Multicoin Capital How to Align POS Networks with the Long-Term Interests of All Stakeholders?

Multicoin Capital Aligning POS Networks with Stakeholders' Long-Term Interests

Authors: Vishal KanKani, Tushar Jain

Translation: Luffy, Foresight News

Currently, almost all proof-of-stake (PoS) networks provide incentives through protocol staking and inflation. However, no PoS network has been able to provide a killer feature: long-term staking.

Term structures allow investors to strategically lock up capital for different periods of time in exchange for higher overall investment returns. In traditional finance, term rates form the yield curve, which is an important component of a well-functioning financial market. However, these primitives do not exist at the protocol level in the cryptocurrency space.

Note: It is important to note that while we use the terms “term structure” or “yield curve,” they operate differently from the traditional fixed income market. For example, in the United States, the Federal Reserve is responsible for managing monetary policy and controlling the flow of money. On the other hand, the U.S. Treasury issues fixed-income products to raise money that is already in circulation. In this proposal, we suggest reallocating cryptocurrency inflation programmatically implemented in PoS blockchains.

In this article, we will explore how PoS networks can better align stakeholders with the long-term success of their networks, and we propose specific financial structures to elegantly achieve this goal.

The Role of Staking

Staking is not just a way to earn rewards. It plays a crucial role in the security of PoS networks, which is why token holders can earn token rewards by participating in staking.

However, in the current staking model, rewards are distributed equally to all participants in the ecosystem, regardless of their specific contributions to the network. Whether they are short-term, long-term, or diamond hands that will never sell, they receive the same rewards. As a result, stakeholders who take risks and bear volatility to improve the network are not adequately compensated.

In addition, the ability to unstake in relatively short waiting periods may pose potential risks to the stability of the network. Especially in extreme cases where a large amount of staking is withdrawn in a short period of time, it is likely to destabilize the network, disrupt the entire system, and even worse, trigger a comprehensive economic attack.

Ethereum uses a queuing system to mitigate this risk. In this article, we explore potential alternatives.

Staking is indeed effective, but it can be better.

Long-Term Staking

Long-term staking would reward long-term stakers with a higher proportion of tokens in exchange for longer staking lock-ups, thereby promoting network stability and longevity.

Long-term staking introduces a time-locking variable during the staking process (e.g., stakers can choose to lock their staked tokens for 1 year, 2 years, etc.). The protocol can treat it as time-weighted equity, where the distribution of equity rewards favors stakers who bear more risks associated with longer durations.

Let’s define a few variables:

We intentionally define k as a separate multiplier instead of purely time-weighting the staking, which allows for flexibility. By avoiding strict time multiplication, especially in the case of long-term lockups, this design prevents excessive adverse effects on short-term staking rates. This, in turn, eliminates any potential barriers for stakers who may not have a long-term interest, ultimately preventing a decline in staking participation (which is crucial for short-term consensus security). Additionally, the long-term staking rate can be increased by increasing k if necessary.

Assuming validators perform consistently, long-term stakeholders can increase their rewards in the following way:

However, rewards for short-term stakeholders will decrease.

Exploring Financial Architecture, Promoting Risk Transfer

A PoS network can implement long-term staking in two direct ways: permanent time-locked contracts and fixed-term contracts.

Permanent Time-Locked Contracts

Firstly, the network can offer a permanent staking contract that lasts for one year to stakers interested in long-term staking. You can think of it as a redeemable bond.

Every epoch/block, stakers can submit redemption requests. After submitting a redemption (i.e., unstaking) request, they must wait for the one-year time lock to expire before they can withdraw the underlying assets.

If stakers wish to continue staking, the time lock will automatically reset to one year every epoch/block (i.e., roll over automatically). From the stakers’ perspective, they avoid any uncertainty of principal repayment beyond the one-year time lock.

If the one-year time-locked permanent staking contract doesn’t meet the stakers’ needs, the network can also introduce contracts with other durations: 3 months, 6 months, 2 years, 3 years, 5 years, 10 years, etc.

Fixed-Term Lockup Contracts

Fixed-term contracts are another way to implement term-based staking. This appears more similar to traditional bonds, where the principal will be returned on a fixed future date, and the expiration time shortens over time.

