Is Staking Rewards a Cost for Blockchain?
The question of whether staking rewards should be considered a network cost has been a topic of controversy in the cryptocurrency community, as these token incentive measures increase the total token supply (thus diluting passive holders). This controversy is further complicated because different parties have different definitions of “cost” and different understandings of “cost.” This research article aims to define from our perspective whether staking rewards are a cost of distributed networks.
What are Staking Rewards?
Staking rewards are provided to token holders who choose to stake their tokens on proof-of-stake (PoS) networks. This process involves locking up digital assets to help verify transactions and secure the blockchain network. These staked tokens serve as collateral for validators, committing to act honestly. If fraudulent transactions are verified, the collateral will be slashed. These collaterals are valued in the native assets of the blockchain (ETH for Ethereum, SOL for Solana).
Staking rewards lead to inflation of token supply, as rewards are distributed to honest validators through newly minted tokens. Validators stake their capital to ensure network security. For example, as of September 18, 2024, the annualized inflation rates for ETH and SOL are approximately 0.8% and 5.0%, respectively, entirely generated by staking rewards.
Controversy:
From one perspective, the network value is affected by the number of tokens, and staking rewards introduce new supply, distributing the same value to more tokens, thus lowering the token price. On the contrary, another view holds that the network value is defined by market capitalization, so staking rewards are not a cost of the network because they are purely a transfer of value from non-stakers to stakers. Our viewpoint is that both perspectives are correct, just from different angles. Staking rewards are a cost in terms of token price, as supply increases; however, it is not a cost of network value, as token supply affects the total number of tokens, not the total value. The table below illustrates the hypothetical dynamics of changes in token value due to changes in supply from period t to t+1:
We believe the key point is that, although the overall network value remains unchanged, the increase in token supply leads to a decrease in the value of each token. We do not believe that increasing supply will change network value. And if one believes that token value will not be affected by an increase in supply, it is like believing that money will fall from the sky.
From the perspective of staking rewards being merely a transfer of value from non-stakers to stakers, we further illustrate this point in the figure below. The figure shows the process of token price and value transfer from period t to t+1 in a PoS network. We assume that 60% of the token supply is staked, with an inflation rate of 10% (through staking rewards). It can be seen that the network value remains unchanged, as the only important variable in these two periods is the token supply.
As shown in the table, the token value is diluted by approximately 9%, further proving that we believe staking does not affect network value but does dilute the value of tokens. The change in network value for non-stakers is the same percentage change as the overall token value. For stakers, the initial capital staked is diluted just like non-stakers, but stakers gain more from staking rewards than the loss caused by dilution. Investors can monitor the yield of these rewards through on-chain data or third-party staking indices (such as the CESR index – Composite Ethereum Staking Rate), which tracks such returns on the Ethereum network.
So, are staking rewards a cost of the network? We believe that staking rewards are not a cost of the overall network value. However, staking rewards do represent an expense for token holders at the current moment.