What follows is a rough draft of how we can design consolidation incentives in Orbit SSF, published to facilitate discussion during Devcon. 1. Introduction A key proposition of Orbit SSF is that validators rotate based on their size, such that those with larger balances are active more frequently. Active validators can be slashed, so large validators will therefore assume greater risk than small validators. Setting aside mass slashing events, a staking pool might prefer to run smaller validators so that a faulty setup can be caught early and affect only a small fracion of its total stake. For these reasons, Orbit SSF should provide individual consolidation incentives. These can be combined with collective consolidation incentives that reward everyone upon consolidation. As stipulated in the Vorbit SSF post, it can be desirable to see activity rates and incentives change across the full range of validators sizes, from 32 ETH to 2048 ETH. However, it can be difficult to assess beforehand how to distribute incentives such that it does not favor certain validator sizes, leading validators to congregate there. Validators' activity rates might also not be the same for the active chain and the finality gadget. This further complicates the analysis. As noted in Practical endgame on issuance policy, it is perilious to let a validator's stipulated activity rate also apply to its probability to propose blocks. However, if proposal rights are distributed according to stake as they are today, then individual incentives must be relatively stronger at a low issuance than at a high issuance, to compensate for the relatively high MEV that a a validator can accrue while staking with a relatively lower risk. This post presents how consolidation incentives can be designed to account for outlined requirements. A consolidation force $f_1$ is presented in Section 2, which determines the overall strength of the incentives, varying with consolidation level. Section 3 then explores the force distribution $f_2$ that defines how the yield differential is distributed across validator sizes.
11/13/2024There is a paradigm for the design of the reward curve, with similar economic effects as the reward curve with tempered issuance, at least with the setting that will be highlighted here. The paradigm is to adopt a reward curve with capped issuance, that replicates the current reward up to some cap, defined by the deposit size at which issuance stops growing $D_c$. Since this policy is rather similar to the reward curve with tempered issuance, the reader is encouraged to review its associated ethresearch post that goes into great detail on various trade-offs for the design. My write-up on the foundations of minimum viable issuance from yesterday might also be useful. The figure below illustrates a reward curve in pink where the cap kicks in at $D_c=2^{24}$. One interesting detail is that Vitalik's active validator cap and rotation proposal from 2021 has the same effect on issuance as when using the setting of $D_c=2^{24}$. The green reward curves are alternatives with tempered issuance specified in Section 3.1 of the previously linked write-up. As evident, the reward curve with an issuance cap would also halve issuance relative to the current trajectory at $D=2^{26}$, just as the tempered issuance under a graduated approach. Of course, it might seem appealing to stakers to then cap issuance at the current deposit size instead, i.e., $D_c=2^{25}$. However, the gains from adopting such a policy would be much more limited, albeit not insignificant. In my view, a change to $D_c=2^{24}$ is then clearly preferable in the case that a change is instituted using this paradigm. The figure below instead shows the effect on staking yield under the current level of MEV (300 000 ETH/year). Hypothetical future supply curves are illustrated in blue (discussed in the longer previous write-up). I will return shortly with a longer write-up on this paradigm, detailing its benefits and drawbacks, and most interesting variants. One of those is extensions using methods described in Section 6.3. Just as with the reward curve with tempered issuance, the reward curve with capped issuance is trivial to implement. One interesting question is if the simplicity of this design makes it easier to accept to the community. The reward curve with tempered issuance is of course also very simple in its design: divide the equation for the current reward curve by $1+D/k$. But it might not "look" as simple. An aspect that can both be a benefit and drawback is the discontinuity and specific shape around the cap, which will be discussed further in the forthcoming longer write-up.
