Cardano monetary policy
Cardano achieves true decentralization with the Voltaire development phase, which includes decentralized voting and treasury systems to empower the community to influence Cardano's evolution, and provide a funding mechanism to transform Cardano into a self-funded, self-sustainable environment.
Decentralization does come with its own set of challenges, as factors such as security, performance, stability, sustainability, fairness, and crucially, economic viability come into play.
Maintaining, developing, and improving a blockchain project requires ongoing monetary support. With Voltaire, the treasury performs this function, and funding for new features, improvements, etc. is allocated through a decentralized voting system.
Stake pools
The principles of decentralization and fairness drive Cardano's development. Cardano offers equal opportunities to anyone who wishes to become part of the network by running a stake pool. But the very freedom to participate opens up the possibility of unfair advantage posed by larger stake pool operators. This presents the challenge of maintaining the integrity of the chain while incentivizing people to create pools and support the chain.
Incentives mechanism
Cardano's monetary expansion relies on a long-term commitment by stake pool operators to provide ongoing support for the chain. This commitment requires a solid and stable incentivization mechanism for the operators, so this mechanism must ensure that the incentive system does not significantly change in time in a way that might adversely affect the operators’ income.
Cardano's incentive system for stake pool operators is designed to balance k fully saturated pools (where k is the number of desired pools), so this equilibrium means that rewards will be optimal for everybody when all stake is delegated uniformly to the k most attractive pools.
Monetary policy
Cardano's monetary policy addresses two issues:
- the necessity to offer rewards for people who participate in the network
- funding the treasury.
Rewards
The expansion and future improvement of the Cardano blockchain will be greatly influenced by its community, who need to be incentivized through rewards to participate in Cardano’s development.
Staking rewards for delegators and stake pool operators come from two sources:
- Transaction fees - fees from every transaction from all blocks produced during every epoch go into a virtual 'pot'. A fixed percentage (ρ) of the remaining ada reserves is added to that pot.
- Monetary expansion - a certain percentage (τ) of the pot is sent to the treasury, and the rest is used as epoch rewards.
This system is designed to ensure that the portion of rewards taken from the reserves is high at the beginning when transaction numbers are still relatively low. This incentivizes early adopters to move quickly to benefit from high initial rewards. Over time, and as the number of transactions increases, additional fees will compensate for smaller reserves.
This mechanism also ensures that available rewards are predictable and do not vary dramatically. Instead, rewards change gradually. The fixed percentage taken from remaining reserves every epoch guarantees a smooth exponential decline.
Funding the treasury
The treasury's goal is the provision of funds to develop Cardano activities through a voting process. This necessitates a process whereby funds are regularly sent to the treasury to ensure that funds are always available.
Policy rationale for the ρ and τ values
A lot of thought was put into determining what the values for ρ (fixed percentage) and τ (funds going into the treasury) should be.
Calculating ρ
While searching for the right ρ value, the team faced a quandary: A higher value would mean higher rewards for everybody initially, and the treasury would fill faster. But higher values of ρ would also mean that the reserves would deplete faster. Paying high rewards and incentivizing early adopters is a crucial consideration, but so is to offer a long-term perspective for all stakeholders. Therefore, the solution to this quandary requires a tradeoff between these two issues.
Adopting an exponential decay approach to prevent Cardano’s reserve from running out makes sense in this situation.
Calculating the 'reserve half life' (that is, the time that it takes for half of the reserve to be used up) visualizes the impact of choosing a specific value of ρ over another. This was the subject of much discussion, and eventually, the value assigned was 0.3%. The reason why is that mathematical projections showed that a ρ (the fixed percentage of ada going into the virtual pot every epoch) value of 0.3% would mean a reserve half-life of four to five years. In simple terms, just half of the remaining reserve would be used every four to five years.
Choosing τ
Determining the right value for τ (the percentage of unclaimed rewards automatically going to the reserves every epoch) was equally challenging. Following discussions, deliberations, and projections, the τ value was set at a fixed rate of 20%.
This rate applies to both the per-epoch monetary expansion and the fees that the blockchain charges for each transaction. The treasury amount is deducted before any other rewards are allocated. The remaining per-epoch monetary expansion and fees may be allocated to stake pools based on the provided formula.
It is important to note that the rewards given to stake pools may be reduced under certain conditions, such as when pools are not saturated, not fully pledged, or fail to produce their allocated blocks. Any unclaimed rewards remain in the reserves for future allocation. This explains the slightly varying difference in the percentage of treasury allocations.