As we inch closer to Polkadot’s beta mainnet launch, it is important to understand how the network will function, and how you will be able to maximize your rewards, while also reducing risk when staking DOT. Although similar to Kusama, we will be mentioning Polkadot and DOT (the native currency on the Polkadot network) in this post. You can learn more about Kusama by reading our other posts here.
Main functions of DOT:
Polkadot will use a Nominated Proof of Stake (NPoS) mechanism to secure its network. Nominators will nominate validators to be in the active set of validators by staking their DOTs with validator(s). Validators will produce new blocks, validate parachain blocks, and guarantee finality. It is important to note that validators will only earn rewards if they have enough staked DOT to qualify to be in the active set. The active set will update every era, which is 24 hours on Polkadot.
Nominators are able to nominate up to 16 validators. It is recommended that nominators choose only trusted validators when nominating. There is a 28 day unbonding period once DOT is staked with a validator, which means you could lose a significant amount of potential rewards if you do not choose validators wisely.
We recommend that you thoroughly research validators before nominating. You will be able to view the history of every Polkadot validator via the Polkadot explorer. This will allow you to view their previous blocks produced, rewards, slashing, and their on-chain identity if they have included it. We recommend using a validator who has consistently produced quality blocks with an on-chain identity that provides quality nodes services on other networks.
Polkadot’s NPoS mechanism distributes rewards on a daily basis evenly across all validators currently in the active set. This means that rewards will not be distributed to validators based on the amount staked with individual validators. Polkadot’s reasoning behind this is that they want to avoid concentration of power among a few validators within the network. Once rewards are distributed to validators, and the validator fees are taken into account, the rewards will be distributed to nominators proportional to amount staked.
You can use the table above to understand how this will affect your rewards. Both of these validators are currently in the active set. The total stake in Validator A is 600, while the total stake in Validator B is 400. Jin, who has staked 100 DOT with Validator A will only receive 16.7 DOT as a reward, whereas Alice, who has staked the same amount of DOT with Validator B will receive 25 DOT as a reward.
This is because all validators will receive the same rewards and then those rewards will be distributed proportionally. Nominators will ultimately be incentivized to stake their DOT with validators who have less DOT currently staked with them.
Validators will be slashed for for three reasons:
Validators will be slashed a fixed percentage of their stake and not a fixed amount of DOTs. This means that more DOTs will be slashed from validators with a higher stake. This further incentivizes nominators to choose validators with a lower stake.
Slashing penalties will be based on how many validators perform a slashing event. The penalty increases when more validators perform a slashing event.
For example, if there are 100 validators in the set, and 15 validators are offline then the slashing penalty is 0.84%. If there are 30 validators offline then that penalty increases to 3.99%.
Slashing penalties are much higher for equivocations.
For example, if there are 100 validators in the set, and two validators perform a GRANDPA or BABE equivocation, then the slashing penalty is 0.36%. If 10 validators perform an equivocation, then that penalty increases to 9.00%.
Although this may seem like a lot, there are ways that you will easily be able to maximize your rewards, while reducing risk.
In our opinion, the potential rewards outweigh the potential risks on the Polkadot network as long as nominators are well informed in the staking mechanics. Of course there are slashing penalties, and the unbonding period of 28 days is fairly long, but it is expected that most nominators staking DOT will earn around a 20% annual return.