desk on a blank sheet of paper and then you only have to build the tag and have some sophisticated um mechanism design around it no this is like just in like in web 2 you have to explore how to be successful and and only then

if you found this and if you found traction then you can put based on the knowledge you gathered on the roles on the actual activities of the stakeholders involved then you can start build a mechanism design that does two things it's it makes it attractive it offers a profit for those who are involved and it secures the transactions because you can always take true directions it's about profits positive side and it's about penalties skin in the game uh let's say um make sure that the incentives of all players are alarmed and this is protocol this very how important is skin in the game you think for you know for for funds uh

particularly and maybe some context here you know like we uh in the early days of of interop ran our own nodes for some Cosmos chains that we were invested in realized that was like really difficult and you know took a lot of time and energy and had like cost Associated so we ended up Outsourcing that to to uh professional validators that run notes for us and for others we we delegate um so what kind of goes into consideration in terms of like as a fund whether you should run your own infrastructure delegate tokens or you know maybe you know white work with a white label um valer service I I think we touched upon a little bit in the talk but I mean uh

we as a fun of course also uh um runner on validators we even have a dedicated devops person because this is like you know not all money at Stakes uh we the the very efficient one is is he up 247 or like does he sleep yeah for sure quite a lot and as busy days less busy days um but of course we also delegate right not for all the like tokens we hold we we run all validators um because then you know we also invest in in in in Somebody Like H and and then obviously have that relationship as well but talking about skin game this is this is the core piece of staking what what also makes it this such an established

mechanism right because it's the perfect not the perfect but it's like one of the great incentive alignments of like I want you to provide something which is like you know just security or like service for deepin or even tvl if you talk defi state taking um and then how can I make sure that you you know you do this like properly and how I as a protocol want you to do it yeah I let you buy skin in the game right and obviously it's fun typically have more skin in the game um but I find like the skin in the game thing is one of those mechanisms which is really really good for staking but also when we talk about initial distributions right I mean icos were I mean right of besides all the bad

things the of the frenzy and the speculation stuff but the core piece of like you get to get your skin in the game very early on and this is how you become basically part of the community early on and the supporter early on uh this is something that in generally is is really good and that's why I'm also you know big fan of sing and that's why I also or we also D dig a lot deep into into how things work yeah I mean I feel like for for investors particularly there there's a lot of credibility that goes with like uh running infrastructure at least having your own validators in networks in which you're invested um and ab you understand right like do learn as

well left absolutely yeah you basically try the protocol you can give feedback of like Hey this not working your documentation what the things like that yeah yeah it's it's it's uh it's a wonder that you know that documentation is not as standardized could be and that you know that best best practices are not always followed by by protocols and um you know in in your work like working with protocols um H like what what kind of sort of Standards have you seen become established over the years or perhaps that you've like helped put in place um I think I mean of course I'm

looking at it from the Journey of a project from the first idea of okay this is what we' like to do this is how we'd like to reward this is why we think we'll be attractive for users um for the protocol to the mechanism and then to verifying if this can be successful because big part of the token engineering work is understand where certain mechanism might break and and this is about risks and handling risk and and rating risks and and then adapt uh the design and I think I mean just yesterday I had some conversations

on um doing something and we are very much Tech driven in in crypto so meaning there's an idea you know H immediately this is how the tech should look like this is how we could make it happen and and then the steps to wait this would mean these are the players what do they have to know what do they have to know about potential profitability how can we equip them with tracking their profitability optimizing their profitability this is a whole a whole stack of tools that might be relevant to

convince contributors uh to come on board and and yeah run transactions on your protocols and since we have more and more competition you have to I think there's really a lot to gain here um it's just this ongoing um iteration on this is an idea this might be relevant how relevant what's the size of uh potential contributors stakeholders users is it worth investing in this direction what do they need and then not only build but have this feedback loop of what's really helpful what's really relevant what puts you apart um and not try

to scale up or um take the efficiency route too early because if you think you can optimize and and just run efficiency infrastructure or build up efficiency infrastructure you might miss the actual point in it because there's there's a lot of details in making your product your offer successful then build a mechanism informed by the insights you gained in um in the conversations with investors with users and establishing this feedback loop is really important and then everything else like how the documentation looks like how the infrastructure how the tools look like

