Delegated Proof-of-Stake Overview

For previous topics covering delegated proof of stake, see Part 1 DPoS: The Protocols and Part 2 DPoS: The Validators.

Delegates are delegated proof of stake (DPoS) coin/token holders who stake their cryptocurrency and vote for block-producing validators. Staking involves locking up tokens in a wallet or web-based portal to gain rights to vote and receive block rewards. Each protocol varies on the consensus mechanism, but most allow delegates to vote for multiple validators to verify transactions and ensure the blockchain network remains operational. Validators must validate transactions, reach a consensus, and the next block is produced by a validator that the protocol chooses based on the number of tokens staked to that validator. Although staked tokens are locked from trading, the tokens remain in the possession of the owner. Thus, when tokens are staked to support a validator, only the power of the staked tokens is directed to the validator, but the validator does not have access to the tokens.

The Ideal Crypto Delegate

When developers are structuring DPoS protocols, they are attempting to solve the blockchain trilemma by optimizing speed or scalability, decentralization, and security. Current DPoS systems do effectively solve the blockchain trilemma, but only with select groups of professional software and hardware managers to ensure the chain operates as designed. Usually, this is a subset of the validators who has the most votes staked toward them. Whether the protocol allows the top 20 or the top 50 to reach consensus, process transactions, and create new blocks, only these top validators earn rewards. The other validators are on standby and must market to users to earn more votes to move into the top positions. But the original goal of Proof of Stake (PoS) was to get the whole community involved in the blockchain project and make everyone holding the native cryptocurrency a node instead of just Proof of Work (PoW) miners making decisions about chain upgrades.

To keep community involvement without demanding individuals buy special hardware, stay connected to the internet 24/7, or quickly upgrade software when patches or improvements are pushed out, DPoS allows engagement by voting for validators who are responsible for software and hardware upkeep. Thus, voting is attached to the staking process.

An ideal delegator will evaluate potential validators and research their qualifications. The delegator will review the team’s hardware or cloud server computing specs, credentials, the team’s plan for community engagement, plans for protocol ecosystem improvement, and what percentage of earned staking rewards they intend to share with voters.

Once a delegate knows which validator(s) they want to vote for, the next step is staking tokens. Delegates fully committed to the protocol’s mission will stake the maximum number of digital assets they can afford to enhance the chances of validators they believe to be the best gaining top positions. If a delegate believes they have chosen the best validator(s), they want the validator teams to be responsible for chain updates, decentralized app developer recruitments, keeping the chain free of malicious actors, and informing their constituents of chain events (good and bad).

Voting is ongoing. Some protocols have epochs, which are dedicated time zones to cast votes for new validators; other chains allow votes to occur at any time, causing validator positions to be in constant flux. So, after a delegate stakes their coins and votes, the ideal behavior is to stay involved with ongoing developments in the protocol’s ecosystem. Staying informed about each validator’s securing the network behavior, accomplishments, and other events could influence votes, and it strengthens the protocol via community governance.

Engagement is especially important when proposals are presented to the community; a protocol needs the maximum number of delegates involved. Proposals could include anything from protocol software upgrades to funding requests for conferences or MeetUps. When educated Delegators pay attention to every proposal, the chances of ensuring the blockchain project continuously moves in a positive direction increase.

The ideal delegate will go beyond voting for good proposals and also evangelize for the project. Delegates empowered with a voting voice expand the community by telling others about the project and creating a compound network effect of involvement.

Problems with DPoS and Delegators

Although developers and validators attempt to create an environment where delegates are highly engaged, a track record is forming for DPoS systems that reflect the same problem as real-world political involvement, voter apathy.

Projects may begin with high delegate engagement, but after the initial vote, participation falls at a steep rate. EOS attempted to hinder this by introducing vote decay. If a delegate does not recast previous votes, a gradual loss of voting power occurs until all power is decayed after 2 years. According to EOS Authority, vote decay averages around 4% and can reach as high as 21%. However, an upgrade solution passed that allows voter proxies to refresh votes on delegates’ behalf, and there are tools within some wallets that allow individual users to auto-refresh votes.

