CARDANO - Rewards Explained

HOW TO WORK OUT SATURATION AND EXPECTED REWARDS


As we soon move into the 1st Shelley Epoch where rewards will be earned there is still much confusion about what saturation is, when a pool becomes saturated, how saturation affects rewards and the ‘D parameter’ which determines how hgh rewards will be, so this article looks at explaining all of these things in detail so delegators can walk away with a much better understanding of how rewards are calculated..





SATURATION

This is going to require a calculator to work out. There is a website called PoolTool.io which is a great resource when it comes to all things Cardano, so in this example we are going to use a screenshot from https://PoolTool.io. Other information resources are available, including https://adapools.org and the PegasusAPP, but in this example we will use PoolTool.

The first thing you need to know is what the current global stake is. so in the screenshot below you will see the current global stake at the time of writing this article is 4.63 Billion ADA. We’re going to need this number in our calculations in a bit.


The equation to work out saturation is fairly simple, so a small calculator is all you will need to work it out.


Saturation = Total Global Stake / ‘K’


Total Global Stake currently equals 4.62 Billion ADA


‘K’ currently equals 150


So Saturation = 4.62 Billion / 150


A quick way to work this out using a calculator is to take the Total Global Stake in Billion, multiply it by 1000 and divide it by 150:


4.62 x 1000 / 150 = 30.8


So Saturation = 30.8 Million ADA


Delegating to pools which have more stake than this saturation number will reduce their rewards significantly, so this is important to understand.



‘D PARAMETER’

The D parameter is controlled by IOHK and IOHK will slowly be decreasing the D parameter over the next 2 to 3 months.


The D parameter started at 1.0 on 29th July at 21:44:51 UTC time which means 100% of the blocks and so the block rewards go to the Treasury.


At 21:44:51 UTC on 8rd August the D parameter will be reduced to 0.9. This means that 10% of blocks will now be created by stakepools, so 10% of rewards will be generated by stakepools, and the remaining 90% of rewards will go to the treasury. This will significantly reduce rewards early on, but it is a necessary safety measure being conducted by IOHK to ensure the safety of the network, so delegates must be patient for the next 2 to 3 months while these rewards are slowly increased to their full potential.


In 2 to 3 months time the D parameter will have reached 0.0 and this is when 100% of blocks will be created by stakepools and so 100% of rewards will be generated by stakepools.



WORKING OUT ROI BEFORE FEES ( A SIMPLISTIC VIEW)

ROI depends on how many Total Global ADA is being staked.

There is an equation to work out how many rewards will be present in each epoch:


Total Epoch Rewards = Cardano Gift + Total Epoch Transaction Fees


Cardano Gift = About 26 Million ADA per epoch


Total Epoch Transaction Fees = The total number of fees generated by all transactions occuring in an epoch. At the moment these total fees are quite low because there are no DAPPS built ontop of the Cardano Network. But DAPPS will come, and they will significantly increase rewards! (More about that later).


There is an equation to work out expected ROI:


ROI = Total Epoch Awards x (365 / 5) / Total Global Staked ADA


So lets run through a quick example you would do on a calculator:


ROI (Without D parameter) = 100x 26 Million x 365 / 5 / 4.62 Billion = 41%


To make this easier on a calculator, whenever you see 26 million type 26, and whenever you see for example 4.62 billion type 4.62 / 1000. It’s important to note that as time goes on the Total Global Stake will change and so this 4.62 number will likely increase.


So on a calculator this now looks like:


100 x 26 x 365 / 5 /4.62 /1000 = 41.08


So ROI (Without D parameter) = 41.08%


What does this mean though? Does it mean the rewards while the total Global Stake is 4.62 Billion ADA are 41%? The answer is Yes and No, because to workout the rewards earned by stakepools we must first remember to factor in the D parameter, which will initially be starting at 0.9.


To work out ROI with D parameter factored in we must use the following equation:


ROI = ROI(Without D parameter) x (1 minus D Parameter)


From 21:44:51 UTC time on August 3rd 2020 the D paramter will be reduced from 1.0 to 0.9. So here is a worked example you can do using a calculator:


ROI = 41.08 x (1 minus 0.9)


Which can be simplified to:


1 minus 0.9 = 0.1


0.1 x 41.08 = 4.08%


So the ROI expected form the first epoch is 4.08%


This is the ROI before any pool fees have been deducted!



POOL FEES. WHAT DO THEY MEAN?

Delegators will see there are two different pool fees every stakepool is charging. There is the fixed pool fee called Cost Per Epoch, and the % commission pool fee called Pool Margin.


COST PER EPOCH FEE:

To create a stakepool every stakepool must charge atleast a minimum fee of 340 ADA. This is the minimum any stakepool is allowed to charge and is why so many stakepools are charging this minimum fee.

This does not mean every delegate must pay 340 ADA per epoch.

If a stakepool creates 1 million ADA in rewards in an epoch then it will deduct 340 ADA from this 1 million ADA rewards. So this would leave 999660 ADA in rewards which could potentially be passed onto delegates.

For stakepools creating a lot of blocks this 340 ADA fixed fee is negligible and can almost be ignored. But for stakepools only creating a small number of blocks this fixed fee will become more important as it will have a greater impact on lowering the pool’s ROI.


POOL MARGIN FEE:

This is a large topic for debate among stakepool operators and understanding % fees is very important for the security and long term health of the Cardanon network.

After the fixed fees have been deducted from the rewards the stakepool charges a commission fee on the remaining total. So to keep numbers simple lets assume this % fee is 1%, and we’ll talk alter about why 1% is not necessarily the safest approach to take when hunting for high ROI.


