On the date of publishing ~69% of current total atom supply is locked in staking meaning that for the rest, their holdings are considered more as speculative rather than potentially revenue generating assets. Most of Proof-of-stake (PoS) networks sometimes offer attractive yield nominated in native tokens. An effective and reasonable relation between risk and reward assists in achieving the implied level of network security and create economic incentive for delegators to lock their holdings if they believe in the value proposition of the token in the long term. Staking yield provides a reliable revenue stream for validators operating the network.

If short term expectations about token price are bearish and speculators see a possibility to repurchase more tokens in future and this amount exceeds the expected return on staking (RoS) nominated in USD for a particular period of time then the reason to lock-up holdings in staking can be less attractive than just to hold and be ready to sell when emotions are high. It can be true for even long-term believers who consider such speculation as an opportunity to increase the overall network share as well.

1. Not staking = missing opportunity

Not staking today may be considered as a missed opportunity to earn rewards tomorrow. The higher the belief in the long-term value growth the less speculation happens in the short term and more people agree to get higher benefits in the future. Atoms are not speculative assets and can be defined as units subject to inflation, generating revenue from transaction fees thus providing an incentive to actively participate in staking, securing the cosmos hub. Validators of cosmos hub will earn fees by validating on other chains in cosmos ecosystem and sharing security with them. Until Inter Blockchain Communication (IBC) and shared security features are not active, transaction fees are close to zero, short term ATOM value may fluctuate.

However, from pure speculators tokens will go over to the long-term participants and their attempts to sell high and buy low may fail. Volatility expectations may become less interesting than staking or even erroneous, which will lead to a missed opportunity to jump into the leaving train. Unbounding also makes funds illiquid for three weeks and decreases the speculative attractiveness of ATOM.

Some short-term traders prefer to store their tokens on exchanges. Even if exchange offer staking opportunities it is not secure because the person has no control over the holdings. Sometimes exchanges suffer from hacking attacks. The recent accident with Binance confirms that that exchanges are not the best option to store funds.

If you believe in the ability of ATOM to gradually increase earnings in the long run, then buying low, adding on deeps and immediate staking with reinvesting rewards in order to increase overall share in the network can be a more reliable strategy, which can provide higher gains from transaction fees in future.

2. Inflation

To get rid of confusion, annual inflation is not the same as annual RoS. Inflation is a mechanism, minting rewards that go to stakers as a percentage of total ATOM supply. As a result, it dilutes a share of the network of speculators and passive holders.

Annual ATOM provisions and annual RoS depend on initial parameters determined in genesis. lnflation percentage was set at 7% from total supply. This number is slowly increasing and can go up a maximum 13% and reach 20% to incentivize staking until 67% of ATOM supply will be bonded.

If staking ratio is <67% then annual inflation change in the moment can be defined with a following calculation: 7% + 13% * (67% - staking ratio). If staking ratio exceeds 67% then inflation will gradually decrease.

Validator ATOM provisions occur every first block of a new hour. These provisions are based on the estimated number of blocks in a year. When cosmos network first launched mainnet this number was calculated with the assumption, that average block time will be 5 sec.

By dividing the quantity of seconds in a year by average block time, we get the estimated number of blocks in a year. Calculated yearly ATOM provisions are evenly distributed to the blocks. After launch, it became clear that actual average block time is higher and stakers will get fewer amount of ATOMs than it planned. That is why the first proposal was about adjusting the number of blocks in a year with 6,75 sec which is much closer to the actual block time.

After we have figured out ATOM provisions per block we can find overall annual RoS. These rewards go only to participants who are involved in staking. If all ATOMs are locked in staking then everyone gets an equivalent amount of tokens and there will be no additional benefit relative to each other. In this case, annual inflation will be the same as annual RoS and no one will be diluted or rewarded.

Otherwise, we need to include staking ratio in our calculation. Annual RoS = annual inflation / staking ratio, where staking ratio = staked ATOMs / total ATOMs. In fact, additional rewards that go to delegators from inflation are ATOMs intended for those who do not stake. In that way, net earnings are the difference between annual RoS and annual inflation rate. Passive holders are penalized by inflation and their share of the network is diluted and redistributed amongst delegators.

Example

Let's make it clear and simple to sum up the information written above. Imagine that we have total ATOM supply equal of 100, annual inflation is 7% (assume it is not changing), staking ratio is 20%. Four participants have 20 20 20 40. Annual ATOM provisions from inflation equal 7 and total supply at the end of the first year will be 107 ATOMs.

