New to Cardano?
Here’s what you need to know
“ADA is a digital currency. Any user, located anywhere in the world, can use ADA as a secure exchange of value without requiring a third party to mediate the exchange. Every transaction is permanently, securely, and transparently recorded on the Cardano blockchain.
Every ADA holder also holds a stake in the Cardano network. ADA stored in a wallet can be delegated to a stake pool and earn rewards for securing the network by doing so. In time, ADA will also be usable for a variety of applications and services on the Cardano platform.” —The Cardano Foundation (cardano.org/what-is-ada)
ADA can be subdivided into smaller units called Lovelaces, where 1 ADA equals 1,000,000 Lovelaces.
“ADA held on the Cardano network represents a stake in the network, with the size of the stake proportional to the amount of ADA held. The ability to delegate or pledge a stake is fundamental to how Cardano works.
There are two ways an ADA holder can earn rewards: by delegating their stake to a stake pool run by someone else, or running their own stake pool. The amount of stake delegated to a given stake pool is the primary way the Ouroboros protocol chooses who should add the next block to the blockchain, and receive a monetary reward for doing so.” —The Cardano Foundation (cardano.org/stake-pool-delegation)
“A cryptocurrency wallet is a device, physical medium, program, or a service which stores the public and/or private keys for cryptocurrency transactions. In addition to this basic function of storing the keys, a cryptocurrency wallet often also offers the functionality of encrypting and/or signing information. Signing can, for example, result in executing a smart contract, a cryptocurrency transaction, identification, legally signing a ‘document’, or voting.”
Once you have purchased cryptocurrency coins on an exchange, it is highly advisable to move them to a wallet in order to ensure that you have full control over them. When coins stay on an exchange, you do not own those private keys. That means that if problems arise with that exchange (hacking attack, legal issues, malicious behavior, etc.) you might lose access to your funds.
There are a number of wallets to choose from, but for Cardano it is probably best to go with one of the two officially-supported options, Daedalus or Yoroi.
Both Daedalus and Yoroi will store your ADA while also allowing you to delegate to a stake pool and will soon feature a voting center as well.
Proof of stake (Pos)
In a proof of stake consensus model everyone who holds a stake (any amount of coins) is considered an honest participant, since he/she has a monetary interest that the system works and that the coins continue to be trusted and keep, or even increase, their value. This means that every ADA holder is theoretically entitled to mint blocks, and in return, receive rewards. Since there are currently about 26 billion ADA coins in circulation, it is impractical that every one of these coins is participating for itself. Hence, the system works by bundling these coins together into pools who then have the right to participate in the protocol on their owners’ behalfs.
Out of all the participating coins, one is randomly chosen by the algorithm to have the right to mint a new block every 20 seconds. The stake pool to which that coin was delegated mints a block on behalf of the winner-coin and will receive the respective reward. Once an epoch of block-minting ends, the accumulated rewards are calculated and distributed to every delegator proportionate to their size of stake.
To keep the network decentralized and prohibit any individuals from gaining too much control, parameters such as “saturation” and “pledge” have been put in place to prevent that. They are explained in more detail below.
Naturally this explanation is only a simplified description in order to get a general idea of the functionality. For a deeper understanding of the technical background, have a look at the following links:
A stake pool is a full node (a server running the protocol software) in the Cardano blockchain network that is able to pool delegations and mint blocks. (A block is a data record of all the latest transactions that is stored and cryptographically linked to the previous block. A data structure that is generated in such a way, where every entry can be re-traced to its origin, is what is known as a blockchain.)
As described above, it is not feasible for everyone to run a server node 24/7 in order for their coins to participate in the protocol, that’s why Cardano uses stake pools that bundle together (pool) the coins of multiple participants and run the network on behalf of their delegators. Stake pool operators are compensated for their costs of running those servers by taking a cut from the earned rewards. The amount they take is set by their choice of fees, which are explained later.
more info at cardano.org
The pledge is the amount of ADA that pool operators commit to their own pool and it indicates how much incentive an operator has for his/her 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. Therefore, as a delegator, you would want to make sure that your chosen pool has a decent amount of “skin in the game” themselves. Additionally note that 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 (see LEVERAGE). If a participant with malicious intent were to gain control of over 51% of the entire network’s stake it would put the safety of the network at risk.
After every epoch there is a calculation of rewards depending on how many blocks a pool was able to deliver. The whole of the rewards go first to the pool operator, their fees are subtracted, and then the remaining rewards are distributed to the delegators proportionate to their stake.
There are two types of fees:
The Epoch Fee is a fixed value of ADA that will go to the operator at the end of every block-producing epoch and is subtracted from the total rewards made by the pool during that period. The minimum value is defined by the protocol to be 340 ADA. 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 block-producing 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 saturation level is the point at which the pool’s rewards are capped because their total amount of stake has become too large. This limit is derived from the protocol parameter k. With the k parameter currently set to 500, the saturation limit of a pool is about 64 million ADA. As pools grow over time and near that limit their returns slightly increase. Once a pool continues to grow beyond that size however, the rewards for delegators drop sharply. This is an intended behavior in order to prohibit pools from getting too large as this would lead to a centralization of power.
It is therefore important to have a look at the saturation level of the pools you’re considering. 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 32 million ADA. This means that a lot of pools currently close to the limit will be above saturation after the change, and their delegators’ rewards will be diminished.
The ratio of an operator’s pledge to their controlled stake (pool size) 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 could 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.
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.
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.
There are three common time frames used to display the returns of a pool—Lifetime ROI, Monthly ROI, and Epoch ROI. The overall Lifetime ROI is a value averaged over all of the epochs during which the pool has been running. This is a good way of looking at a pool that has been around for half a year or more. The next is the Monthly ROI which averages the annualized returns of the last 30 days. This is probably the most valuable indication, since pool parameters like pledge or fee can be changed by the operator, and it allows you to see what the pool has delivered with its 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 pronounced 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. (E.g. 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 cannot be influenced or predicted by the operator, but depends on the probabilistic algorithm of the Cardano protocol. The only meaningful prediction is that over a sufficiently long period the “luck” will average out to 100% for pools who deliver every block they are assigned. If a pool has been around for a significant amount of time but still shows well below 100% it might indicate other issues such as poor network connection, mismanagement of updates, or other flaws.
We hope you found this summary helpful. The vision behind Cardano is truly inspiring and we at Atlas Stake Pool wholeheartedly support a world that gives everyone a fair shot at succeeding in life—being in charge of one’s own identity, having access to the world of finances, and participating in free and fair elections. We demonstrate our commitment to this vision by running a stable stake pool with a high 500k ADA pledge and a competitive low fee.
We also believe in building a community and staying in close contact with our delegators through our social media channels. We invite you to say “hi” and ask us any of your questions in our telegram group at t.me/AtlasStakePoolChat.
Please share this link if you think this introduction could help others as an entry point to learning about Cardano.