CARDAO aims to enrich Cardano’s DeFi ecosystem and grow the pie through reserve currency. We will create new added value here and provide it to Cardears. We post this article to bring Cardears deeper insight into Cardano’s ecosystem.
Cardano uses Ouroboros, an algorithm that uses proof-of-stake (PoS) protocol to mine blocks. Excluding technical security, the PoS method is based on the premise that a good person’s deposit assets must be at least 51% to be maintained in the right direction [1].
Meanwhile, in the Cardano ecosystem, numerous Dapps are being launched and developed in fields such as NFT, Game, and DeFi. In this article, we explain how Cardano’s PoS system can “economically” affect the expansion of Dapps.
PoS
PoS participants earn ADA as interest instead of depositing ADA assets to enhance the security of the Cardano system (Fig. 1) [2]. There has been a lot of discussion and verification on this. However, it seems that there is not much discussion about what kind of “economic” effect the PoS method will bring to the Cardano ecosystem. We propose a possibility that the PoS system can generate a negative effect on the Cardano system.
Staking vs Dapps
Since the launch of Cardano’s mainnet, numerous Dapps have been developed and launched explosively. Especially in DeFi, promising projects such as COTI, SundaeSwap, Indigo, and Adax are attracting the attention of community members (Fig. 2).
Staking in the PoS system can cause two negative impacts on the Cardano ecosystem:
- It can disincentivize the development of ecosystems.
- Staking incurs a lot of opportunity cost.
Let’s assume that you can earn an average of 5% APR from staking in Cardano. Dapps that pay token interest in return for liquidity supply have no choice but to compete to provide an interest rate exceeding 5%. This can be an hurdle to the development of the DeFi ecosystem. Of course, there is a possibility that the ecosystem will find an equilibrium over time, but it is questionable whether it can maximize the UX of users and find an equilibrium at the same time.
Also, if a user staking 10,000 ADA in PoS, that 10,000 ADA is not used for various DeFi services and is only deposited. Assuming that the DeFi service A in the Cardano ecosystem pays 10% interest on the liquidity supply of ADA, the staker cannot see the profit of 1,000 ADA that can be obtained through 10,000 ADA.
From a long-term perspective, this is an issue that cannot be ignored. The more ADA staking, the more robust the PoS of Cardano becomes. However, the more ADA that is staked, the greater the opportunity cost for it. There is one more problem, which we will address in the next paragraph.
Tradeoff of Inflation Rate
There is a very important tradeoff between the inflation rate for PoS and network prosperity.
- Inflation rate ↓
If the interest rate for staking in PoS is low, the ROI (Returns On Investment) that can be obtained from various Dapps is relatively large. Users will use the Dapp more and the ecosystem will become more active.
However, this situation will exacerbate the vulnerability to potential network attacks, reducing network security.
- Inflation rate ↑
High inflation will cause an increase in demand for staking. As a result, the number of staking participants increases and network security can be increased. However, if we need to expand the ecosystem and create new applications, and the ADA to be used is all used for staking, this can become an obstacle to the expansion of the ecosystem.
Closing the Post
We delved deeply into the possible tradeoff between a strong PoS system and active ecosystem for Cardano. It looks very difficult to remove the essential tradeoff. Then, is there any perfect solution for this problem?
CARDAO believes that CARDAO’s well-designed economic system can resolve this problem little by little. We wanna try this on Cardano.
This post is for introducing a fundamental matter that Cardano has as a PoS-based public chain. Next post will show you how CARDAO tries to resolve the problem.
Thank you for reading this article.
(🏎️, 🏎️️)
Follow us on Twitter: @cardaofinance
Follow us on Medium: CARDAO
Join the discussion on Discord
Subscribe the announcement on Telegram
References
[1] CARDAO. “Why CARDAO chose Cardano?”, “https://cardao.medium.com/why-cardao-chose-cardano-b4f1acc9d188”, Jan. 2022.
[2] Cardano. “Ouroboros”, “https://cardano.org/ouroboros/”.
