New DeFi Track: How to Balance staking voting rights and rewards (Part III)

Let’s discuss the second part of the rewards settlement, how the contract account settles rewards to Staker?

If users are allowed to choose their own validator, the reward settlement is naturally settled to the user based on the current validator’s commission rate. This is a simpler situation to handle. It’s the same interaction as with wallets that generally support staking.

In the case of a protocol to uniformly select validators, the rewards will also be distributed by the derivative protocol to all stakers in uniform proportions. We need to think about the most efficient way to implement interest distribution.

If we were to make the value of a derivative vDOT always 1:1 equal to DOT, then we could have it so that a user staking 1 DOT at any time could only generate 1 vDOT.

Destroying a vDOT will redeem only 1 DOT. In order to synchronize the staking reward, the protocol needs to periodically update the number of vDOTs in each account. After the update, the account that originally held 1 vDOT may become 1.1 vDOTs. vDOTs act as if they will reproduce themselves. On rare occasions, vDOT may also be reduced,for example when a slash occurs and the slash amount is higher than the amount of reward distribution in the current period.

However, this method has two major drawbacks, the first being that it consumes a lot of computational resources to periodically settle rewards to all addresses. The second is that a token that reproduces itself is a heterogeneous token for DeFi, which is not conducive to cross-chain circulation or widespread participation in DeFi.

Therefore, the current Staking derivatives protocol basically adopts another method: breaking the 1:1 exchange rate between derivatives and original assets, allowing the rate to change in real time as the staking reward continues to increase.

For example, at the beginning of the period, user A staked 1 DOT and obtained 1 vDOT. After a period of time, due to staking reward, 1 DOT in the contract account became 1.1 DOT. At this time, 1 vDOT can be redeemed to 1.1 DOT.

As staking accumulation proceeds, the number of DOTs that can be exchanged for a vDOT continues to increase, and the exchange rate of vDOT to DOT increases. If a slash occurs, the exchange rate decreases.

Changes in exchange rates mean that both redemption rates and mint rates are changing. When the current redemption rate of the protocol is 1 vDOT can be redeemed to 1.1 DOTs and only 1 vDOT can be obtained through the protocol as 1.1 DOTs. Only in this way, new users will not take advantage of old users, nor will old users take advantage of new users.

We convert the changes in contract asset value caused by slash and staking reward distribution into changes of exchange rates. Under this mechanism, the derivative represents the sum of the principal and rewards accumulated from the beginning of the staking to the current point in time.

For DeFi, such derivative tokens are no different from other tokens and can be easily compatible. In addition, only when users mint or redeem, the system needs to calculate the current exchange rate (the current exchange rate is equal to the total number of derivative tokens: the total number of staking tokens in the protocol pool), and then mint or redeem according to the current exchange rate, eliminating the need to calculate regular dividend payments.

Minting and redemption by itself will not affect the exchange rate. Because at the time of token minting, the staking and derivative assets held in custody in the chain increase in equal proportion. At the time of redemption, the staking assets and derivative assets held in custody on the chain are reduced in equal proportions. The only things that can affect the exchange rate are the staking reward payout and slash.

Slash probabilities are low, while staking rewards are ongoing and are constantly compounding. Overall, the exchange rate of derivatives to the original token will continue to grow. In the short term, the impact is small, but it could grow to very large numbers over time. At that time, the protocol will need to split the new derivative measurement unit.

The Future of Staking Derivatives

What kind of derivatives will attract users to swap more, what kind of derivatives are more friendly to the original chain, and what kind of derivatives can be more widely adopted as the basic assets of DeFi? This is something nobody can predict. What is certain is that staking derivatives will be a prosperous field. Because different choices based on the Mundellian Trilemma will meet different subdivision needs.

Looking forward to the moment of prosperity!