Multicoin Capital: Exploring Long-Term Staking in PoS Networks, a Fairer Incentive Mechanism?

Original Title: 《Exploring Long-Term Staking in PoS Networks》

Authors: Vishal KanKani, Tushar Jain

Compiled by: Luffy, Foresight News

Currently, almost all Proof of Stake (PoS) networks provide incentives through protocol staking and inflation; however, no PoS network has yet been able to offer a killer feature: long-term staking.

Term structures allow investors to strategically lock up capital over different time periods in exchange for generally higher investment returns. In traditional finance, term interest rates constitute the yield curve, which is a crucial component of well-functioning financial markets. However, in the cryptocurrency space, these primitives do not exist at the protocol level.

Note: It is important to note that while we use the terms "term structure" or "yield curve," they operate differently than in traditional fixed-income markets. For example, in the U.S., the Federal Reserve is responsible for managing monetary policy and controlling the flow of money into circulation. On the other hand, the U.S. Treasury issues fixed-income products to raise money that is already in circulation. In this proposal, we suggest a programmatic redistribution of cryptocurrency inflation on PoS blockchains.

In this article, we will explore how PoS networks can better align stakeholders with the long-term success of their networks, and we will propose specific financial structures to elegantly achieve this goal.

The Role of Staking

Staking is not just a way to earn rewards. It plays a crucial role in the security of PoS networks, which is why token holders can earn token rewards by participating in staking.

However, in the current staking model, regardless of intent, rewards are distributed equally among all participants in the ecosystem, ignoring their specific contributions to the network. Whether they are short-term, long-term, or diamond hands who will never sell, they receive the same rewards. The result is that stakeholders who take risks and volatility to improve the network are not adequately compensated.

Moreover, the potential risk to network stability from unstaking within relatively short waiting periods is significant. In extreme cases where large amounts of staked assets are withdrawn in a short time, it could lead to network instability, disrupt the entire system, and worse, trigger a full-scale economic attack.

Ethereum uses a queuing system to mitigate this risk, and in this article, we explore potentially better alternatives.

Staking works, but it can be better.

Long-Term Staking

Long-term staking would reward long-term stakers with a higher proportion of tokens in exchange for a longer staking lock-up period, thereby promoting network stability and longevity.

Long-term staking introduces a time-lock variable into the staking process (for example, stakers can choose to lock their staked tokens for 1 year, 2 years, etc.). The protocol can treat this as time-weighted equity, where the distribution of equity rewards favors stakers who take on more risk over a longer time.

Let’s define a few variables:

We intentionally define k as a separate multiplier rather than purely time-weighting staking, allowing for flexibility. By avoiding strict time multiplication, especially in the case of long-term locks, this design can prevent overly adverse impacts on short-term staking rates. This, in turn, eliminates any potential barriers for stakers who may not have long-term interests, ultimately preventing a decline in staking participation rates (which is crucial for consensus security in the short term). Additionally, if needed, the long-term staking rate can be increased by raising k.

Assuming consistent performance from validators, long-term stakeholders can increase their rewards as follows:

However, short-term stakeholders' rewards will decrease.

Exploring Financial Structures to Facilitate Risk Transfer

PoS networks can implement long-term staking in two direct ways: permanent time-lock contracts and fixed-term contracts.

Permanent Time-Lock Contracts

First, the network can offer a permanent staking contract for one year to stakers interested in long-term staking. You can think of it as a redeemable bond.

Each epoch/block, stakers can submit a redemption request. After submitting a redemption (i.e., unstaking) request, they must wait for the 1-year time lock to expire before they can withdraw the underlying asset.

If stakers wish to continue staking, the time lock will automatically reset to 1 year at each epoch/block (i.e., it rolls back automatically). From the staker's perspective, they avoid any uncertainty risk of principal repayment beyond the one-year time lock.

If the one-year permanent staking contract does not meet the staker's needs, the network can also introduce contracts with other terms: 3 months, 6 months, 2 years, 3 years, 5 years, 10 years, etc.

Fixed-Term Lock Contracts

Fixed-term contracts are another way to implement term staking. This looks more like traditional bonds, where the principal is returned on a fixed date in the future, and the maturity time shortens over time.

