Why Validators Need to Be Able to Charge Commission on Block Rewards

The current idea for Cosmos as per validator FAQ (https://cosmos.network/validators/faq
) seems to be that validators can only charge commission on fees, but not the block reward. This comes from the understandable concern that power shouldn’t accumulate too much in the hands of validators over time.

Unfortunately, this idea has many negative implications and would, in my view, significantly reduce the chance Cosmos succeeds. Here is why:

  1. Demand for Transactions Will be Minimal
    In the bootstrapping phase of any blockchain network, the demand for transactions is very low. This was true for Bitcoin, for Ethereum and any other blockchain network that I know of. There is no reason to think that it will not also be true for Cosmos. In fact, it may even be worse, since Cosmos as the internet of blockchain derives its utility from its connection with many chains. But in the beginning there will be just to hub and no connections. Thus demand for transactions will be very low. This phase can easily last 1 year or longer.
  2. Pricing Power of Validators is Limited
    In addition, even if there were a lot of transactions, validators aren’t actually able to enforce high fees. There are several reasons for this:
  • The capacity of the Cosmos network will be very high. Thus, there will be ample space in blocks until the Cosmos hub starts to reach a transaction volume many times bigger than Ethereum. (Even though there are no smart contracts on the hub.)
  • Thus any transaction above the spam limit will be included in a block for a long time. Even if let’s say 50% of validators apply a higher limit and don’t include transactions with fees just at the spam limit, this doesn’t provide a significant incentive for users to increase their fees, since blocks are produced very frequently. Just getting in every second or third block still means transactions get processed fast.
  1. Full Blocks Make the Network Unattractive
    The only point, where validators may really start making actual money from fees is when blocks are full. Of course, Bitcoin has shown what headaches come with that like unpredictable confirmation times, complex fee estimation logic in wallets and a deteriorating user experience. Thus only reaching this limit AND refusing to increase the blocksize would create real fee pressure in Cosmos. But even in that scenario there will be the question, whether low transaction fees and inflation wouldn’t be preferable? It is my view, that especially in proof-of-stake networks transaction fees above the spam limit aren’t required to secure the network. If we force this onto the Cosmos Hub, it will make it extremely vulnerable to a competing hub that scales with transaction demand and has low fees. It’s a suicidal move in my view.

  2. It creates a tragedy of the commons situation
    Validators run an absolutely essential service for the network. Cosmos can’t work without them. If I am an atom holder, I want to stake so I get the block reward. But if transaction fees are low in the beginning and I can only earn commission on those, I have no incentive to validate myself. I much rather not have the hassle and delegate to someone else. Thus even for large atom holders, not being able to charge commission on fees means that it will be better to delegate to someone else than validate yourself.

The Cosmos fundraiser had likely around 600-800 actual participants. What is the chance that the best possible validators are all among them? Basically zero. Qualified outside parties should have an incentive to invest in infrastructure, become a validator and run a business that way. But if they don’t have any atoms, and they can only earn commission on fees, there is really no incentive to do so.

  1. Block Rewards are the Proven Way of Bootstrapping Networks
    Regardless of what role transaction fees and block rewards will play in the long term, the only proven way to bootstrap blockchain networks is through block rewards. This was true for Bitcoin, Ethereum as well as other PoW chains. We should stick with the best practice.

So what are the consequences if we actually do this? What is the Nash Equilibrium that the network will naturally gravitate towards?

We have seen that atom holders have no incentive to validate. They’d rather delegate to someone else. We have seen that qualified parties who don’t have atoms, but would make for good validators have no incentive to validate since they won’t be able to generate revenues.

The result will be that running a profitable validator business will not be possible for a long-time. Validators will not have the economic incentive to invest in security, infrastructure, compete on features or even participate in the Cosmos network in the first place. As someone currently excited about and preparing for running a validator, we would certainly need to consider reevaluating those plans if the Cosmos design choices make that economically infeasible.

A Better Approach & General Comment
In my view, the design of Cosmos should be done in such a way that there is a maximum of options and choices. Many of us are driven by the desire to create a world, where people have more options and where they can enter contractual (or quasi-contractual/on-chain) relationships with the highest degree of flexibility. This is also, in my view, how blockchains should be designed.

Thus whenever there are two design choices, we should choose the one that gives people more options unless there is an extremely strong reason to the contrary.
A much better way would be to give validators the option to set separate commission rates on the transaction fees and on the block reward.

If it really turns out to be that transaction fees are high and this generates a lot of revenues for validators, surely some will lower fees on the block reward, maybe as far as 0, to attract more customers. That’s the nature of a free market and giving people options. But if this isn’t the case, then a different market can form. We need to preserve the freedom of choice for both validators and delegators to maximize the freedom provided to Cosmos participants and allow the system to naturally evolve to the most efficient state. The current proposal does the opposite.