A conversation about staking rewards and why inflation doesn't make you money

I don’t want to spend a lot of time on this post, but I think it is important to have a conversation about staking rewards and what they actually mean. I’ve been seeing a lot of posts on Reddit and Telegram with people speculating about the percent return from staking. There seems to be a misconceived notion that a higher return somehow means that people are getting richer… This is false.

People seem to think that if staking rewards are set to 10% annum, that this will result in the value of their ADA holdings going up 10% relative to the USD. This couldn’t be more wrong. The newly minted ADA being introduced to the circulating supply after each epoch is a result of inflation. Inflation does not mean that the total value of ADA is increasing. It means that the total value is simply being split into more/smaller pieces. It is essentially a tax on every ADA holder that is proportional to the amount of stake they have in the network.

Staking rewards will basically be split into two pieces…

Pool Operator – The pool operator piece will likely be a fairly static cost and is an incentive for pools to be available 24/7 and to be honest actors. This will be calculated by adding together the cost of the infrastructure to run the pool and the desired amount of money that the pool owner wants to charge for their time and effort to maintain the service.

Stake Delegator – The stake delegator piece is the amount of the block reward that remains after the pool operator has been paid. This portion is designed to incentivize ADA holders to stake their holdings honestly or to delegate their holdings to an honest pool operator.

With this, let’s take the example of 10% staking rewards and look at a quick example.

Let’s assume that I own 600M ADA of the currently 30B that are in circulation, and I want to stake them to a pool that takes 1% of the 10% stake rewards.

Before staking rewards begin, this would mean that I have 600M ADA which is 2% of the total circulating supply.

After one year, my block rewards would look something like this:

Total block rewards: 60M ADA
Block rewards paid to stake holder: 54M ADA
Block rewards paid to pool operator: 6M ADA

End of year total ADA in circulation assuming 10% inflation: 33B ADA
End of year total ADA that I own: 654M ADA

At the end of the year, I now only own 1.98% of the total circulating supply. So while my total number of coins has increased, I actually own a smaller percentage of the total ADA.

(Please note that I am only looking at relative amount of ownership in the total network. I do understand that the ADA coin will likely see capital appreciation after decentralization, because it is seen as adding value to the system. I am simply making the argument that a higher inflation rate does not somehow mean that you are “making more money”. A higher inflation rate would simply mean that those who choose not to stake would essentially be punished more harshly. That is all.)

There is something wrong in your calculation. You assume that the percentage of staking rewards and the inflation is the same (10% in your example). That would be true only if every ADA is staked, which will not be the case.

Let’s assume that 50% of all coins are staked and the staking reward is 10% (as far as I know it will be much less). The 50% of staked coins get rewarded, the other 50% don’t. So the overall inflation is 5%.
In your example, you will have 654M ADA at the end of the year with 31.5B ADA in circulation, which makes 2.076% of all coins belonging to you.

Assuming that the overall value of Cardano stays the same, stakers will gain value, non-stakers will lose value.

By what monetary theory does the additional currency issue (rewards) automatically cause inflation? If you assert constant capitalization, then you can calculate it straight from the expansion of money supply. So the question is whether capitalization is constant, and it isn’t.

Also, take a look at the currency use cases. For store of value, inflation means you would need to offset with some return (interest?). On the other hand, for moving value, a constant small rate would not impact this use case much. It has the beneficial effect of encouraging currency velocity and economic activity in the currency.

Main point is that this is all somewhat speculative, and we will need more data and theory.

Agreed… I was simply using 10% as an easy example as far as people following the calculations. If we take into account your assumption of 50% staking participation and reduce the staking rewards to 3-4%, that would still result in a net loss of stake ownership as a percentage.

As I pointed out in my main post, I am not saying that capital appreciation will not offset the cost of running the network. When I say “inflation” I am simply referencing the expansion of the asset supply. The point of this post is to show that even if block rewards are paid at 10%, that does not mean that you are making 10% in interest each year. They are absolutely not the same, yet people seem to be talking like, “Oh, this PoS coin pays 8%, but this other one only pays 6%, so therefore I am making more money with the 8% coin!” This is the point of the post.

Right, reward rate has almost nothing to do with interest. Inflation in the sense of the coin value relative to some reference is related to interest, and is what you need in interest to break even with so much inflation. Inflation in the sense of money supply is a different thing as you state.

At 100% staking, the rewards are being distributed in proportion to stake, minus the cost of minting whether direct or via pools. The implication is that there would be almost no change in the distribution of tokens, just the costs. It all feels pretty circular so that the actual rates make little difference. Of course, it isn’t a simple percentage of stake, transactions are A+B*size and would grow with transaction volume, no?

Yes, that is the cost for on-chain transactions. With there being so few transactions currently, this will obviously not be enough to cover mining costs and incentivize ADA holders to stake their coins. The bootstrapping of staking rewards from the treasury is supposed to do this instead. As @Herr_Rossi pointed out, the higher % return for staking rewards is not a benefit for the those staking their coins. Instead, it is a punishment to those who choose not to stake.

I see the point about punishment. I am curious about what the transaction rates need to be to be sustainable. Obviously it depends on the costs to run a participating node. Are there any models or estimates of this or is it just way too early to know much?

I would imagine it would be possible to forecast the costs associated with running a pool–hardware, electricity, internet access expenses, plus some small profit. The ultimate unknown is how much incentive do ADA holders need to actively participate in staking, and what percentage of participation is needed to give certain network security guarantees. This is why Charles has said that he assumes that the initial block rewards will probably be too high, but they want to ensure that participation is high enough to keep the network secure. From there, they can tinker with the rate a bit to minimize expansion and still retain a high amount of ADA being staked during each epoch.