Understanding the security budget

[Jaromir]

Every public blockchain network needs to reward those who care about its security and decentralization. This is a similar mechanism to a company paying its employees. In order for a network to pay for services, it needs to have a steady and sustainable income. Let’s take a look at how the economics of blockchains work and how Cardano is prepared for the future.

This article was prepared by Cardanians with support from Cexplorer.

Read the article: Understanding the security budget | Cardano Explorer

[Terminada]

Great article.

Here are a couple of things I find are compelling security arguments for proof-of-stake.

Proof-of-work security is proportional to cost of work

With proof-of-work, security is proportional to the real world costs of the actual work. This is the real world costs of electricity, equipment depreciation, rent, taxes etc. that go in to produce “the work”.

Proof-of-stake security is proportional to value of capital

With proof-of-stake, security is proportional to the value of the staked capital (Ada). But, the cost of this capital is only around 3-5% of its value at current interest rates. (Any other real world costs in running the computers are minimal by comparison.)

In other words, the security of Cardano’s proof-of-stake system costs around 20-30 times less than a proof-of-work system with the same level of security. Or, put another way, the security of Cardano’s proof-of-stake system is around 20-30 times greater than for a proof-of-work system with the same costs.

The other thing I find compelling is the different effect of the “skin in the game”.

Proof-of-work “skin in the game” has alternative uses

The skin in the game for proof-of-work is the computing power. This is a real world resource with alternative uses.

Proof-of-stake “skin in the game” does not have alternative uses

The skin in the game for proof-of-stake is the token (Ada). This token does not have alternative uses outside of Cardano.

The important corollary is that using computing power to attack a proof-of-work system does not devalue that computing power. You could even short Bitcoin and profit on the downside. For example, someone could re-purpose government super computers + some mining rigs for a few days to obtain 51% of Bitcoin’s hashing power to do some double spending. Later you can hand this computing power back and it can be put to work doing something else. You haven’t destroyed its value because it has alternative uses.

On the other hand, if you acquire 51% of the Ada supply, and then use this to attack Cardano, then you have now devalued your own asset. Furthermore, you would not be able to adequately hedge your downside loss for 51% of the supply. If you held 51% of the Ada, you would be attacking your own asset and you are unable to re-purpose this asset.

These reasons, plus some others, is why I believe proof-of-work is a dead end.

[HeptaSean]

One effect of the mechanisms you describe in the article is that at some point, when the reserve is (almost) depleted and rewards will basically be collected fees, it is quite likely that the rewards you get will hardly cover the transaction fees you pay, especially if you do not have a large stake and/or are very active in terms of transactions.

I tried to discuss this a few weeks ago:

What will happen to the rewards once the reserve is (nearly) empty?

As far as I have understood it, the transaction fees shall pay the rewards in the long run, when they are not significantly boosted by the reserve, anymore. But then, for all users together (and, hence, for the average user) the rewards are approximately the same as the transaction fees they pay. So, it will be a redistribution of ADA from users with less stake and more transaction activity to users with more stake and less transaction activity. If I’m doing a lot of things in the Cardano ecos…

The answers pointed out that we have a few decades, until that is completely the case (although ROS is already going down and the 5% you are giving in the article is not really true anymore for most pools). And they surmised that there will probably be a shift to rewards going primarily to pool operators (to cover their costs) and less to delegators (which would make the calculation fees vs. rewards even worse for them).

[Terminada]

@What will happen to the rewards once the reserve is (nearly) empty?

So, it will be a redistribution of ADA from users with less stake and more transaction activity to users with more stake and less transaction activity. If I’m doing a lot of things in the Cardano ecosystem and got in too late to even become close to a whale, I will probably pay much more in transaction fees than I can ever get back as rewards.

I agree.

But I see this being ultimately viewed a little differently. I think staking rewards are going to be minimal in the long run and I think stake pool profitability, from just Ada rewards, will reduce to almost zero so that it just covers running costs.

I think Ada will be used as security for many other uses in combination with staking. Stake pools will be able to use their capital to provide security for many additional opt-in services. Side chains are one example where their staked Ada can be effectively providing security for both the Cardano base layer and the side chain at the same time. Stake pools will be able to earn additional revenue from these supported side chains. There could be multiple additional such services and the exact same Ada is being used as security for all at the same time.

Rather than seeing transaction fees as a wealth transfer to those with more capital. I think they are just fees and these fees will be driven down through competition. And capital will still be able to earn a yield dependent on demand, but this has always been the case. And it doesn’t matter how that capital was obtained - whether through being an early investor in something or by inventing some new gizmo.

If you are looking for a wealth transfer: Just tax the high earners more and transfer this money to pay for public services and to those in need.