A Six-Step Guide for How to Choose a Cardano Stake Pool Like a Pilot
In the daily operation of a passenger aircraft there are a multitude of decisions that have to be made. Some of them are easy judgment calls, others are largely predefined by regulations and extensive training procedures. But occasionally, when it comes to critical abnormal situations due to technical malfunctions, irregular and unexpected weather phenomena, or other conditions impacting the safety of a flight, pilots rely on a formal method of decision-making called FORDEC.
In the following text we would like to show you how that method works by applying it to the task of “How to choose a Cardano stake pool?”
The six letters of the acronym FORDEC stand for:
The very first step would be to determine if the situation is time-critical and needs immediate action. In the case of staking we can answer that in the negative. Epochs in the Cardano ecosystem are five days long, so you have plenty of time to make an in-depth assessment.
There are 1500+ pools to choose from. By checking a site like pooltool.io or adapools.org, you can find each pool’s defining parameters. These will show you how much of your staking rewards will go to the operator for running the stake pool and what you can expect for yourself. These parameters are:
The Epoch Fee is a constant value that will go to the operator at the end of every epoch and is subtracted from the total rewards the pool made during that period. The minimum value is defined by the protocol at 340ADA. No operator can choose less because it would not be possible to register the pool on the blockchain. Most operators choose the minimum value in order to be attractive to delegators, but a few do go with a higher amount.
The Variable Fee is much more diverse. It is the percentage cut an operator gets from the pool’s rewards, which are paid out after every epoch. For example, a Variable Fee of 2% would mean that 98% of the rewards would be forwarded to you, the delegators, whereas a 5% Variable Fee would mean a payout of only 95%.
The Pledge tells you how invested the pool operators are themselves. It can give you a feel for how much incentive the operator has for their pool to run well, and furthermore, for the entire network to succeed. An operator with a very small pledge does not have as much to lose if they run low-quality equipment that risks failing and destabilizing the network. Additionally, a combination of a stake pool operator with a low personal investment, but a large control of the stake through one or more pools, could pose a danger to the Cardano ecosystem. If a participant with malicious intent were to gain control of over 51% of the entire stake it would put the network at risk of a Sybil attack. Therefore, as a delegator, you would want to make sure that your chosen pool has a decent amount of “skin in the game” themselves.
The ratio of an operator’s pledge to their controlled stake is called Leverage. If an operator controls a high amount of stake for delegators, they have a high leverage, and the security of the network is weakened. (In this case, control means the operator has, for instance, the possibility to shut down the pool and create fluctuations in the network. But your funds are not in danger since you hold them in your own wallet.) A purposeful or even unintended disruption of the network might, however, reflect negatively on the market price of ADA. It is therefore in your own best interest to avoid pools who have too high of leverage. Especially with operators who operate multiple pools in parallel in an attempt to maximize their profits.
* The term leverage is currently not standardized in the Cardano ecosystem and you might find some sources who use the reciprocal value. In this case it would be best to choose pools with a high number that represents a low leverage.
An excellent article on that matter published by IOHK’s Chief Scientist of Academic Research, Professor Aggelos Kiayias, can be found here. It’s a highly recommended read to understand the dynamics of the staking ecosystem.
The Saturation is a limit to the pool size after which the pool’s rewards are capped. This limit is derived from the protocol parameter k. With the k parameter currently being 500, the saturation limit of a pool is about 64M ADA. As pools grow over time and near that limit their returns slightly increase. Once, though, a pool continues to grow beyond that size, the rewards for delegators drop sharply. This is an intended behavior in order to prohibit pools from getting too big and leading the network to more centralization of power. It is therefore important to have a look at the saturation level of the pools in consideration. If a pool is already close to the limit, it might be a good idea to look at other pools that are less likely to become oversaturated. This holds especially true when there are planned parameter changes ahead such as the change of k in March 2021. After this change, the new saturation limit will be around 32M ADA. This means that a lot of pools currently close to the limit will be well above saturation after the change. There lies a danger that some pool operators might use this as a reason to split their current pools into multiple smaller pools. *see above regarding leverage
The final metric is the Return a pool delivers. There are several terms presently in use for the return–ROA (Return of ADA), ROS (Return of Stake), and ROI (Return of Investment)–but they all refer to the same concept. It is the annualized return on your investment as a percentage value, and it is a reflection of all of the above-mentioned factors: fixed fee, variable fee, pledge, saturation, and the pool’s actual performance. The fees have a negative influence on the possible returns whereas the pledge has a positive effect on the returns. The Saturation has a positive effect up until the limit is reached and thereafter it has a negative effect. Lastly, the performance is the ability of the pool to deliver the blocks that it is designated to mint each epoch. The ideal case is that a pool will mint 100% of assigned blocks. In case of suboptimal operation where the pool is offline over extended periods of time or not updated to the current protocol versions, the pool will see diminished return rates over time.