can be built on u based on this information so I would say then it's much easier to solve and much easier to decide on how to prioritize because obviously there's a lot to sort out yeah so you you you had a you had like these really nice charts and and kind of came up with a number which is the average revenue that uh a node operator uh generates per Anum uh and I was actually quite surprised that it was well as low as as it was I expected it to be higher uh but I guess like once you once you deduct infrastructure cost and like Personnel cost and all that um

you're staking Rewards or you're staking revenues um do take uh a big cut so what can you can of summarize um the the different costs and what are the average returns that validators are making brand new yeah sure um I mean this goes back to like something we published earlier this year where we had the Deep deepen focused uh article like okay in the deep in the service provider cost right like if you run storage or like just some hotspot or you have a cost to to to maintain it to set it up and and to maintain it and it's something which obviously isn't publicly

available often on purpose because often protocols want to gain efficiency by setting not competition right only the best 100 can can compete and then that's how a lot of the networks work like this um but that obviously makes makes it hard to say like okay uh you can run your own node and you understand what are your costs but overall on the network level ass setting this cost is is hard so you need to go really through the all the components labor hardware and then get some you know economies of scale assumptions of like okay if you run one versus 1,000 you probably have some some gaining here uh but rep publish the whole framework if people are interested they they they can go to

the onek website and and reach how we did that and that can obviously be translated to like staking like POS networks right you can say like hey um if you look into running an e validator um or Solana validator there's like the hardware cost which I mean for for E validators if you're really efficient then that might be you can break it down to 20 bucks however if you run it in cloud and you know you don't care so much that might be even more than 100 200 bucks then you know you do some people like how you faor in labor cost all that stuff solar Val datas by typical questions I mean they typically say like my cost is zero but they're like well the thing still runs at home has some

power cost it's low uh but even if you put that aside every time you claim there's gas cost there's additional cost when you set up the no was one of the most surprising things to me it also depends like when you do it like I think if you set up a value data right now it takes a couple of month months even be more than six months I guess to regain the gas cost that you have when you when you set up the validator um because gas is high right like like okay do solers really time their I mean they probably set it up and then it it's gone and then it's fine but these big guys you know kill light or I mean they all the time like spin up spin down validators um but

but anyway taking all this you kind of like come up with ranges of like okay what's kind of like a minimum you pay for your um validator uh on on the hardware side on verite what's more the upper range and then you just go through like okay looking at the current staking landcape where you're like okay it is you know 80% like larger operators right even on the solar valid dator side you wonder like how much of those actually a node operator um running multiple validators and and that that's kind of like the addition because this is a range on the cost side then on the income side you also have a range because it's not like everybody just gets the emission and that's it because you know it it depends

you know where you be lucky on getting the rounds for validation all that stuff it is is a wide range the 3% is just basically the average and then you just need to understand like okay that that range from negative 40 to to plus 40% APR because somebody you know got slashed or like you know got taken away a little bit because they they missed certain things and uh somebody were lucky and had the Big M Block when when it was their turn and so so they got the the tip on that end um and if you take that together on an aggregate level uh or basic say like okay this is like uh 50 bips you want to call it between like okay what's your income uh sort of uh um margin versus what's the profit

margin and interesting piece on that is okay what you bring together is kind of like the income is e but the cost side is mainly dollars so obviously as e now pumps that spread goes smaller because the the the and then I guess it's a little bit the idea also for your protocol design to understand like how how that how that fits together right because it also goes the other way around when you know when things go south the dollar aspect becomes more and more and this is when you look for example at fcoin where the cost is like way way bigger I mean running these large machines right where is some some of them pabes of of storage and this is not something you run from home and uh that that is a big chunk of dollar based

cost and then if highco is like very low that cost is very very high versus if highco is like higher than the relative uh impact of the margin is lower and then what you also see in the data Plus on top why I also feel is important to take a look at that and ficon I guess did that as well because a year ago or whatever they change the protocol uh you know the way you need to do the the proofs and and all the things don't get to into details basically cutting down the the cost of proofs by by 90% over 90% right just by making it more more efficient and these are the things pocket networ is another good example where we di into to understand how can protocols first assess okay what's the cost base of my

