On any PoS protocol, a node or stake pool operator wants to optimize their participation in order to receive the highest amount of rewards possible. The most important way to achieve this goal is by operating the node successfully—not missing blocks, remaining updated and in sync with the chain, and avoiding downtime.
Some protocols, however, have additional mechanisms to optimize participation (and in turn, rewards) based on an operator’s individual goals. Cardano is one such protocol.
There are three levers available to a Cardano stake pool operator to optimize rewards: the pool pledge, pool margin, and pool fixed cost. The use of these levers depends on whether the operator’s goal is to operate a private stake pool or to accept outside delegations.
To understand how to best use these levers, one must first understand Cardano’s defining rewards parameters, and when the levers come into play in Cardano’s rewards mechanics.
From there, one can explore how the pool pledge and margin mechanics may be optimized by the operator of a public or private stake pool to maximize potential rewards earned.
There are two protocol‐set parameters that exist to prevent centralization on Cardano, by impacting the amount of ADA, and the number of pools in the network, that an individual stakepool can control: the k parameter and the a0 parameter.
The Saturation Parameter (k) is intended to control the number of stake pools in the network, and help increase decentralization by incentivizing the creation of more stake pools.
The parameter determines the amount of stake on a single stake pool that can earn rewards. The higher the k parameter, the lower the maximum stake cap per pool. Any stake above the maximum does not earn additional rewards for the stake pool.
For example, if the k parameter was set so that the stake cap per pool was 100 ADA, a stake pool with 100 ADA staked and a stake pool with 200 ADA staked would both earn the same rewards. A stake pool is most profitable when it has reached, but not surpassed, the stake cap.
As of December 2020 the k parameter on Cardano is 500, bringing the saturation point (stake cap) for a stake pool to 64 million ADA.
The Pledge Influence Parameter (a0) is how the protocol adjusts rewards to reflect the pool’s percentage of pledged tokens. The a0 parameter is intended to create a benefit for pledging more of one’s stake to a single pool instead of splitting one’s stake, thus promoting decentralization by incentivizing large operators to control fewer pools with a high pledge rather than many with a low one. As there is no slashing in Cardano, pledging functions as an important mechanism to prevent Sybil Attacks on the network. Adding X amount of pledge to a pool increases its rewards additively by up to a0*X.
First, let’s define some terms:
The following process takes place each epoch to determine the amount of inflationary rewards that will be distributed to all the stake pools.
Once this total pool of rewards available to participants for the epoch is determined, the protocol must then distribute the rewards to the participating stake pools.
The protocol first divides the total pool of rewards available by participating stake pools, then for each pool:
Cardano stake pool operators can be either private, using only their own self-bonded stake, or public, by accepting delegation.
A private stake pool retains 100% of the pool’s profits but must also provide 100% of the pool’s staking power. Alternatively, accepting delegation increases the number of entities that can contribute to a pool’s stake, but also increases the number of entities that receive the rewards as delegators get a pro‐rata share of the pool’s profits.
By default, a pool with a margin set below 100% is considered a public pool; ADA holders may choose to delegate their stake to it.
A stake pool is by default private if its margin rate is set to 100%—meaning that the stake pool operator retains 100% of the pool’s profit margin. As such, delegators should not delegate to it as they do not earn any rewards for their delegation, and most stake pool explorers will not give the pool visibility as a staking option for that reason.
When setting up their stake pool, an operator must decide whether it will be public or private. Once that is determined they can go about optimizing their participation and expected rewards.
A stake pool operator must first consider their pool pledge amount.
While pledging is optional, this self‐bonded amount indicates to the protocol that the stake pool operator has "skin in the game." Locking up some of their own stake helps secure the protocol and functions as a mechanism to prevent Sybil Attacks on the Cardano Network. As an incentive for operators to pledge ADA, the pool’s reward rate is increased for doing so. The higher the pledged amount, the higher the reward rate for the pool.
A pool that has reached the stake cap (aka is fully saturated) solely via ADA pledged by the pool operator is eligible for the maximum total amount of rewards identified for the pool. As the pledge percentage of the total stake decreases, so do the total rewards for the pool. A stake pool that reaches the stake cap completely from delegation earns only 77% of the rewards that a stake pool composed completely of pledged ADA.
Private stake pool operators optimize their rewards by pledging the whole stake cap for their pool. If an operator has the required ADA to meet the saturation point alone, their rewards will be 100% of the potential earned when adjusted for the a0 parameter.
Public stake pool operators must balance their pledge amount with their expected delegation amount. Delegators consider the pledge amount of a stake pool operator when choosing which stake pool to delegate to. A high pledge signals a long‐term commitment to operating the stake pool, and increases delegator rewards as dictated by the a0 parameter. However, the larger the pledge amount, the less room for productive contributions from delegators’ tokens before reaching the stake cap.
Some pool operators may choose to adjust their pledge amount over time, while others may choose to prioritize other rewards factors, community engagement, or promoting their stake pool’s robust performance as alternative methods for attracting outside delegation.
Because private stake pool operators keep 100% of their rewards margin, they do not need to spend time determining an appropriate pool cost or pool margin. The pool cost should just be set at the minimum allowed by the protocol and the margin set to 100%.
Public stake pool operators, however, earn both fixed and variable fees from delegators for conducting the service of validation. At the end of each epoch, the stake pool operator retains a set amount of ADA (the pool cost) which is intended to cover operational costs for the pool operator regardless of market fluctuations. In addition, they receive a percentage of the remaining pool rewards (pool margin). The pool margin rate, determined by the pool operator themselves, provides an opportunity to scale rewards earned with the pool’s success.
Public stake pool operators must determine the best fixed fee and margin rate to optimize the rewards for delegates and for themselves. The fees can be updated regularly to account for changes in the market factors, such as fluctuations in the cost of ADA, changes in the cost of operating the pool, or increased/decreased rates of delegation to the stake pool.
The minimum pool cost an operator can set is 340 ADA per epoch. Operators are encouraged to set a realistic fixed cost that accurately reflects the expense and time of running the stake pool. In addition, operators are encouraged to be transparent with potential delegators if their pool cost is in the higher range, in particular noting any special pool features such as the providing multi‐regional failover and enterprise‐grade infrastructure that increase operational expenses.
Pool operators want to set a pool margin that allows their pool to be competitive but also takes their pool’s performance advantages into account. Offering and promoting the special features of your stake pool, such as 99% uptime, enterprise‐grade security, professional node maintenance, or high participation rates, are all good reasons to set a higher than average profit margin for your stake pool as these features will contribute to increased security and higher validation performance, with accompanying higher rewards for your delegators.
Use this calculator from Cardano to game out the potential rewards you might earn as a stake pool operator from different stake pool scenarios, including the amount of pledged and delegated tokens, varying margin rates and fixed pool costs, and more.
Learn more about Cardano, its economics, and how the protocol functions, in our guide.
The most important way to maximize rewards is to operate a stake pool successfully—not missing blocks, remaining updated and in sync with the chain, and avoiding downtime. All of the mechanisms to maximize rewards discussed in this article are based on the assumption that the stake pool is already operating at the highest level of performance possible.
Want to operate a Cardano stake pool without having to manage the infrastructure yourself? Contact us to get started on the Bison Trails platform.
Bison Trails is a blockchain infrastructure platform-as-a-service (PaaS) company based in New York City. We built a platform for anyone who wants to participate in 21 new chains effortlessly.
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