Rewards: Cardano Stake pool

The above image is that of a wallet of a person holding cryptocurrency. In this wallet he is the big boss as he knows his own private key. As long this is not leaked, no one can take away his money. In addition to make the money work for him, he has some dApps (Decentralized app) installed. There is a marketplace of apps which can be installed if the user wants. In addition, he can assign some/all of his crypto holdings into Staking-pools which are visible in his wallet.

In order to understand the reward mechanism we have to understand the above flow because many terms later will have reference to them. So the user above has in his wallet installed a set of dApps that are available in the marketplace. The whole system is automated. In addition, the wallet also contains the list of stake-pools that can be used for delegation of the stored cryptocurrency space.

What is delegation and how does delegation happen ?

The owner of the wallet holds his own private key, and it means only he can authorize the money going out of his wallet. When money is sitting idle, he may try to generate returns on capital. To this end he wants to assign some part of money to a pool (one of the 1600+). This process of assigning his own capital to another stake pool is called Delegation.

The beauty of Cardano Staking is that the money does not have to leave the wallet, which means that the owner of the wallet does not lose is money while generating returns. (soft ownership)

Proof of stake

As seen above the rewards after the introduction of smart contracts allow different dApps(1,2,3) to be built in Cardano and the transactions from this dApps are to be committed to the blockchain. These transactions are packaged into a single or multiple blocks and then committed to the blockchain. The transaction fees given by dApps are distributed algorithmically to the miners (Stake pool operators), Delegators and Treasury of Cardano.

REWARD DISTRIBUTION ECONOMICS:

Let us explain the above image carefully. This will help us in understanding the whole process and help us design the future of Stake pool operation.

Blockchain is basically a ledger that registers transactions. Transactions can come from different sources. Below are few of them

• Crypto exchanges where people buy and sell crypto tokens.
• dApps that are built on smart contract layer, on top of the ledger layer and allows real world use cases such as DeFi, supply chain traceability etc.
• Oracles can be run on stake pools, which can provide on chain data to dApps who require external data sources. For example Cardano is tying up with Wolfram for making their data available on chain.

Now these transactions finally when they need to be committed to the blockchain, has to go through an active node that runs the full blockchain and these are the stake pools. The control of which node actually commits the blocks is controlled by the consensus algorithm (which Ouroboros for Cardano). When a stake pool is selected to mint a block, it is based on many factors, such as the amount of pledge (financial commitment in form of ADA from the pool owner) and amounts delegated to the stake pools(from the participants in the stake pool) using their wallets like Daedalus & Yoroi.

We are not discussing here the different factors that controls how the different pools compete with one another. Instead, we are assuming that the pool has a fair set of parameters (pledge, delegation amounts, costs) such that it is competitive among the stake pool participants and is able to participate in the block generation.

CONCLUSIONS:

Now from the above what is obvious is that the stake pools become the channel to generate return out of the economic involvement of the blockchain. Thus, for example right now Cardano has not yet started the smart contract platform. But they are working hard in generating the corporate B2B connections with industries providing them the tools for using the blockchain to conduct their daily business.

Once the smart contract kicks later in March 2021, then within next 2 years the chain will be used more and more, along with the other chains in the ecosystem. As the POS chains gain dominance in the market, the utility of the networks will increase exponentially in the coming years. Obviously then the number of transactions in the chain will also increase.

Total number of transactions = (transactions packaged per block) X Number of blocks

Thus, transactions packaged per block (density) is directly proportional to the total number of transactions. Thus, as the total number of transactions grow the density is also optimized to fit into a block.

And higher this density higher is the rewards per block. In this way as the density of dApps driven transactions increase the rewards distributed to the delegators.

This is the end goal of the blockchain networks. To democratize returns to the people who own the networks (via holding of tokens of that network, in this case Cardano ADA). Currently, all these networks are controlled by the banks and large financial institutions like visa etc.

Summary

We have briefly sketched how the holding of tokens of Cardano (ADA) and delegating them results in ever-increasing rewards as this network has more dApps built upon it and block density (# of transactions in one block) increases when these apps are executed.

Since ADA ownership can be by common people and also the stake pools (small/medium scale enterprises)are run by small pool operators, it allows to democratize the returns generated by the financial transactions.

References:

• Cardano library
• Nice video explaining the pool parameters