4/18/2024When discussing issuance policy, it is important to recognize that staking is a service, and performing it comes with costs to the home staker, node operator, and delegator. This post will take a closer look at the dynamics of cost and surplus in staking, demonstrating how all token holders can benefit from reduced issuance. Two weeks ago, Martin suggested that changing the issuance curve just shifts incentives from one group to another, and thus creates no value. The quote is a good starting point for the discussion. Modifying Ethereum's issuance policy is critical for several different reasons---and at the very foundation, it creates value by reducing total costs for users. The figures in this post come from my recent ethresearch post, suggesting that Ethereum should adopt a reward curve with tempered issuance. Cost and surplus Review the figure below from Section 2.1, featuring a hypothetical future supply curve in blue. The supply curve indicates the amount of stake deposited $D$ at various staking yields $y$. It captures the implied marginal cost of staking. What that means is that every ETH holder is positioned along the supply curve according to how high cost they assign to staking, with their required yield implying that cost. Relevant costs include hardware and other resources, upkeep, the acquisition of technical knowledge, illiquidity, trust in third parties and other factors increasing the risk premium, various opportunity costs, taxes, etc. The area above the supply curve indicates the stakers’ surplus (what they actually gain) and the area below the supply curve the costs assigned to staking (the marginal staker would not stake at a yield below the supply curve). Two reward curves are shown, both under the present level of MEV (300k ETH/year). By maintaining the current reward curve in black, Ethereum compels users to incur higher costs than necessary for securing the network. Adopting the proposed green reward curve eliminates the costs represented by the dark blue area (around 450 000 ETH), thus improving welfare. The issued ETH covered for hardware expenses, taxes, reduced liquidity and risks that users would choose to sidestep under a lower yield. With the green curve they can, and the benefits are shared by everyone (including remaining stakers), creating value for all token holders through a reduction in newly minted ETH. It may seem strange that it matters how many new ETH that are created. But imagine if every ETH was converted to 10 ETH tomorrow so that there were 1.2 billion instead of 120 million ETH in total. Then every ETH would be around 10 times less valuable. What matters is the proportion of all ETH that you hold; a concept that we will get back to. There is also a surplus shift from stakers to everyone from a change in issuance policy, indicated by the darker grey area. That ETH indeed previously benefited stakers, since it was taken from everyone (in the form of newly minted ETH), and then given specifically to them. Effect on stakers, de-stakers and non-stakers What happens here to everyone involved in terms of utility? There are three categories: the remaining stakers, the de-stakers between the green circle and black square on the supply curve, and those who were non-stakers already from the beginning. As mentioned, everyone is rewarded with a proportional share of the combined dark blue and dark grey area, in the form of a reduction to the circulating supply inflation rate $s$. In essence, $s$ captures the percentage change over a year to how many ETH that exist. This means that $s$ rises if the yield is high and a large proportion of the ETH is staked. Conversely, $s$ falls if a lot of ETH is burned through EIP-1559; this post will use the approximate burn rate since The Merge (0.8 %) in the examples. The stakers lose out on some yield $y$, corresponding to the height of the dark grey area. How about the de-stakers? This is where the magic happens. A staker assigning a cost to staking corresponding to $y=0.025$ is indifferent to staking at that yield. It wouldn't really matter to them. They only lose out on $y$ across that gradually diminishing height of the dark grey area, and then they are just cashing in on a reduction to $s$ like the non-stakers.
4/17/20241. In my last thread, minimum viable issuance was introduced as an important guideline for staking economics. This thread will take a closer look at how issuance level affects Ethereum’s equilibrium staking conditions and guide us toward a utility-maximizing reward curve. 2. This thread is also available on Twitter and Farcaster, and I will shortly provide an ethresearch post covering the topic for those more comfortable with that format. Part 2 is also in preparation. 3. Before I start I would like to thank Barnabé Monnot, Francesco D’Amato, Vitalik Buterin, Thomas Thiery and Justin Drake for fruitful discussions and feedback for this thread, as well as Ansgar Dietrichs, Davide Crapis, Caspar Schwarz-Schilling and Julian Ma for fruitful discussions. I also wish to thank Flashbots for providing the data used for this analysis. 4. The demand curve shifted upwards after The Merge when stakers started to receive MEV and priority fees. Reservation yields fell after Shapella due to improved liquidity, and the supply curve shifted downwards. Both changes pushed up the equilibrium quantity of stake. 5. Because of this, Ethereum has arguably entered a phase of overpaying for security. To what extent can we stop overpaying? Can we reduce issuance while still retaining consensus stability, proper incentives, and acceptable conditions for solo staking?
1/11/2024