A month ago, we walked into an emotive X (formally Twitter) exchange on the subject of staking ADA as a way to enhance Cardano’s network efficiency, stability, and, ultimately, its speed. It quickly became evident that this was not, in fact, a debate but the outrushing unawareness of the ADA staking process and its impact on Cardano — and more so among Cardano newbies, perhaps even delegators — that was the subject of a recent article, Staking ADA to improve Cardano’s speed.
Still, we couldn’t miss an opportunity to provide more insights into staking, particularly running stake pools, so this will be a three-part article series. We’ll start by answering a few questions:
What is Ouroboros, why do we need stake pools in Cardano, and what are the benefits of running a stake pool?
Running proof of work (PoW), as is the heart of Bitcoin’s operation model, is costly, and combining it with other consensus mechanisms, Ethereum’s model, which uses PoW for block production and integrates proof of stake (PoS) on top, for example, is costlier still, both financially and in terms of computational resources. Technological advancements in blockchain technology through generations have developed scientific techniques to bring forth sustainable and environmentally stable ecosystems. Cardano is such an example.
As a tech frontier, Cardano falls into the third blockchain-generation family. It has delivered remarkable aspects in terms of decentralization, security, and scalability in the context of building a Web3 ecosystem. This regime debuted in 2015 when Cardano’s development began. As this continues, Cardano segments and solidifies its position as a balanced ecosystem for which cryptocurrencies and their applications ground. Central to this blockchain platform is Ouroboros, Cardano’s consensus mechanism.
“The blockchain revolution started with Bitcoin. It continues now with Ouroboros” — Cardano Org.
From definition, Cardano’s Ouroboros definition is the first provably secure proof-of-stake (PoS) protocol based on peer-reviewed research. Ouroboros employs unique technology and mathematically legitimate mechanisms, reflecting behavior psychology and economic philosophy, to power secure and sustainable blockchains. Put another way, it is a secure baseline protocol that guarantees the dissemination of global, permissioned, and permissionless networks with minimal energy requirements. If global, a network needs to grow and remain sustainable ethically, providing great opportunities for all its users while self-preserving; Ouroboros on Cardano does precisely that.
We now know for sure the principles that shape Ouroboros. The defining factors are provably secure, incentives and rewards, stake delegation and stake pools, and energy efficiency. Today, the key point of interest centers around rewards and stake pools. Ouroboros ensures the sustainability of Cardano through incentive mechanisms that reward users for participation in the network. Either by operating a stake pool or delegating your ADA in one, but the pillar of this is to distribute network control across stake pools.
Records show that running a Cardano stake pool has many benefits, including staking rewards, support for network decentralization, community engagement, accessibility to blockchain infrastructure, control over a pool’s management, long-term sustainability, governance participation, and brand visibility for your projects. These benefits outweigh the challenges of technical know-how required to run a stake pool. Inspired, we can now look into everything running stake pools on Cardano.
What is a Cardano Stake Pool?
A stake pool in Cardano is a block-producing server node that combines the stakes of various participants into a single unit. Using the Cardano node, stake pools wire up the backbone of Cardano’s Ouroboros through block production, transaction validation, and processing. ADA is the ultimate finite resource, and when you stake it on Cardano, its size is proportional to the amount held. Because there are two ways to earn rewards for holding ADA, delegated or pledged as stake, this is fundamental to how Cardano runs. The primary way Ouroboros chooses which pool adds the next block and gets monetary rewards for doing so depends on the amount of stake delegated to a pool, with chances increasing with more stakes, and there’s a limit to how much this rule dominates.
Two roles are available in stake pools: operator and owner(s), but their conceptual differences are rigid. One, a stake pool operator owns the pool’s cold and verifiable random functions (VRF) signing keys. Two, the operator configures, maintains, and monitors the pool infrastructure running it and is tasked with a pool’s registration, retirement, re-registration, or certificate updates to ensure a block-producing node signs, validates and processes transactions. In pool ownership, this determination of the owner rests on the signing keys used in pool creation, and the owner’s pledge provides protection against Sybil attacks.
In practice, the pool operator and owner are often the same person, but a pool can have multiple owners combining their stakes. Worth noting is that the owner’s combined stake must meet a pool’s declared pledge, or else the pool will be unable to produce blocks. Based on this operation model, all operator and owner rewards are dispensed into a single rewards account for the pool’s address. This, in turn, falls to the owner to redistribute rewards to the operator and other owners. It is readily evident that an agreement is required to dictate when and how the accumulated rewards are split. Either to have the operator in control of the shared account or to use a multi-sig account.
Overall, a stake pool can be public (other users can delegate to it and receive rewards) or private (rewards are delivered to their owners). The biggest acknowledgment here is the comprehensive research and development done to ensure a fair and competitive marketplace that incentivizes participation with rewards for invested time, energy, and resources.
What Exactly are the Parameters Influencing Stake Pools and Received Rewards?
- Pledging mechanism — Althiough there’s no minimum amount, pool operators stake some or all of their ADA to make their pool attractive. The higher the ADA pledged, the more pool rewards, attracting more delegation.
- Saturation parameter (K) — A term that indicates that a particular pool holds more delegated ADA than its ideal for the network, K being the targeted number of desired pools. Once a pool gets saturated, it offers diminishing rewards. We have the saturation mechanism to prevent centralization and encourage operators to set up alternate pools with maximum rewards. The whole point here is to preserve the interests of ADA holders and pool operators and prevent any pool from becoming too large.
- Decentralization parameter — An adjustable parameter that regulates the ratio between slots created by the node federation and stake pool nodes. It stabilizes the network so that all rewards are disbursed to operational stake pools and none to federated nodes during the deployment of the Shelley fork.
- Desirability index — A number used to rank pools in wallets, showing how ‘attractive’ the pool is to potential delegators. The desirability of a pool stems from the combination of the pledged owner’s stake, costs, and margin, influenced by saturation and pool performance.
How to Evaluate the Performance of a Stake Pool
While running, a stake pool’s performance can be hard to evaluate. This should not surprise. If your pool misses the scheduled slots for which it produces blocks, most of your return on stake (ROS) could take a blow. It would be sensible to consider the hardware a pool runs on and the network coverage, for example. A pool’s server is weighed with resources to keep up with the blockchain to avoid missing out on block mints.
Another point of concern is power outages. Even if a pool runs on an uninterrupted power supply (UPS), the internet service provider could go down, rendering the pool inactive for some time. In effect, a pool could have a low ROS during an epoch, and the only way to evaluate its performance is to gauge it over many consecutive epochs for an authentic overall feel. Large cloud computing providers are a good way to ensure all-time availability. This opens up the requirements for running a Cardano stake pool.
Next Steps:
In this article, we introduced Cardano’s Ouroboros as a cornerstone of its operation model and stated the need for stake pools and the benefits of stake operation in Cardano. We have also decomposed the stake pools into what they are, their available roles, the factors that influence stake pool rewards, and ended with a note on stake pool performance.
In the next piece, we will list the requirements for running a stake pool on testnet and mainnet and also walk through a step-by-step guide for setting up a stake pool.