So 999660 ADA of the 1 million ADA rewards generated by the pool was left in the example above after the 340 ADA fixed fee was deducted.


The commison fee of 1% in this example = 1 x 999660 / 100


So in this example the commission fee = 9996.6 ADA


The remaining ADA after this fee has been deducted will be split up and paid to delegates as their epoch rewards. so in this example the total rewards paid to delegates from this pool would be:


1,000,000 -340 -9996.6 = 989,663.4 ADA


So delegates get rewarded with 98.96% of the total rewards the hard working stakepools earned for them.



PLEDGE

Pledge is very important to consider when selecting a stakepool. The pools will highest pledge will pay higher ROI than the pools with lower pledge if all other fees are the same! It doesn’t get any simpler than that :)

The system has been designed like this to incentivise people to delegate to high pledge pools and this acts to secure the network against 51% attacks.



AVOIDING 51% ATTACKS:

A 51% attack can happen if a bad actor gains control over 51% of the global staked ADA, and they can only do this by creating many stakepools and attracting many delegates to stake to those stakepools by offering low fees. In this article we will not go as far as to name names, but lets for example say a stakepool operator charges 1% fees and creates 10 stakepools. Lets call these stakepools XYZ0, XYZ1, XYZ2, XYZ3, XYZ4, XYZ5, XYZ6, XYZ7, XYZ8, XYZ9. Whenever a delegator sees such a setup alarm bells should start ringing in their heads. Who is this stakepool operator? Why have they got so many pools? Are they trying to perform a 51% attack on the network? Is it a good idea to delegate to them so they can perform this 51% attack on the network?


WHY CHOOSING LOW POOL MARGIN FEES MAY BE BAD FOR YOUR ROI

Ok, so now lets talk about why the normal human response of choosing the lowest fee may not be such a great idea.


Running a stakepool is a business, and it costs money to run a good reliable stakepool that createsd all of it’s blocks and so generates the maximum possible return for it’s investors.


This is cryptocurrency so there are many very small low cost setups running on simplistic setups, and by doing so it’s true their costs are very low, but are these setups reliable and can you guarantee they will create all their blocks to maximise your rewards? The answer with many of the setups seen is no, so lets explain why.

Each stakepool needs to have a core node, hidden behind atleast 1 relay node, and it also for security reasons needs to have another completely offline node to generate secret node keys. So the most basic setup requires 3 computers, yet some node operators will be running using a simple small PC, because it is possible to do this.

So why is this not good for your ROI. Lets explain:


First of all, safety. If a node operator has generated secret node keys on the same PC as the node runs on then the entire node could have been compromised putting funds at risk. This is really bad practice and none of the professional stakepools will have created a pool in this way.


Now lets look at the number of relays a stakepool operates and explain why running a single very low cost relay node is a bad idea and risks losing many rewards:


A stakepool operating behind a single relay node has a single point of failure. If something happens to that node, if it is attacked, has a power outage, or is simply going through a routine system upgrade, then the node stops producing blocks and stops creating rewards. Delegators could easily see rewards drop to 0% if delegating to pools operating behind a single relay node.


If a stakepool has 2 relay nodes then 1 of these relay nodes can go offline whilst theo ther relay node still continues creating all of the blocks. So you can see that operating atleast 2 relay nodes costs more, but is a good idea.


At the time of writing it seems hundreds of stakepools are operating with a single relay node so are risking your ROI in order to reduce costs. Is the risk of losing all rewards really worth saving a small percentage in commission? I’ll leave that question up to you to answer.


At PlanetStake we operate 3 relay nodes which are public and then of course some which are private as this lowers the risk of all nodes being attacked and taken offline. Some pool operators are running 18 relay nodes, so they have significantly higher operating costs, but are offering the safest service, soplets give a brief shoutout to these heroes:


Digital Fortress : DIGI, DIGI2

AdaFrog: FROG, FROG2


These are very safe stakepools to delegate to if you’re looking for the most stable rewards, but they have to charge more to offer his service as it costs significantly more to run this many relay nodes. This extra cost is not very significant though, because it is split between all delegators in their pools.


Digital Fortress charges 3% and AdaFrog charges 4% commission, meaning delegates wanting stable and continuous rewards still keep 96–97% of the rewards their ADA earned each epoch.



HOW WILL GOGUEN AFFECT REWARDS?

Goguen is a very exciting time for all delegates, because this is when DAPPS go live on the Cardano network.


You remember we talked about rewards in each epoch also consist of all the transaction fees generated in that epoch? Well this is significant and has the potential to significantly boost ROI.


The rewards form each epoch are currently around 26 Million ADA and are a gift from the tail end of the Cardano chain to stimulate interest in coming to stake and earn ROI on the Cardano blockchain. But now consider the minimum fee per transaction is 0.155 ADA.


How many transactions will be required to generate an additional 26 Million in rewards and so double ROI per epoch!!?


The answer is 26 Million / 0.155 per epoch


167.7 Million Transactions per epoch


which is 33.5 million transactions per day!


Does this seem feasible? Yes!


In the future when Cardano is used by billions of people daily will the ROI be significantly higher?


YES!


So now is a very good time to start thinking about Goguen, anbout all the DAPPS that will be going live on Goguen over the next few years and many years to come, and all the comanies creating those DAPPS. The future looks very exciting for Cardano, it really does!



FINAL NOTE

So hopefully this article has done a good job at explaining how rewards are calculated, the exciting times to come, and why the lowest % fee stakepools do not necessarily offer the best ROI.


We are PlanetStake, we operate with 3 public relay nodes and are offering a 0% trial until September 1st offer, so please consider trying us out. But please remember how the D parameter affects rewards when comparing the performance of all stakepools :)