A portmanteau of “token” and “economics”, tokenomics is a catch-all for the elements that make a particular cryptocurrency valuable and interesting to people who want to participate in the network. That includes everything from a token’s supply and how it’s issued to things like what utility it has.
First, a short overview of the tokenomics: the initial token distribution, supply schedule, and rate of inflation, are provided. Then, the token utility is discussed which will be followed by the network incentives. Here we will go in depth on how the participants of the Cardano ecosystem are incentivized through game theory.
The native token is ADA, named after Ada Lovelace, an English mathematician1, which is used for fees, rewards and deposits.
Cardano does also have multi-asset support via "native tokens"2, but usage does not have any direct economic impact on the network.
There was a public sale of 25.9 billion ADA and an additional 5.2 billion ADA (20% of public) was allocated to the three entities supporting the ongoing development of the project:
| Seed Sale | Amount |
|---|---|
| Public | 25.9 billion ADA (57.6%) |
| IOHK (development company) | 2.46 billion ADA (5.5%) |
| EMURGO (commercial adoption) | 2.07 billion ADA (4.6%) |
| Cardano Foundation | 640 million ADA (1.4%) |
| Reserve / Uncirculated | 13.9 billion ADA (30.9%) |
Cardano currently has approximately 75% of its tokens in circulating supply:
| Supply | Amount |
|---|---|
| Initial Supply | 31.8 billion ADA |
| Circulating Supply* | 33.93 billion ADA3 |
| Max Supply | 45 billion ADA |
'* The top 100 addresses on network hold ~17% circulating supply.
Expansion of the circulating supply comes from the reserve, where reserve = max supply - total supply and
total supply = ADA in circulation plus ADA in treasury. Expansion is non-linear, greater amounts are released during
earlier years but decrease over time until most rewards will come from transaction fees. The supply schedule can
therefore be described as monotonically decreasing inflation.
Source: https://forum.cardano.org/t/how-does-cardano-reach-its-supply-cap-via-staking/39697/8
The rate of inflation is 0.3% of the reserve per epoch (every 5 days), where:
- 80% will be used to reward staking pools
- 20% goes to the treasury
The token has three main uses, which will be discussed in more detail in the following sections:
- Staking: ADA stakers delegate to stake pools and earn rewards for securing the network
- Fees: transaction fees paid in ADA
- Governance: ADA stakers participate in governance and vote on CIPs
ADA held on the Cardano network represents a user’s stake in the protocol, the size of which is proportional to the amount of ADA held. Important to note is that unlike other protocols, ADA token holders don't have to lock up their tokens. Users who hold a stake in Cardano can earn passive rewards for validating blocks. The amount of rewards they can earn is proportional to the amount of ADA they pledge or delegate to a stake pool.
Stake pools may be either public or private. A public stake pool is a Cardano network node with a public address that other users can delegate to, and receive rewards. Private stake pools only deliver rewards to their owners.
Stake pools are run by a reliable operator: an individual or business with the knowledge and resources to run the node on a consistent basis. ADA holders can delegate to public stake pools if they wish to participate in the protocol and receive rewards, but do not wish to operate a Cardano network node themselves.
The more stake that is delegated to a stake pool, the greater chance it has of being selected as a slot leader. Each time it is selected and produces a block that is accepted onto the blockchain, it is rewarded, and these rewards are shared between the stake pool operator and stake pool delegators.
Saturation is a term used to indicate that a particular stake pool has more stake delegated to it than is ideal for the network, while k is the targeted number of desired pools (currently 500 -> 64 million per stake pool). Once a pool reaches the point of saturation, it will offer diminishing rewards. The saturation mechanism was designed to prevent centralization by encouraging delegators to delegate to different stake pools, and to incentivize operators to set up alternative pools so that they can continue earning maximum rewards. Saturation, therefore, exists to preserve the interests of both ADA holders delegating their stake and stake pool operators, and to prevent any single pool from becoming too large.
The pledge is the amount of ADA that the stake pool operator ‘delegates’ to their own pool when it is created. This pledge represents the operator's commitment to maintain their pool and support network activity. Making a pledge is not required, however, it is recommended to pledge some ADA to the stake pool prior to running it. The more ADA that is pledged, the higher the pool rewards, which makes the pool more attractive to delegators.
The pledge is declared during pool registration, (alongside the cost and margin values), and has to be honored by the pool owners who are delegating to the pool: If they collectively delegate less than the declared pledge, pool rewards for that epoch will be zero. Note that the pool will be public, if its operator margin is set to less than 100%.
Delegators delegate their stake to a staking pool and get rewarded proportionally to their stake. When it is time to receive rewards as a delegator, a snapshot will be taken and your current balance at that time will be used to calculate your reward. Pools with a high pledge and a low margin are the most interesting for delegators.
To clarify, the higher the pledge of a stake pool, the higher the rewards. The higher the total stake, the greater the probability the stake pool will be elected to produce blocks.
Stake pools are rewarded by the sum of:
- 80% of the monetary expansion.
- All the transaction fees during the new epoch.
- Fixed costs - a fixed fee of 340 ADA to every pool (covers the pool's operating costs).
