Staking: Diversification is Decentralization

Stakin Reports

May 06, 2019

4 min read

Staking: Diversification is Decentralization

If you are reading this article, you are probably already familiar with Proof-of-Stake and staking cryptocurrencies. If not, we recommend that you read our article “An Introduction to Staking & Crypto Dividend”.

When staking your crypto, you get the choice between DIY and delegation. The first requires IT skills, minimum stakes, and constant monitoring. The second, delegation, only requires you to carefully select a validator, and check regularly that everything is fine. ⛵

When selecting a validator, also called baker in Tezos, you usually look at its uptime, performance, ROI, fees, self-bond size, community and governance involvement. Conducting your own research is crucial since, as a token holder, you do not want to miss on potential earnings or get slashed, and your wish is to have your lovely protocol thrive in the years ahead: that’s why you choose to support some validators with consistent returns and great community contributions. And because you know that diversification maximizes returns and contributes to decentralization, you choose to delegate to several validators.

Diversification maximizes your Returns 💹

We all know the old adage “Don’t pull all your eggs in the same basket”. Well, guess what? This also applies to crypto staking.

Delegation, although non-custodial, is still risky. Let’s say you chose to only delegate to 1 validator, have you thought about what would happen to your stake if this validator is down or commits a fault? Hopefully, in most of the protocols, you won’t lose your holdings, but you will:

  • Miss rewards: When your validator is down, it means that it is not verifying transactions at the moment, which can be due to several reasons. The main job of your validator is to communicate with its peers and verify blocks, maintaining the state of the chain, that’s why he’s able to earn rewards for you. Being down happens to everybody, even Amazon, Google, Facebook, and other large tech companies: it’s hard to maintain 100% all-time performance for your servers. But, in the case of your validator, when it’s down, it’s not earning any rewards for you.
  • Probably get slashed: Some protocols, such as Cosmos, IRISnet and Terra, which are ‘Bonded Proof-of-Stake’ protocols, have punitive mechanisms for liveness faults and security faults. What does it mean? If your validator is down for a long period of time or commits a security fault — such as validating twice the same block, he will get slashed, and you too. You may lose a small % of your hard earned cryptocurrency, just because of that.

If you delegated to only one validator, that won’t look nice for your holdings. Hopefully, it is still possible to “Redelegate” to another one, except that in some protocols, you may have to wait for several weeks before being able to do so.

If you had delegated proportionally to 10 delegators and only 1 of these was down, you’d still get 90% of the returns you are entitled to. You may wonder why only one of these would be down? It’s simply because validators are operated by different people, in different countries, with different servers and infrastructures. When diversifying, also make sure to take a look at that.

In the long term, diversification has proven to maximize returns and reduce risks. That is why in traditional financial markets we have funds, funds of funds and exchange-traded funds helping investors to build portfolios spread among several assets. Crypto has not killed finance, it’s just the new decentralized finance.

Diversification contributes to Decentralization ❤️

As a delegator, you may be tempted to delegate to the largest validators. After all, if they have such large “Voting Power” or so many delegators, they must be trusted: why not trust them too? Crowd intelligence is a factor to take into consideration, especially if you are a bit lazy in your due diligence. 200 validators, 100 validators? That’s just too many to analyze, why not go for the few large ones?

This decision process makes sense, but you need to be aware that, by doing so, you may be contributing to the centralization of the network. Giving so much voting power to a few selected validators put the network at a risk and creates points of failures: 51% attacks, cartels, cohesion between validators. Blockchain networks have been created to be decentralized, do you really want to have a few actors controlling it? Then go ahead, delegate to the big guys.

Voting rights detained by top 10 block producers on selected protocols

Another good practice would be to look for some small “under-delegated” validators. You can use explorers or comparator websites, such as MyTezosBaker, Cosmos Overview by Genesis Lab, Irisplorer, Terra StakeID, to conduct a quick analysis of the ecosystem validating for your protocol. By doing so, you will notice dozens of smaller validators with strong metrics, waiting for you to have a look at them. If anything goes wrong, you can still redelegate, but if everything goes fine, why not stay with them and support the decentralization of the network? A decentralized network is a healthy network.

DISCLAIMER: This is not financial advice. Staking and cryptocurrencies investment involves a high degree of risk and there is always the possibility of loss, including the loss of all staked digital assets. Additionally, delegators are at risk of slashing in case of security or liveness faults on BPoS protocols. We advise you to DYOR before choosing a validator.

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