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Delegating digital assets 101

January 26, 2022

Everything you need to know about blockchain token delegation and how to get involved

Owners of digital assets from proof of stake (PoS) protocols can do more than simply hold their assets in a wallet. One of their options is to delegate crypto tokens — a process of contributing them to a public validator node to help it conduct PoS validation. 

By delegating to a trusted validator on a protocol such as Polkadot, Tezos, Celo, or NEAR, assets are put to work securing the network. In exchange, they may earn rewards in the form of more tokens.

With proper consideration of the risks and trade-offs involved, delegation can present an opportunity for token holders to support and participate actively in secure blockchain networks. Furthermore, they can earn more digital assets while doing so.

Digital asset delegation and staking

Many aspects of delegation are common across PoS protocols — though the process for each network can have its own specific nuances. To understand how delegation functions within a PoS protocol, it’s helpful to make the distinction between proof of work (PoW) mining and PoS validation.

Proof of work vs. proof of stake

PoW

The earliest blockchain protocols used PoW mining to secure networks and validate the transactions included in each block. In PoW mining, network participants use either general-purpose computer hardware (CPUs or more expensive but more efficient GPUs) or purpose-built, application-specific integrated circuits (ASICs) to find the answer to a mathematical problem and to certify transactions on the chain. In exchange, those participants earn rewards in the form of crypto coins or tokens.

This process is known as mining — and being a miner can be lucrative. At the time of writing, mining just one block on the Bitcoin blockchain can earn a miner the equivalent of approximately $290,000 in block rewards, not inclusive of transaction fees.

Critics argue that PoW mining tends toward centralization and brings with it negative implications for security and accessibility. The increasing cost of participating in PoW mining has led to the consolidation of miners into mining pools. Miners are further clustered within regions with cheaper electricity and preferable conditions for operating. 

Elsewhere, broad or even hobby-level participation in PoW networks is limited by the race for increasingly tailored computers, and the high cost of entering and operating within the market. 

PoS

Proof of stake validation was developed, in part, to lower these exclusionary barriers and reduce the energy expenditure required by PoW mining.

Whereas proof of work miners operate a mining set-up to keep the network secure, proof of stake participants operate a node on the network to validate transactions and create blocks. In return for executing this work, they earn block rewards. 

A set amount of value must be locked, or “staked,” to the node for it to become active as a validator on the network. Once active, it is eligible to produce work on-chain in exchange for rewards. On some PoS protocols, the node risks losing a portion of its rewards if its operators behave poorly or maliciously, commonly referred to as “slashing.” 

The incentive of rewards for good behavior and penalties for bad behavior are critical to maintaining the security of a network.

Because a PoS node is picked to validate a block based on the amount of tokens that are staked to it, the more there are, the higher the likelihood it will be selected to perform work and earn block rewards.

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Active stake by validator on the Solana mainnet beta: Source

Why delegate digital assets?

Certain PoS protocols allow for delegation, whereby a holder of a network’s tokens can earn block rewards by adding their asset to the staked tokens on someone else’s node. In exchange for locking the value of their tokens to a validator node, the delegator earns a percentage of the block rewards earned by the validator.

As having more tokens staked to a node increases the likelihood that it will be selected to perform work and earn rewards, delegation increases PoS validators’ reward-earning opportunities.

Delegators also benefit, as they can earn a percentage of block rewards without needing to become a validator themselves. So digital asset holders who don’t have the resources or technical know-how needed to operate validator nodes, but still want to earn rewards, may choose to delegate.

Operating a validator is often difficult and time-consuming. Validators must be active, viable participants in a network to earn rewards; they must be built and managed with proper consideration for uptime and participation, and they must comply with the often complex specifications of each protocol team’s code base. 

Although a casual token holder may use a blockchain infrastructure platform-as-a-service provider such as Coinbase Cloud to run a node on their behalf, many do not have the number of digital assets that would make it worth paying to run validators with a premium infrastructure provider.

On many protocols there is no minimum quantity of tokens required for a token holder to delegate their assets to an active validator node. So delegation allows even digital asset holders without many tokens to participate in a network.

Delegators have the flexibility to unbond, or remove, their tokens at any time — subject to each protocol’s unbonding period — and may pay only a small percentage of their rewards as a fee for the service provided by the validator. 

By delegating to a public validator node, even those token holders with very limited quantities of digital assets can help to secure the network and put their assets to work. 

On the Tezos network, for example, there is no minimum required amount of XTZ to delegate to a validator, and the cost of one XTZ is currently the equivalent of about $2.66. With the current rewards rate on the network hovering around 6% annually (120 times the average interest rate on savings accounts in the U.S.), even after paying a 10% validator service fee, a person delegating as few as 100 XTZ could still receive an additional 0.45 XTZ after just 30 days of delegation — or an additional 5.47 XTZ over the course of a year, all network variables remaining stable.

One must also consider that there is no unbonding period on the Tezos network, meaning that someone could cash out their delegated XTZ immediately if they needed to use those funds. As such, delegation on the Tezos network, as an example, may be a good choice for an individual who wants to earn more XTZ with little effort, while still retaining their XTZ as a liquid asset.

Considerations before delegating

Every blockchain network operates by its own protocol parameters. To make sure of a good fit, it is important to understand the specifications of the network before you delegate. 

A few key considerations include:

  • Liquidity Warm-up periods (the amount of time after delegating to a validator before your tokens are eligible to earn rewards) and unbonding periods (after you request to remove tokens from delegation until you get them back) vary greatly per protocol. They may range from a number of hours to a number of weeks or even up to a year. One’s liquidity needs will determine whether or not to delegate.

  • Inflation and reward rate Expected inflation and delegation reward rates also vary by protocol. It’s crucial to weigh the expected rewards for delegation against other methods for rewards generation — particularly given the emergence of DeFi applications.

  • Validator service fees On most PoS networks that allow delegation, validator node operators charge a small fee (a percentage of rewards earned) to delegators for the service provided. However, when comparing public delegators, it is vital to consider more than who charges the lowest service fee. In many cases, those low-fee validators may cut corners on security and carry a higher risk of loss than premium-rate validators.

The risks of delegating

In most PoS networks, if the node is slashed, delegators are subject to a portion of the losses incurred by a validator. Slashing is when a predefined percentage of a node’s tokens is lost because it behaved maliciously or abnormally on the network. Conditions for slashing can include downtime (a node being offline) and double-signing transactions. Potential delegators should delegate their tokens to a trusted validator to ensure their assets are not placed at undue risk of loss due to the validator having minimal protection from slashing or cyberattack.

How to get involved

There is no single way to delegate digital assets to a blockchain protocol. Each one has its own process and uses tools to enable delegation such as CLI developers, a mobile or web-based wallet, custodial providers, or hardware wallet interfaces. Given these differences in delegation methods, researching the open-source developer tools for each protocol is a great way to learn how to delegate specific tokens.

Get started delegating to our enterprise-grade public validators today, following our step-by-step guides.