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Cardano: IOHK sets parameters for Shelley and the rewards, ROI

  • While the release of the Cardano Shelley code on 30 June in the testnet remains on schedule, the parameters for the mainnet have been defined, which will determine, among other things, the rewards for ADA holders and the operators of the stake pools.
  • Based on the current ADA price and further assumptions, IOHK expects an average return on investment (ROI) of 6%-6.5% for stake pool operators.

As Aparna Jue, IOHK’s product manager, explained last Thursday in the June development update, the release of the Cardano Shelley code in the public testnet on June 30th remains on schedule. The Hard Fork Combinator was successfully released in the public testnet this week, and numerous tests in internal networks have been successful, so that a release candidate has been selected.

Last week’s focus, as Jue reported and Lars Brünjes explained, was on defining “solid parameters” for the Shelley network. The behavior of Cardano Shelley is controlled by about 20 parameters for which IOHK has to set values before the mainnet is launched. As Brünjes outlined in a blog post, most of the parameters are technical in nature, so while their correct setting is important for security and optimizing system performance, they do not have a significant impact on the user experience.

However, some parameters have a very large influence. They determine the degree of centralization of the Cardano ecosystem, as well as the profitability of delegation and operation of a stake pool. Their optimal setting is therefore crucial for the success of Cardano Shelley mainnet. One of these parameters is the desired number of stake pools (k), as Brünjes described:

Cardano incentives have been designed to encourage an equilibrium with k fully saturated pools, which means that rewards will be optimal for everybody when all stake is delegated uniformly to the k most attractive pools. The higher k chosen, the more decentralized the system becomes. But a higher k also leads to a less efficient system (higher costs, more energy consumption) and lower rewards for both delegators and stake pool owners.

In order to create a balance between decentralization and the attractive rewards for operators of stake pools, IOHK will initially set the value at k=150 and then gradually increase this value. This will ensure that the system is stable and efficient in the beginning and can grow gradually over time to become more decentralized and even more secure later on:

The number of 150 stake pools of roughly equal size makes Cardano an order of magnitude more decentralized than any other blockchain. And this is only the beginning. There is no reason why there could not be thousands of stake pools in the future.

The rewards for Cardano stake pool operators and the ROI

In this sense, another enormously important parameter is of course the reward for ADA holders (for delegating) and the operators of the stake pools. These are drawn from two sources, the transaction fees, which are collected in a “virtual pot” per epoch and then distributed, and the monetary expansion. The latter is regulated by a fixed percentage (p), which controls the release of the remaining ADA reserves. In addition, a certain percentage (τ) of the pot is sent to the treasury, the rest is used as an epoch reward.

As Brünjes explains, p will initially be 0.22%. This means that every four to five years half of the remaining reserve will be used. This is roughly equivalent to halving Bitcoin, so ADA will have a similar inflation rate. The continuously decreasing emission is to be compensated by the increasing adaptation and thus by the increasing transaction revenues:

We therefore feel that it makes sense to expect Cardano transaction volume and exchange rate to increase sufficiently over the next eight years to more than make up for the decrease of monetary expansion during that time.

The value τ, which goes to the treasury per epoch, is parameterized to 5%, which means that in the next 5 years at least 380,000,000 ADA will flow to the treasury.

The returns for stake pool operators will average 6%-6.5% based on the above parameters, assumed costs of USD 2,000 for operating a stake pool, the current ADA price and the target number of pools (150 to 500). With a rising ADA price, the ROI can still increase significantly.

However, as Brünjes also noted, the values suggested initially are only a start. In the coming months and years the values will have to be refined and adjusted:

No other blockchain has ever done what we are going to do, we are charting new territory with every step and move at the cutting edge of science and technology, so we can’t rely on existing data and statistics or past experience, but have to use educated guesses and mathematical models, which can never be perfect, more often than not.

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About Author

Jake Simmons

Jake Simmons has been a crypto enthusiast since 2016, and since hearing about Bitcoin and blockchain technology, he's been involved with the subject every day. Beyond cryptocurrencies, Jake studied computer science and worked for 2 years for a startup in the blockchain sector. At CNF he is responsible for technical issues. His goal is to make the world aware of cryptocurrencies in a simple and understandable way.

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