not Raiders and like what can we do to to make them more efficient because at the end of the day if more and more is Run Red it might not be good for your for the sustainability of your network just from the operational standpoint have to react oh I just I wanted to confirm okay yeah one one thing that was not mentioned in the talk and I'd love to get both your your thoughts on is um is kind of this this I I I guess this is more true for the tendermint style chain with high inflation and and we seen how difficult it has been for Cosmos app chains to uh to maintain High inflation and and keep their token prices afloat

and also keep have their validators continue to make money um so chain is basically they don't have Revenue yet and and and it's kind of Illusion of of of profitability when in fact you're you're you're being inflated away perhaps at some point your underlying token that you're that you're staking will will drastically reduce in in value um yeah maybe just kind of you know touching on that like what are some what what what are the uh the imperatives here that uh token holders funds validators should be thinking about uh when when when validating on

the high inflation chains and and getting these inflation rewards but you know is it is it really Revenue at the end of the day if your if your underlying asset is being deflated I mean in inflation is um the design or dealing handling inflation in a way that so that it's beneficial both for the protocol and all stakeholders involved is something that any protocol has to keep an eye on and and it's generally this is designing economic systems and I would say recently there are several very interesting approaches on mint and burn mechanisms um not even staming from

from protocols or staking ecosystems also um we'll just have um a conversation next week with huddle they have just published their white paper with an interesting mint and burn mechanism where you look at both sides so how can we design rewards and since you want to or since we have this opportunity to reward with newly minted tokens and also then step by step grow our ecosystem in volume at the same time we have to always think about how to balance this because otherwise it's just um uh you you hurt your own ecosystem yeah so what are the main takeaways I mean just

inflation uh May to go that like there's different viewpoints from protocol perspective or like a stakeholder perspective in you're investing I mean the way you can think about it is like okay this issuance this inflation based issuance is kind of like a similar to depth right because you get basically you give them something and then I need to trust you that okay at the end of the day I can cash it out whenever I want generating sell pressure or if I believe that you know we're drawing we're getting somewhere I can hold on to it so you know cash out later we're very similar to to that if you think think about it so from prod pers we like okay you're basically financing your operations issuing this debt and the more you issue in you know the higher

the depbt burden and then you see this in traditional economies it's like there are economies like the US that can create a lot of debt and nobody cares so much because they're like yeah we don't have any choice we need the dollar um whereas there are some economies that also generate a lot of debt and they're just like okay you know your exchange rate goes go sucks right and so you as a protocol it comes like when you take this perspective is like okay what do you do with that if you just maintain your operations and that's like okay the validators keep a blockchain running okay that's a good basis but you need something on top right and that's for example is an example where saw they had the staking rewards they got a

validation running they got their product out but then they started to realize okay generating more traction we maybe cut into that emission not to only incentivize the supply side but also go for the demand side and this is something we like yeah that makes ton of sense because at the end of the day there needs to be revenue or at least an outlook for existing depbt holder issuance holders to believe okay this is something and they get that by okay there's traction There's real demand for it but also outside token demand generated through that right and that that's the play you can do there's obviously also other perspectives uh where it's more about um ethereum 2 3% Solana 5 six 7% where you can where you

can think about okay if I can get that as a staking as kind of like a risk-free yield like making this comparison that has impact on your defi ecosystem for example right and this this other perspective again use a protocol design what do you actually want to enable benefit on your protocol because then again you can also make more adjustments to your design to maybe uh help Foster that if you if you really want that but I think this dep perspective is something that protocol designers or like Founders should should keep in mind that okay then the end of the day it's like okay how much do you basically how much Capital you want to raise with a depth that the debitor can cash in at any time yeah and we we've seen a lot of chains especially tenament chains Cosmos

SDK chains in the last cycle uh just issue tons of debt and never be able to repay it with with actual Revenue um and I love this uh I love this analogy with you know traditional economies I think it it uh it is very appropo uh at this particular time in uh in in place thanks so much uh this has been really fascinating enjoy the rest of uh Devcon and Bangkok enjoy as well great Devon yeah [Music] [Music]