There are also different time frames one can use to display the return of a pool. The most common ones are the overall lifetime ROI where that value is averaged over all of the epochs the pool has been running. This is the good way of looking at a pool that has been around for half a year or more. The next is the monthly ROI that averages the returns over that last 30 days. This is probably the most valuable indication, since parameters like pledge or fee can be changed by the operator, and this way you see what the pool delivers with the latest parameters. The last one is the epoch ROI, which is the least helpful, since it experiences the biggest variation. According to the base protocol, the right to mint blocks is determined in a probabilistic manner in relation to the amount of stake held within the pool. This means that in the short term, there are bigger fluctuations to be expected which will average out over time. This effect is more amplified for smaller pools since their relative number of blocks are smaller too.
One more parameter to mention is “Luck.” It signifies the amount of blocks a pool is actually assigned to mint in relation to what the theoretical statistical chance would be according to the pool’s size. (If a pool is theoretically expected to mint 10 blocks and ends up getting assigned 11 blocks then this pool’s luck for that epoch is 110%. If the pool gets only 9 blocks assigned, then the epoch luck is 90%.) This factor can not be influenced by the operator and can also not be predicted. The only meaningful statement is that over a sufficiently long period the “luck” will average out to 100% for every pool.
Now is the point when you will have to do a little bit of investigation. Check out the website of the operator and see what kind of setup is used. Be aware that equipment run out of private homes will most likely not have the same power backup systems as machines run out of larger data centers. Additionally, a reliable and consistently available internet connection is of utmost importance. Availability and low-latency far outweigh a high-speed connection that has random outages. If you cannot find this information on your operator’s homepage or social channels, go ahead and ask directly. You should avoid putting your money into a pool that promises very low fees but doesn’t deliver because of under-performing equipment. A transparent operation, whether through published information or strong communication, is another good indication to go by.
Risks and Benefits
Option 1: This choice is decent, however, you may not get the best rewards because well-known pools often have higher fees that they can justify with their popularity. They are also most likely to hit the saturation level first, at which point, your rewards will decrease even further and you will either have to move to another pool, or hope that enough other delegators will move in order to bring the pool back down below saturation. Recent development has also shown many of the initially fast-growing pools setting up more and more new pools thereby significantly increasing their leverage on the ecosystem (pool farms). This is a serious problem for the security of the ecosystem and delegators are acting in their own interest if they do not contribute to pool farms.
Option 2: A pool with very low fees might not earn enough money to keep proper equipment and maintenance running and will be forced to cut costs wherever they can. This could lead to substandard performance which might ultimately lead to fewer or no rewards at all. Should you be very lucky, however, this choice would return the highest rewards.
Option 3: As with the popular pool option, a pool with an already-high amount of staked ADA runs the risk of reaching saturation more quickly than pools with less stake, and you might have to make another decision as soon as that happens. On the plus side, pools with a high amount of ADA delegated to them will make blocks more consistently if they run at optimum performance level.
Option 4: Requires the biggest initial effort on your behalf by investigating, comparing, and even communicating directly with stake pool operators about any questions or uncertainties you might have. The benefits of this approach are that you will have a clear understanding of where you are putting your money to work and will have more confidence with the operation, setting your mind at ease. By establishing a connection with the operator through their social channels, you will be able to stay informed on a personal level.
Option 5: If you choose not to stake your ADA, the downside would be a lost opportunity for extra rewards, but a benefit might be that you would not be bound to a wallet and could more easily use them for day trading. But remember, if you do stake your ADA, it stays in your wallet at all times and is only linked to a stake pool. You can access them whenever you need or want. Staking with a pool simply allows for the opportunity to grow your current amount of ADA.
Option 6: Staking with multiple pools requires more initial research and extra effort since you will have to split up your funds into different wallets. If you have very high funds, however, this approach would diversify your “risk.”
Now you are in the pilot’s seat and have to make the decision depending on your personal risk assessment of all the facts, your options, and their respective risks and benefits.
After selecting your stake pool(s), execute your decision by using your Daedalus or Yoroi wallet to stake your ADA.
This last point is often overlooked but is nonetheless very important for your overall success. After you have made and executed your decision you should regularly check whether some of the conditions have changed and would justify a different choice. For instance, have the fees changed? What’s the level of saturation? Is the pool performing as promised? Etc. Should any of those factors change, modify accordingly. If you are content with how everything is working, and have re-confirmed that your initial facts have stayed the same, then your decision stands.
We hope that you find this guide helpful, and that you will consider ATLAS among your FORDEC options.
Happy staking, everyone!