Only one participant with holdings of 20ATOMs bonded. For these conditions, we observe the following parameters.

The first participant P1 increased his network share by 5% but also he decreased the distance from P4 by 8%. If we change staking ratio from 20% to 60% we will see the following results.

You can notice that gains in network share of staking participants are equal to the loss of passive holders.

Voting power and network decentralization

Cosmos network is a community driven project where all important solutions are accepting or declining via on-chain governance process. These decisions can have an enormous impact on token holders and other players. Participation is mandatory for validators but not for token holders. By staking, delegators transfer the voting rights to a validator. The higher the voting power the higher the influence on the results of the governance process. If a delegator does not agree with the decision of a validator he delegated to, then he is still able to cast his own vote subtracting voting power in this particular proposal from the validator.

If a delegator has no intention to participate in governance then his stake will increase the voting influence of validators he bonded. If such power is distributed unfairly and a small number of validators control too much, it can lead to centralization of the voting process. Situations like Aragon experienced undermine believef in the healthy decentralization and fairness of on-chain governance.

Currently there are 100 validators in the cosmos hub participating in consensus and the top 6 of them control ~36% meaning they can possibly collude and cast a veto, declining any healthy proposal. To avoid that cosmos hub delegators are able to transfer their voting rights in order to support the sustainability of the network increasing voting power distribution amongst validators.

Delegating to various validators is much better for the network than not delegating. In addition, it helps to decrease slashing risk for the stakers. The cosmos network is still in the early stages and new active participants may come as the project evolves so power distribution can change drastically in the future.

4. Compounding

Compound interest may serve as an effective tool for increasing the share of the network in the long-term. Walter Schloss, a famous notable disciple of the Benjamin Graham school of investing said:

Remember the power of compounding. You don’t need to stretch for returns to grow your capital over the course of your life. Even small gains matter. By re-delegating your rewards you increase the overall return from year to year. The longer the period, the bigger the difference.

RoS depends also on the frequency of re-delegating. The most common re-investment frequencies are year, quarter, month and day. We know, that in theory, continuous compounding can offer the highest return and the higher the frequency the higher the percentage in the end.

However, in some cases in crypto networks it could be incorrect. To re-delegate ATOM rewards you need first to withdraw them manually. To conduct this operation you need to pay a transaction fee. After withdrawal another fee occurs when you stake your rewards. So if you are not a big fish and don't have a big stake then withdrawing too frequently can lead to a situation where small fractions of pending rewards may be less than the transaction fees or the difference may be too small and not make sense.

Monthly compounding looks like the most optimal frequency to re-delegate ATOM rewards. However if the stake is higher than 3000 atoms re-investing on a daily or weekly basis becomes more reasonable with stated RoS of ~12,2%.

"Compounding matters and does so far more than people expect. The human brain thinks in a linear way which means that if we were asked to estimate what 10.22% (close to current annual yield of cosmos network) compounded over 100 years would be then our answer is likely to be closer to 1,022% than 1,679,600%, something economists call exponential growth bias. This means that compounding is often underestimated and should be at the heart of long-term investing" Marathon Asset Management

Increase of stability and network security

As pointed in the previous article, cosmos ecosystem utilizes tendermint consensus. It achieves absolute finality and any block that receives >2/3 pre-votes and pre-commits are considered as valid. If >1/3 malicious validators collude they can cause a fork. Off-chain coordination will allow honest validators to make a reorganization proposal as it would not be possible to perform on-chain as the malicious group will be able to veto every proposal.

The resiliency and overall network protection depend on the staked tokens. In theory, bad actors should accumulate enough voting power and the cost of such an attack is higher when more ATOMs are bonded. Currently to accumulate >1/3 of voting power and execute a successful censorship attack, bad actors need ~56 000 000 atoms. That is equivalent to ~300 000 000 USD.

To sum up everything written above we can conclude that:

• Staking saves you from inflationary dilution of the network share
• Staking early increases your ability to earn higher rewards in future
• Smart staking helps the network to achieve higher decentralization of voting power
• Compound interest on staking rewards work for you and increase your network share
• By delegating, you increase the network security and support reliable project evolution in the long-term.

Special thanks to @asmodat for bringing clarity to the inflation part of this article

P2P Validator offers high-quality staking facilities and provides up to date information for educational purposes. Stay tuned for updates and new blog posts.

Web: https://p2p.org

Stake ATOMs with us: https://p2p.org/cosmos

Twitter: @p2pvalidator

Telegram: https://t.me/p2pvalidator