Following our previous statement regarding Adaptive issuance, we would like to express additional concerns which include increased slashing parameters, the risk of overstaking, and two recently discovered issues in the implementation of Adaptive Issuance.
Furthermore, in this post, we would like to share our suggestions for changes to the original proposal that may mitigate the negative effects of reducing inflation.
- Overstaking
- Bakers will have the option to decide whether they accept stake from stakers, and if so, up to which fraction of their bond (the maximum enforced by the protocol is up to 5 times the baker’s own stake). Even though there’ll be a limit for bakers to set when it comes to the stake from stakers, stakers will still be able to exceed it, resulting in a baker being overstaked and thus being subject to reward penalties.
The main concern here is that there’ll be a limit that stakers still will be able to exceed, which will result in reward penalties for both stakers and bakers, and it is not possible for bakers to avoid being overstaked when accepting stakers.
You can read a more detailed explanation of overstaking in the article: A Walkthrough of Tezos’ New Staking Mechanism | by Nicolas Ochem | The Aleph | Aug, 2023 | Medium
- Bakers will have the option to decide whether they accept stake from stakers, and if so, up to which fraction of their bond (the maximum enforced by the protocol is up to 5 times the baker’s own stake). Even though there’ll be a limit for bakers to set when it comes to the stake from stakers, stakers will still be able to exceed it, resulting in a baker being overstaked and thus being subject to reward penalties.
- Increased slashing parameters
- While slashing incidents are extremely rare in Tezos, the new staking mechanism implies a significant increase in the slashing amount. Currently, there is already a substantial penalty for double-attesting. Why would we want to increase the risks further? Whether it’s a double bake or a double attest, it’s not just about the financial risks; it also concerns bakers’ reputation, therefore, no baker would intentionally engage in such behavior.
- Another contributing factor here is two recently discovered issues in the implementation of AI, affecting issuance and bakers’ rewards. However, they are expected to be addressed only in the next proposal.
We believe it is better to address the issues in the first place, make the necessary alterations, and not to rush into implementing AI in its current state.
The biggest point of our concern is still a huge influence of the Adaptive Issuance implementation on inflation and therefore on the validator’s incentives. Although it won’t be implemented right after proposal approval, it’s still going to cut XTZ rewards both to delegators and validators (bakers) in the future. This may make Tezos look way less attractive to both retail holders/bakers since investing in other chains with higher APR would have better economic outcomes.
Therefore we want to share our suggestions for changes to the original proposal which may neglect the negative influence of reducing inflation.
1. Gradually decreased minimum issuance
Rapid changes in the XTZ issuance may drive away both regular community members and bakers, therefore weakening the chain security and causing troubles to the entire ecosystem. Decreasing staking income without implementation of any additional XTZ utility and making direct influence on its price will hit the economic motivation of participating in the network.
The easiest and simplest way to make sure incentives won’t be too low is raising the starting minimum nominal issuance from 0,05% to, for example, 3%. The goal is to ensure that bakers and stakers are still getting incentivized properly while simultaneously adjusting inflation based on the staked ratio. Minimum nominal issuance can be adjusted by further proposals according to the market and network conditions, and the main idea is to implement the decrease gradually instead of instantly, because the possible fluctuations of staked % along with dynamic/static ratio may be unpredictable. We believe that this approach will make the XTZ community more confident in the network incentives and make transition to the new economic model more smooth.
2. Price rate, as addition to dynamic and static rate
The current Oxford Adaptive Issuance model offers to change inflation based only on the fluctuations and amount of staked funds, but this approach may be quite doubtful in case of major price volatility/continuous trends. The original idea was to increase the XTZ value by limiting its supply on the market, but this does not always work, especially given the current market conditions. The main risk of this approach is the possible price decrease, which along with the inflation cut may have a negative economic impact both on regular holders and validators independently of the staked XTZ ratio in the network.
The price rate is the new addition to the inflation rate formula, which is designed to respond to changes in the price of XTZ tokens on the market. The price rate would depend on the current market price of XTZ and its primary purpose is to counterbalance fluctuations in the token’s value. When the price of XTZ rises significantly, the price rate would reduce the inflation rate, and when the price drops, it would increase the inflation rate. That way it will work as an additional security layer along with dynamic and static rates. Initially, the price rate can be bound to the target price of 1,5$ or 2$ per XTZ, but it’s also a subject to discuss. Later, the target price may be changed by the community voting according to the current market conditions and other reasons. The price rate alone should be able to hold the inflation high enough to compensate for the possible price decline in a way that even if the staked ratio will be close enough to 48-52% target, the inflation may remain on the same level as it would be with a staked ratio of 10-20%. The main idea is to incentivize moving XTZ away from the market to staking in case of the price dump, therefore cutting supply and increasing demand.