In general, we consider permanent time-locked contracts to be a better financial structure than fixed-term contracts because:

The 1-year time lock structure of permanent time-locked contracts allows the network to operate with the maximum possible time lock at every epoch/block, which effectively incentivizes long-term staking;

Because each epoch/block is locked for 1 year, multiple k can remain constant throughout the entire staking lifecycle. This is particularly important because as the expiration date approaches for fixed-term contracts, the staking multiplier for participants interested in long-term staking decreases, narrowing the interest rate differential between long-term and short-term stakers and reducing the attractiveness to long-term stakers.

DeFi: Facilitating Risk Transfer

Even the most basic implementation should cater to the preferences of long-term stakers, who need to be able to exit the native asset through liquidity staking before the staking period ends. We expect to see token pools based on term and liquidity staking emerge to facilitate this risk transfer.

Furthermore, due to the mean-reverting nature of yield rates and the power of composability, automated market makers can facilitate seamless risk transfer across terms between market participants through liquidity staking pools. In fact, yield curve trading is already an important market in traditional finance. For example, we expect independent trading of stToken-12month and stToken-6month, which will drive on-chain trading and liquidity development.

Thought Experiment: Long-Term Staking in a Hypothetical PoS Network

Let’s consider a hypothetical PoS network with a staking return rate of y = 6%. Let’s use K = 2 to balance short-term and long-term staking rates. In this calculation, we assume T = 1 year.

We find that in an extreme case where everyone engages in short-term staking, everyone would receive the same staking return rate of y = 6%. However, the first person to engage in long-term staking would receive double the rate, i.e., K * y = 12%. On the other extreme, when everyone engages in long-term staking, the staking return rate remains at y = 6%, but anyone choosing short-term staking would only receive y / K = 3%. In reality, the final equilibrium state may lie between these two extremes. Therefore, under the same inflation rate, the network has the potential to achieve higher security over a longer period of time.

Note: The above graph shows that as more people engage in short-term staking, the staking rate curve becomes steeper and incentivizes more people to engage in long-term staking.

It must be acknowledged that this thought experiment focuses on a specific time length: one year. This simplifies implementation while maintaining flexibility to easily expand to other lockup periods in the future. The process of expanding to multiple lockup periods should be a collaborative effort where the community can delve into the specific characteristics of each subsequent lockup and respective PoS network.

This design has the following characteristics: 1) simple and intuitive, 2) easy to reconfigure based on market feedback, 3) integrated with the demands of the free market, 4) ensures that the long-term staking rate is greater than the short-term staking rate.

Managing Design Risks

Long-term staking is not a panacea and there are some limitations to consider.

One of the most important risks in this design is that whales who hold a large number of tokens can lock them for the longest term and achieve the following objectives:

  • Control K (multiples of the long-term staking rate), which may penalize short-term stakers, increasing the risk of short-term stakers leaving the network and leading to centralization of the network.
  • May have a negative impact on validators who are short-term stakeholders. It may reduce the competitiveness of these validators, increasing the likelihood of these validators leaving the network.

The solution is to design a community-driven approach to determine the value of K. This multiple should be large enough and significant enough, but small enough to not harm the interests of short-term stakeholders. The determination of the final value of K requires consultation with multiple stakeholders – short-term stakeholders, long-term stakeholders, validators with different stakeholder combinations, etc.

A Stronger Blockchain

We believe that in order to ensure the resilience of the network and develop into a financial infrastructure that supports billions of users and trillions of dollars, PoS networks need to seriously consider how to incentivize long-term, value-aligned stakeholders. The yield curve is a pillar of well-functioning financial markets. Long-term staking is a native cryptographic way to turn this vision into reality, and we can also use the power of composability to create seamless risk transfer mechanisms among different market participants.

By implementing long-term staking, PoS networks can create a strong ecosystem that rewards those who participate long-term and align with the network’s values. In addition, by voluntarily locking their tokens for the long term, long-term stakers can significantly enhance the implicit security of the network. As long-term “stakeholders,” they instill confidence in the security of the blockchain, attract more stakeholders, and promote a virtuous cycle of network growth. By implementing these measures, we can significantly improve the state of PoS blockchains and enhance their stability, security, and long-term viability.