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DeFi Governance Weekly - Aug 6th 2021 - A Focus on Celo
This week, I'll focus on the Celo platform's token economics and governance token emissions. First, in other news:
Gary Gensler gives a speech indicating his initial approach to US crypto regulation: https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-03 .
Some recommended reading on what provides stability to crypto prices - from the Bank for International Settlements: https://www.bis.org/publ/work951.pdf
Analysing CELO Token Emissions.
Celo is a proof of stake blockchain that is operated by validators, which are roughly the equivalent of nodes in Ethereum 2.0 .
CELO serves as the governance token, and also as the token that is staked (or "locked" in Celo terminology) to support the proof of stake algorithm.
There is a fixed total supply of CELO tokens, and there is an emissions schedule directing tokens to the following buckets:
Rewards for those locking Celo to support proof of stake (in Ethereum these would be known as "staking rewards"). This is the biggest chunk of emissions and provides rewards of roughly* 6% annually to locked Celo holders.
Celo Community Fund - currently 25% of emissions.
Validator rewards - validators (of which there are 110, and these are like "nodes" in Ethereum) are paid about* 75,000 cUSD per year for their services. cUSD is the Celo stablecoin that is pegged to the US dollar.
Carbon offsets. This is about 1% of Celo emissions and offsets any carbon impact of the blockchain.
*Note that, at present, there is an adjustment factor that is applied to CELO emissions in order to drag them towards the target emission schedule. While this will help emissions stay on track, it distorts the rewards going to locked CELO holders and validators. This may well mean that locked CELO and validator rewards fall to levels where the number of locked CELO or the number of validators is not enough to support the network.
Here is a graph of token emissions by epoch (effectively groups of blocks from genesis) - courtesy of Tobi Kuhlmann:
Currently, the challenge faced is that Celo emissions are ahead of schedule, i.e. the protocol will run out of CELO tokens before hitting the maximum fixed supply of CELO. This is shown here:
Ways to get emissions back on track would be to:
a. Reduce locked Celo (i.e. staking) rewards.
This doesn't make a lot of sense because the current rewards rate is around 6%, which is about competitive with what Ethereum 2.0 will be. Unfortunately, since this is the largest bucket of emissions, this means the protocol has to rely on reducing smaller levers to get back on track, which is not easy.
The big question on locked Celo rewards is how they will evolve over time. Further, if locked Celo holders are to earn 6% indefinitely, this means that it would not be possible to keep the total supply of CELO tokens finite, as it currently is by design. (Note that the total supply of Ether tokens is not finite).
Technically, the only way that the supply of CELO can remain finite is if the product of the rewards rate times the percentage of locked CELO asymptotes towards zero. I don't see how this can happen because I think at least some level of rewards is required in order for CELO holders to be incentivised to lock their CELO and support the proof of stake, i.e. there must be a real cost of maintaining proof of stake.
b. Reduce emissions to the community fund.
Out of about 7M CELO issued to the fund, less than 1M have been used. Further, at the current rate, about 5M more CELO tokens are being added to the fund each year. So, this is one area that emissions could be reduced (See CGP 35 on the forum).
However, the Celo platform is still young. Just because the community fund hasn't yet been used doesn't mean that it won't be beneficial in the future.
c. Reduce validator rewards
Celo differs to Ethereum proof of stake in that the hardware requirements to be a validator on Celo (you need to run a secure cloud service) are higher than that to run a node on Ethereum (which can be done from a Raspberry Pi).
To enable this, Celo provides about 75k cUSD in rewards to validators. Currently, there is no "market" for validator services. There is a roughly fixed fee paid, and there is a fixed number of validators (currently 110) elected that are difficult to displace if you want to join as a validator yourself.
Note that, in Ethereum 2.0, there are no specific rewards given to validators (node operators). Instead, node operators only earn the staking rewards plus potentially any benefits from any value they can extract by favourably positioning transactions within blocks (the proof of stake equivalent of miner extracted value). Node operators can also charge those who stake their Ether (but don't run a node) a percentage of their staking rewards (as is done by rocketpool.net).
Ultimately, Celo needs to increase the number of validators to improve decentralisation. Additionally, the price paid to validators will need to become market driven.
In theory (as demonstrated by Ethereum 2.0), it is possible to completely eliminate validator/node rewards and have validators instead get paid by taking a share of locked Celo rewards and extracted value. This might result in the platform needing to increase locked Celo rewards. [Actually, the adjustment of locked Celo rewards would automatically happen if CGP 33 goes through which will make locked Celo rewards dynamically adjust to achieve a target ratio of locked Celo (currently 50% but increasing to a 60% target if CGP 34 goes through). For what it's worth, it seems that CGP 33 is likely to go through and I think probably 34 as well.]
The more practical approach, given the starting point that validators are already paid, is probably to dynamically adjust validator rewards to maintain a minimum queue size of validators waiting to be voted in. Or, maybe even better in the long run, remove the limit on number of validators allowed and instead dynamically adjust validator rewards to maintain a minimum number of validators that meet certain uptime/security criteria.
d. Reduce carbon offset efforts
This wouldn't have a meaningful impact on overall Celo emissions because the portion of CELO emissions going to carbon offsets is tiny, less than 1% of total emissions.
Celo Outlook and Recommendations
I see the challenges above as important to address but not necessarily urgent.
The biggest issue will be how to sustain locked Celo rewards (and validator rewards) if the Celo supply cap is fixed.
The second most important issue I see is how to make validator payments market based and further increase the number of validators. I also think it would also be helpful to have a longer term plan for increasing the number of validators.
With respect to the community fund, it seems laudable - although maybe too generous - to allocate 25% of emissions to community development. I would think the first step is increasing awareness. The second step is to evaluate - once funds are being spent - whether there is a good return on those funds. Only then would the protocol know whether the fund is too small or large.
That's it on Celo and that's it for this week.
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