Part 4 DPoS: The Big Money Backers
Alternative Consensus Mechanisms To Proof-Of-Work
For previous topics covering delegated proof of stake, see Part 1 DPoS: The Protocols, Part 2 DPoS: The Validators, and Part 3 DPos: The Delegates.
A definitive uptick in Proof of Stake (PoS) occurred in 2020. Proof of Stake (PoS) is a consensus model different from the first-generation cryptocurrencies’ Proof of Work (PoW) model. Included with PoS is every variant, such as Delegated Proof of Stake (DPoS), Liquid Proof of Stake (LPoS), Nominated Proof of Stake (NPoS), and Bonded Proof of Stake (BPoS). For a detailed explanation of each consensus model listed, see Stakin’s article, “The Proof of Stake Guidebook.” With proof-of-stake, validators are required to generate new blocks by staking tokens and operating proprietary software instead of miners utilizing high energy outputs to solve complex math problems to win new block generation as within proof-of-work consensus models.
With more protocols utilizing PoS models, more demand for validators arises within the cryptocurrency ecosystem. Most validators are smaller operations, but more protocol developers need a larger percentage of enterprise-scaled validator teams. Professional validation requires not only high levels of technical skill but also large outlays in capital expenditures for infrastructure. Who finances enterprise-scale validators? A variety of visionary backers invest in server-side professionals who deploy fast, highly secured, and scalable PoS blockchains. They range from angel investors to venture capitalists. Investors familiar with Distributed Ledger Technology (DLT) seek to invest in layer-one protocols (tokens) and companies that enable base-layer protocols (equity). This pioneering class of investors focuses a large percentage of their investment strategy in PoS-based projects to gain maximum leverage in DLT’s governance influence and economic expansion.
Slashing Risk
A consensus model is a means for all nodes operating and validating blocks to stay in sync while adding new blocks to the blockchain. If a node attempts to add a block whose hash value does not match the other nodes, the block is rejected. For some staking chains, if a validator misses blocks due to careless mistakes or malicious behavior, the validator is slashed by code. Slashing is the process of punishing a validator by taking away staked tokens and/or not allowing the team to validate blocks for several rounds.
Why is slashing important to investors? For some protocols, slashing includes penalizing the delegates who vote for the validator being slashed. Although most protocols do not punish the delegates as severely as the validators, slashing could risk thousands of dollars if a delegate is heavily invested. Professional investors who want to ensure their token stacks are safely growing will only invest in validators who operate a commercial infrastructure business, are properly staffed, and have disaster recovery protocols in place. So far, only a few validator companies are organized with the necessary business and legal structure to receive such funding.
Most validators are self-funded small teams or operate under bootstrapped conditions with proceeds from angel investors. Funding is critical for talented teams to upgrade equipment and expand to levels that match their capabilities. Although PoS coins have been around since the inception of Peer Coin in 2012, the space is still considered nascent, but the last 2 years have experienced rapid growth. According to CryptoSlate.com, pure PoS tokens make up 3.10% of the sector, DPoS makes up 2.86%, and masternodes now only make up 0.49% of the cryptocurrency space. Development is early, and there is much room for additional talent to grow alternative consensus methods to PoW. To date, most of the new protocols launched in 2020 are built with some variant of the PoS consensus code.
The Players of Distributed Ledger Technology (DLT)
Several companies foreshadow what will soon become the industry standard for enterprise-scale validators. Companies such as StakeFish, Chorus One, STAKED, EverStake, and Infinity Stones. In addition to staking, professional node services are offered for various projects, such as Bison Trails, Blockdaemon, and SKALE. Most businesses on the scale of the firms listed above were backed by institutional funding. Those within the crypto space are familiar with firms highly dedicated to blockchain projects such as Galaxy Digital, a16z, Coinbase Ventures, etc. However, other players who did not originally include DLT projects in their portfolio are investing, such as Kleiner Perkins backing Bison Trails, or Bonfire Ventures backing Figment Networks. Even the oil company Shell backs Blockdaemon’s promise to expand support for validators’ onboarding to new Web3 projects.
Backing entities that perform work with physical infrastructure is more attractive to some traditional equity investors versus investing directly in digital assets. The demarcation of ownership and rights is clearly laid out by established business legal structures and case law. Having recourse to physical collateral is a natural comfort for investors delving into a new asset class of investments. Until a greater understanding of DLT is established and evidence of its potential is seen in consumer behavior, investing solely in digital assets will remain the playground of a few whale investors.
The next question for institutional investment in DLT is private ledgers vs. public ledgers. Entities such as State Street Corporation, one of America’s oldest banks, have demonstrated interest in blockchain technology since 2015, just as many other members of the R3 consortium. However, using IBM’s Hyperledger proved these entities were attempting to develop internal well-controlled blockchains of whom validators would be selected by the consortium. After proofs of concept were established and teams within large financial institutions sought solutions to legacy problems, a turn towards a private-public blockchain hybrid is trending. In the CoinDesk article, "State Street Slashes DLT Developer Team as Bank Rethinks Blockchain Strategy," an inside source states, “They are moving away from this giant in-house DLT initiative." The shift in thinking may open opportunities for validators outside of financial institutions to assist in meeting their technology demands. “Now, however, the bank is now describing its approach as ‘ledger-agnostic’ and relying more on outside providers.”
Conclusion
Large enterprises can maximize distributed ledger technology (DLT) by balancing public and permissioned blockchain networks. This will allow companies to benefit from decentralization’s security, transparency, and efficiency while keeping data and transaction control. To build a foundation, venture capitalists, businesses, and governments must invest in validator operations, large and small. DLT has huge promise, but only with the correct infrastructure. Balanced public and permissioned networks would enable digital asset exchange, smart contracts, decentralized finance, and more. This balance would also ensure that enterprises can control their data and transactions while benefiting from decentralization. Governments, enterprises, and venture capital firms must invest in infrastructure development, because the potential of DLT is now limitless
