Staking and DeFi war

Recently, the question about Staking has been rampant. In addition to causing the price of the currency to fall, Staking may have more adverse effects. This article may bring you different feelings.

I. Economic Analysis of Proof of Equity (PoS)

Proof of Rights (PoS) is increasingly popular as a core consensus layer for blockchains. Blockchain platforms such as Ethereum, EOS, Cosmos and Tezos have adopted PoS or plans to adopt PoS soon.

For a long time, many considerations have been made on the security of PoS. However, there is not much thought about the potential economic impact of the ecosystem and its possible negative impact. This article describes three potential issues that may arise from a PoS-based economic system.

Competing Staking and DeFi products

1. Suppress ecosystem development

The first problem that may arise is that the pledge rewards that exist in PoS can seriously affect the development of the DApp ecosystem. Currently, by pledgeing ATOM in the Cosmos hub, the annualized yield is about 11.5%.

Since the simple act of pledge ATOM has an annual revenue of 11.5%, for ATOM holders, investments (such as providing liquidity) for DApps with a return rate of less than 11.5% (especially DeFi) will not be preferred.

This actually creates an inefficient ecosystem where applications must compete with the underlying protocol to compete for users. This is not just a problem with Cosmos, but also for other PoS-based platforms.

Some might think that this is natural, and because of the market effect ecosystem will reach an effective balance. However, while it is possible to strike a balance, it is highly questionable whether it is efficient (the way to maximize user utility). Here, use Compound and Uniswap for in-depth explanation.

1)Compound on the Ethereum after Casper optimization

If you look at the current state of Ethereum, it does not have any form of pledge reward, so there is no barrier to using ETH to provide liquidity. In fact, the holders are motivated to do so to offset the depreciation of assets caused by inflation.

That's why even if the interest rate received by the lender is extremely low (the current annual interest rate is about 0.1%), Compound has accumulated so much ETH worth more than $60 million. Due to the high supply of ETH credits, users can benefit from ETH from Compound at a low interest rate of approximately 2%.

In contrast, in the Ethereum after Casper optimization, assuming an annual interest rate of 2% from now on, the ETH holder is motivated to pledge instead of putting ETH on the Compound.

The supply of loanable ETH in the compound will decrease until the annual interest rate of the loan exceeds 2%. This will cause the borrowing rate to rise to 4% or higher, forcing the lender to raise interest rates, resulting in a decline in social utility.

2) Uniswap on Cosmos

Decentralized exchanges based on liquidity providers like Uniswap may also be affected by inefficiencies in the PoS platform. In the case of Cosmos, an ATOM transaction that fails to provide an annual interest rate of more than 5.75% may be caught in a vicious circle of declining liquidity and reduced trading volume.

2, hinder the use of DApp

The second potential problem is that PoS may prevent people from using DApps (especially DeFi) more freely and casually. Users are less willing to use these DApps because they use DApps that require locks on PoS tokens to cause users to miss out on rewards. MakerDAO on Ethereum after Casper is such an excellent example.

Casper optimized MakerDAO on Ethereum

The lack of a pledge rate of return for further solutions also hit the creation of the MakerDAO CDP. Since the ETH locked in the CDP cannot be used to claim the pledge reward, the user actually missed a relatively stable annual interest rate of 2%.

CDP holders now lose additional opportunity costs, which is a possible 2% pledge annual return. Such opportunity costs may indeed reduce the number of people willing to create DAIs in MakerDAO.

Kava on Cosmos

The DeFi DApp on Cosmos is even more serious on this issue. Kava is a good example. In order to use their ATOM as a collateral to generate stable coins, Kava users must sacrifice 11.5% annual pledge return. This obviously hurts the user's enthusiasm for using the product.

3. Opportunity cost of cross-chain transmission

This issue applies to cross-chain platforms. The purpose of the cross-chain platform is to connect different blockchains so that assets can be transferred between blockchains. The problem arises in the transmission of PoS-based tokens, which will hinder cross-chain transmission.

Ethereum and Cosmos peg

The Cosmos program uses the peg zone to connect to Ethereum. This may not be a problem now, but with Ethereum upgrading to 2.0 and adopting Casper technology, only ETHs that are pledged on the Ethereum blockchain will be eligible for pledge rewards, while those that transfer to the Cosmos network will not be rewarded. .

Therefore, since the transfer of ETH to the Cosmos holder essentially misses the possible pledge reward, the willingness to transfer ETH to Cosmos is reduced.

In order to develop the Ethereum and Cosmos ecosystems, ETH should be transferred to Cosmos on a regular basis, but the above problems hindered this situation.

Second, the inflation rate problem

Another interesting aspect is the impact of inflation on the network and the ensuing problems. For the PoS blockchain, it can choose between high inflation and low inflation. In reality, both options are trade-offs between security and usability. Such trade-offs will prevent the network from implementing the Pareto principle more effectively.

High inflation

Achieving high inflation rates by increasing the rate of return on pledges will encourage the holders to pledge more, thereby increasing the total value of the collateralized tokens. In this way, the attacker must have more funds to attack the network. The high inflation rate also forces attackers to generate more potential losses due to Byzantine/offline nodes, thus further strengthening the security of the network.

However, since in the current model, tokens can only be pledged or used for investment/use, this reduces the total amount of assets that can be used to develop the ecosystem. This negative impact will be further deepened, as those useful applications that offer a rate of return that is lower than the pledge rate of return will probably be ignored.

Low inflation

Low inflation rates can help advance ecosystems by stimulating more investment in applications, but may hinder the pledge of more tokens and reduce the potential loss of attackers and reduce network security.

———— District Brother Comments: ————

This paper discusses some problems that may arise in the POS economic system, and some of the ideas are instructive.

The “risk-free benefits” offered by Staking will increase the cost of other DAPPs to obtain liquidity, which may reduce the efficiency of the entire ecosystem and hinder the development of DAPP.

On the issue of inflation rate, the author believes that high inflation rate will improve system security, and low inflation rate will better stimulate investment behavior to help ecological development.

But for high inflation, there is one more point that should be noticed. Calculated at an inflation rate of 10%, the system will issue 10% of the total amount of mortgages per year. The high yield means a high mortgage rate, and the number of additional tokens will not be small.

But the supply has increased by 10%, and the demand can increase by 10%? How many tokens are issued, how much will be supported by the corresponding value, only the additional issuance, no support, the price will inevitably fall, and the gains obtained by Staking may not cover the losses caused by the decline.

The real losers are those who don't have Staking, but if all the tokens are Staking, can the ecology develop?

Without the Staking system that generates sufficient incremental value, the token price will inevitably continue to decline. How many users can participate in the ecosystem where the price of the token continues to decline?

But every year, 10% of the value is injected into the ecology, or more than 10% of the incremental funds enter the ecology every year. If it is not a bull market, it is not easy to do, and there are still institutional investors waiting for the market.

Are you optimistic about Staking? Willing to Staking? I look forward to your comments.


Author: Ryan Park.

Translator: chuan, the special author of the Blockchain Learning Society.

Disclaimer: This article is the author's independent point of view, does not represent the position of the Blockchain Institute (Public Number), and does not constitute any investment advice or suggestion , the image source network .