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PoS Economics - Too Much Reliance on Fees?

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Satoshi&Co Daily Crypto Newsletter

May 20 · Issue #179 · View online
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Check out past issues of the newsletter along with more interesting crypto content as well as our recently-launched podcast series with leading crypto industry participants at our newly-launched website www.satoshiand.co

(Listen to our latest podcast here. It is with Sandeep Nailwal of Matic Network, which is a layer 2 protocol working on ETH’s Plasma. Matic Network recently finished a successful launch on Binance Launchpad and is also the first Indian crypto startup to receive funding from Coinbase Ventures).
Ethereum is currently on track to shift to a new Proof-of-stake based consensus system from the existing Proof-of-work consensus protocol in 2020. One of the biggest features in the transition to PoS is going to be the changes in the underlying validator economics. Block rewards should be considered as the cost required to maintain the integrity of the blockchain by incentivizing block producers/miners/validators not to act in a malicious way and attack the blockchain. The downside to that is that block rewards invariably dilute the ownership of existing token holders.
Designing appropriate incentive structures for miners/validators involves striking a fine balance between security and dilution (maintaining adequate security whilst not overly diluting the ownership through block rewards). In the current scenario, under the current block reward of 2 ETH per block, roughly 4.8 million ETH is being created on an annual basis to secure the network. However, after moving to PoS, the reward mechanism is going to be a function of total ETH staked in the network. As the ETH staked in the network increases, the network becomes more secure, and the new issuance of ETH decreases. For example, at 30 million ETH staked, the annual issuance drops to as low as 100k ETH per year in contrast to the 4.8 million ETH in block rewards right now.
The first iteration of the proposed rewards structure for validators came under scrutiny as it was not deemed to be profitable for small scale validators based on current ETH price and existing fees market. Under the model, validator profitability is driven predominantly by the growth in fees, and the fee market is actually expected to shrink once sharding comes into effect. You can see the profitability matrix for the rewards structure in Figure 1. The matrix shows the net yield of a validator node as a function of network fees per day, ETH staked in the network and ETH price. At the current fee market rate of 500 ETH per day, staking more than 2 million ETH in the network is going to put validator profit in the red, assuming an ETH price of $148.
Figure 2 is a sensitivity analysis of Net yield with daily network fees and ETH price. Expectedly, keeping the volume of network ETH at Stake constant at 32 million ETH, the higher the ETH price, the higher the yield.
Figure 1. Source: Consensys
Figure 1. Source: Consensys
Figure 2. Source: Consensys
Figure 2. Source: Consensys
To address this issue, a new rewards structure was proposed with higher ETH issuance per block, one that also introduced a fee burning mechanism to counter the effects of incremental dilution. The latest rewards structure is set to be implemented during Serenity Phase 1 upgrade which is expected to happen in 2020.
Meanwhile in Crypto Wonderland....
“Ethereum-based SprinkleXchange To Start Listing”
SprinkleXchange, the exchange platform that utilizes the Ethereum blockchain for settlement and clearing, is getting ready to list its first partnering company next month. According to CEO of Sprinkle Group SA Alexander Wallin, the SprinkleXchange blockchain bourse is on the verge of getting its first public listing. Notably, the company aims to become home to over a thousand organizations in the following 3 to 4 years. The trading platform reportedly targets organizations with a market capitalization between $20 million and $200 million and has gotten keen interest from a wide range of suitable sectors, such as forestry, real estate, and biotech firms. Wallin also noted that the company is looking for investor groups that are familiar with the new innovation as well as firms with a large customer base.
“World’s Banks Investing In a Digital Cash Settlement Project”
Several of the world’s largest banks are in the process of investing around $50 million to create a digital cash system using blockchain technology to settle financial transactions, according to people familiar with the plans. The previously disclosed project, known as the “utility settlement coin,” was first proposed by Swiss bank UBS Group AG and London-based technology startup Clearmatics in 2015. It aims to develop a system to make clearing and settlement in financial markets more efficient.
“Crypto Over WhatsApp”
A new WhatsApp bot, called Lite.Im, developed by Zulu Republic now allows the popular messaging platform’s users to send and receive both Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Zulu’s own token, ZTX. After adding the bot, users simply have to follow the on-screen instructions to send crypto. Zulu is also promoting the tool through a referral program where users can earn crypto for getting their friends to use Lite.Im.
“Facebook Sets Up A Fintech Company In Switzerland”
Facebook has reportedly set up a fintech company dubbed Libra Networks in Switzerland. The move clearly correlates with the social media giant’s Project Libra. According to Reuters, the focus of the fintech is on the blockchain, payments, data analytics, and investing. Libra Networks, which was registered in Geneva on May 2, will provide financial and technology services. Also in its wheelhouse will be developing related hardware and software.
Tweet of the Day
Pomp 🌪
JP Morgan is now putting out reports about “Bitcoin’s intrinsic value.”

Thought it was worthless and had no value according to Jamie Dimon??

Never listen to what a bank says.

Watch what they do.
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