In general, we believe that permanent time-lock contracts are a better financial structure than fixed-term contracts because:

The 1-year time-lock structure of permanent time-lock contracts allows the network to operate under the maximum possible time lock at each epoch/block, effectively incentivizing long-term staking;

Since each epoch/block has a 1-year time lock, multiple k can remain constant throughout the entire lifecycle of the staking. This is particularly important because fixed-term contracts reduce the staking multiplier for participants interested in long-term staking as the maturity date approaches, thereby narrowing the spread between long-term and short-term stakers and reducing the attractiveness for long-term stakers.

DeFi: Facilitating Risk Transfer

Even the most basic implementation should be able to meet the preferences of long-term stakers, who need to be able to exit native assets through liquid staking before the staking period ends. We expect to see the emergence of term-based, liquid staking token pools to facilitate this risk transfer.

Moreover, due to the mean-reverting nature of yields and leveraging the power of composability, automated market makers can facilitate seamless risk transfer across terms among market participants through liquid staking pools. In fact, yield curve trading has already become an important market in traditional finance. For example, we expect stToken-12month trading to occur independently of stToken-6month trading, with these tokens driving on-chain trading and liquidity development.

Thought Experiment: Long-Term Staking in a Hypothetical PoS Network

Let’s consider a hypothetical PoS network with a staking return rate of y = 6%. Let’s use K = 2 to balance short-term and long-term staking rates. In this calculation, we assume T = 1 year.

We find that in an extreme case where everyone stakes short-term, everyone receives the same staking return rate y = 6%. However, the first person to stake long-term can receive double the rate, i.e., K * y = 12%. In another extreme case, when everyone stakes long-term, the staking return rate remains at y = 6%, but anyone choosing short-term staking will only receive y / K = 3%. In fact, the final equilibrium state may lie between these two extremes. Thus, under the same inflation rate, the network has the potential to achieve higher security over a longer period.

Note: The above chart indicates that as more people engage in short-term staking, the staking rate curve becomes steeper, incentivizing more people to stake long-term.

It must be acknowledged that this thought experiment focuses on a single time length: one year. This simplifies implementation while maintaining flexibility for easy expansion to other lock times in the future. The process of expanding to multiple time locks should be a collaborative effort, where the community can delve into the specific characteristics of each subsequent time lock and their respective PoS networks.

This design has 1) simplicity and intuitiveness, 2) ease of reconfiguration based on market feedback, 3) integration of free market demand, and 4) ensures that long-term staking rates are greater than short-term staking rates.

Managing Design Risks

Long-term staking is not a panacea; it has some limitations that need to be considered.

One of the most significant risks in this design is that whales holding large amounts of tokens can lock in the longest terms and achieve the following:

• Control K (the multiplier for long-term staking rates), which could impose penalties on short-term stakers, increasing the risk of short-term stakers leaving the network, leading to centralization.
• It could adversely affect the validators of short-term stakeholders. It may reduce the competitiveness of these validators, increasing the likelihood of them leaving the network.

The solution is to design a community-driven approach to determine the value of K. This multiplier should be large enough to be significant but small enough not to harm short-term stakeholders. The final decision on the value of K should consult multiple stakeholders—short-term stakeholders, long-term stakeholders, validators with different stakeholder compositions, etc.

A More Robust Blockchain

We believe that to ensure the resilience of the network and develop into a financial infrastructure supporting billions of users and trillions of dollars, PoS networks need to start seriously considering how to incentivize long-term, value-aligned stakeholders. The yield curve is a pillar of well-functioning financial markets. Long-term staking is a crypto-native way to turn this vision into reality, and we can leverage the power of composability to create seamless risk transfer mechanisms among different market participants.

By implementing long-term staking, PoS networks can create a robust ecosystem that rewards those who participate long-term and align with the network's values. Furthermore, by voluntarily locking their tokens long-term, long-term stakers can significantly enhance the implicit security of the network. As long-term "stakeholders," they instill confidence in the security of the blockchain, attracting more stakeholders and promoting a virtuous growth cycle for the network. By implementing these measures, we can significantly improve the state of PoS blockchains, enhancing their stability, security, and long-term viability.