An issue with rewarding delegates with a portion of block rewards is the danger of a race to the bottom for validators to gain attention by giving away the most rewards, regardless of their technical prowess. This is especially problematic for talented smaller teams that need ongoing funding to operate. It takes much time and energy to convey to Delegates other benefits of voting beyond rewards. Teams must put forth the effort to communicate how competent teams catch bugs before they are destructive to the chain, engaged teams think creatively about community outreach efforts, technical excellence means making efforts to improve the software code and provide details about new functions, and the burden is on knowledgeable teams to communicate plans that may never happen if certain Validators are voted to controlling positions. However, even after such efforts, there is no guarantee that a percentage of Delegates will only care about short-term gains.

Lack of involvement with chain developments ties in directly with governance. Protocol developers envision mass participation with decisions about protocol updates, expansions, and project funding. Usually, better and uncorrupted decisions come from many disinterested parties. However, if the majority of Delegate Stakeholders are uninterested in the daily maturation of the ecosystem, there is a higher chance for collusion, neglect, or bad decision-making by those who are responsible for the blockchain’s upkeep. Continuous governance presents advantages and disadvantages to every proof-of-stake model, but it’s critical to building value and eventually either attracting mass adoption or providing enterprise-level solutions.

New Delegates Secure A Network

As DPoS protocols mature and their value increases, more institutions that can control more tokens will enter the space. The first wave of this phenomenon, which has been growing steadily since 2018, is cryptocurrency exchanges and venture capitalists controlling large sums of tokens. The irony is that this is good for the security of the protocol.

Cryptocurrency trading exchanges can hold users’ tokens and dedicate a large percentage, not used in day-to-day trading, towards staking. Initially, this was done without retail traders’ knowledge; now, most exchanges promote a token rewards-sharing program called either staking pool, soft staking, or lending. While encouraging users to stake, the percentage of staking rewards kept by exchanges ranges from 0.5% to 50%. Although staking with an exchange is simple and convenient, the ideal situation is for users to maintain control of their tokens. Beyond staking rewards, the power to vote and participate in the governance of a DPoS chain is outsourced to the exchange, which may not participate in governance or vote on decisions that go against the token owner’s beliefs.

Increased value is attracting larger players into DPoS participation. Crypto Funds are noticing projects beyond Bitcoin, Ethereum, and ICOs. As reported by Nathan Reiff in 2018, “According to a report by Benzinga, the number of hedge funds with a cryptocurrency or blockchain focus stands at roughly 150.” Now, we can count over 800 cryptocurrency funds launched. The funds are primarily focused on non-DPoS coins, however, DPoS tokens, with built-in inflation rewards, could offer more stability to funds and provide steady return rates without the need for trading. CryptoFunds are positioned to offer custodian crypto asset solutions and will be arbitrators of voting powers for DPoS systems. Many may need nudging to involve themselves with governance, but Alpha Stake has plans for providing them guidance in such decisions.

Other investment sectors with growing interest in digital assets are venture capitalists and family offices. V.C.s and family offices are more flexible with investment allocation and can direct a percentage of their portfolios toward digital assets more readily than traditional fund managers. Many are seeking Alpha in a time of risk-on with equity markets and bond yields near zero. 2021 may offer exceptional real estate deals, however, timing is crucial, and some markets may not behave as in previous cycles. For example, commercial real estate and office space may undergo dramatic changes with the newfound “work-from-home” culture. Infinite Quantitative Easing begs the question of fiat currency’s worth even as the strongest reserve currency, the U.S. dollar. Cash is good to have on hand for short-term deflationary-priced asset purchases, but unless our economies undergo massive expansion, fiat currencies worldwide are bound to experience levels of weakened purchasing power for hard assets. Thus, hard money alternatives, such as gold or bitcoin, will grow toward stability and present a viable long-term hold collateral option versus fiat currency holdings. For families who are familiar with digital assets, only a little guidance is needed about quality DPoS assets. Those who want deeper involvement in web3 development, are prime candidates for self-custody, proposal voting, and reaping the rewards offered by delegated proof-of-stake blockchains.

Delegated Proof-of-Stake Conclusion

Amongst the many advantages of involvement within the cryptocurrency space, staking, governance, and consistent rewards stand out as superior forms of consensus models. Most new DLT chains are building their network’s consensus algorithms in a DPoS-like model, and even legacy chains like Ethereum are moving towards a proof-of-stake model that will mimic DPoS based on pools created by retail and institutional investors. Staking not only promotes loyalty within a highly liquid digital asset trading environment, but more importantly, staking empowers users to guide and direct protocol development toward a foundation that is ready for all the complexities of Web3.