The following formula outlines how the rewards mechanism works. The available rewards amount, transaction fees, plus monetary expansion, is denoted by R. First, the share of all available rewards that a specific pool can receive is determined, as follows:
Source: https://docs.cardano.org/static/af61f8d4a9c10ce3b83a7c499be5af2c/374ac/pledge_formula.png
These elements are defined as follows:
R - total available rewards for this epoch
a0 - pledge influence factor (can be between 0 and infinity)
z0 - relative pool saturation size, i.e. 0.5% based on a number of desired pools (k=200)
σ - stake delegated to the pool (including stake pledged by the owners and stake delegated by others)
σ’ = min(σ, z0) - as σ, but capped at z0
s - stake pledged by the owners
s’ = min(s, z0) - as s, but capped at z0
Two important considerations are:
- Rewards increase with σ, but stop increasing once σ reaches z0, that is, once the pool becomes saturated.
- If a0, (the pledge influence,) is zero, this formula simply becomes R·σ’, so it is proportional to pool stake, up to the point of saturation. For larger values of a0, the pledge s becomes more important.
- If we reach saturation, the share becomes
$R \cdot z_0$ .
The rewards that are produced by this formula are now adjusted by pool performance: we multiply by β/σa, where β is the fraction of all blocks produced by the pool during the epoch and σa is the stake delegated to the pool relative to the active stake (i.e. total stake that is correctly delegated to a non-retired pool).
For an optimally performing pool (that is, a pool producing all the blocks that it can produce), this factor will be 1, on average. The actual value will fluctuate due to the stochastic nature, or random process of the Ouroboros Praos consensus algorithm.
After pool rewards have been calculated and adjusted for pool performance, they are distributed amongst the pool operator and the pool members, or people who delegated part, or all of their stake, to the pool. This happens in several steps:
- First, the declared costs are subtracted and given to the pool operator.
- Next, the declared margin is subtracted and given to the pool operator.
- Finally the remainder is split fairly (proportional to delegated stake), amongst all people who delegated to the pool, including the pool owners.
Fees are constructed around two constants (a and b). The formula for calculating minimal fees for a transaction (tx) is:
a * size(tx) + b
a: reflects the dependence of the transaction cost on the size of the transaction. The larger the transaction, the more resources are needed to store and process it.size(tx): is the transaction size in bytes.b: is a payable fee, regardless of the size of the transaction. This parameter was primarily introduced to prevent Distributed-Denial-of-Service (DDoS) attacks. b makes such attacks expensive, and eliminates the possibility of an attacker generating millions of small transactions to flood and crash the system.
When a user initiates a transaction, they commit enough ADA to cover its execution cost. Transactions that call and use non-native smart contracts (known as phase-2 contracts) also need enough collateral to cover costs related to potential transaction failures. This amount can be small, but it is sufficient to make a denial of service (DOS) attack prohibitively expensive.
Collateral fees are collected only if a transaction fails validation. If the contract passes validation, the transaction fees are collected, but the collateral is not.
For every post-voting epoch, 20% of the treasury fund will be distributed between voting committee members, experts and voters. The voting committee members will receive a fixed amount upon completing their required actions in the next voting epoch.
The voters and experts will be rewarded regardless of the outcome of the vote, voters in proportion to their own stake, experts in proportion to the amount to their received delegations.
Cardano has aligned its economic incentives to encourage decentralization, which it deems as critical to the long-term success of the project. Rewards are therefore shared between delegators and stake pool operators, a symbiotic relationship maximising rewards so long as they are intelligent and rational, and there is complete information.
The protocol incentivizes validators to stay honest and online. Penalisation of malicious participants is deemed to be unnecessary, provided the desired number of pools exist, and they are in Nash equilibrium4.
Cardano's incentive mechanisms seek a balanced distribution of stake across pools towards perfect competition, allowing delegators and stake pools to find market equilibrium: where rewards are optimal for all when stake is delegated evenly across pools.
This design also allows for economic specialization: stake pool operators have the time, technical expertise and capital to run nodes which secure the network. Delegators may have none of these, instead delegating their stake to a stake pool to increase the overall pool stake, thereby increasing the probability of the stake pool being elected to earn block rewards.
Finally, Cardano currently has no auction mechanics and/or price discovery methods, but they could be implemented in the future as other tokens are added to the network.
- Rewards shared between stake pool operators and delegators, no lock up period so delegators can easily re-stake with another operator if a stake pool performs poorly or its operator behaves maliciously (liquid democracy).
- No slashing, reducing delegator staking risk.
- The pledge can be removed at any time (no evidence was found that it is locked/bonded in any way). This means that the propagated pledge could not be met which results in no rewards. Nothing really mailicious can come out of it but delegators should definitely have a closer look at the pool they consider choosing. Bad behavior of pools will only really come to light in the long run but then a lot of people will already have missed out on rewards.
- No slashing, in theory all people think rational but in practise this is not always the case. Arguably people need some sort of punishment and the exclusion of rewards is not enough.
Sources: (https://docs.cardano.org) (https://cardano.org) (https://www.youtube.com/watch?v=EAzyN3H8MOA&t=7s) : provided by IOHK
Footnotes
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The accounting model is extended to accommodate transactions using custom token types (with their own monetary policy), without the need for smart contracts. Multiple token types can be included within the same transaction. https://github.com/input-output-hk/cardano-ledger/blob/master/doc/explanations/features.rst ↩
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https://medium.com/coinmonks/why-cardano-does-not-need-slashing-85630ff55092 ↩