Introduction to NEAR Protocol’s Economics
April 23, 2020 — Illia Polosukhin
Intro to NEAR Protocol’s Economics
NEAR is a developer platform for the Open Web. This means that NEAR has a set of protocols and tools that enable people to build a new wave of community-owned applications.
The main protocol, NEAR Protocol, is a blockchain to power the security, economy, and incentives of NEAR’s developer platform.
Open Web is a paradigm shift of how applications and businesses are built. In the current paradigm, a company with investors and shareholders started by founders provides some service to its users. Over time, though, the divide between what users want and what generates more revenue usually grows. At the same time, companies try to reduce external dependencies to defend against the chances that one of its suppliers fails or gets acquired by competition.
The principles of Open Web are as follows:
- Governed by community
- Hackable and composable
- Open and permissionless
- User-first and sovereign
- Open markets
To ensure these principles are followed, a combination of efforts is required:
- A trustless and permissionless base layer that can be leveraged by all parties for various contracts, marketplaces, rooting sovereign data storage and more.
- An independent currency that can be operated in a permissionless way and that can have a monetary policy to incentivize the behaviors of the parties.
- The ability of new teams to create their own community-driven economies around their applications.
- Backend for high-risk and low-trust serverless decentralized applications.
NEAR Protocol sits at the bottom of the stack, providing a permission-less base layer, independent currency and predetermined monetary policy and marketplace of computing resources.
This article explores the economic principles governing NEAR Protocol, and how they keep aligned the interests of its community.
Native cryptocurrency Ⓝ
$NEAR (Ⓝ) is the native cryptocurrency used in NEAR Protocol and, as the lifeblood of the network, has several different use cases. As the native currency, it secures the network, provides a unit of account and medium of exchange for native resources and third-party applications, and, over the long term, aims to become a unit used by individuals as well as by contracts and decentralized finance (DeFi) applications.
Security of the Network
NEAR Protocol is a proof-of-stake network which means that Sybil resistance from various attacks is done by staking Ⓝ. Staked Ⓝ represent a “medallion” for service providers that supply a decentralized infrastructure of servers that are maintaining state and processing transactions to NEAR users and applications. In exchange for this service, node providers receive rewards in Ⓝ.
Network Usage Fees
The utility of the network is provided by storing application data and providing a way to change it by issuing transactions. The network charges transaction fees for processing the changes to this stored data. The NEAR network collects and automatically burns these fees, such that higher usage of the network will increase the incentives to run validating nodes (as they receive higher real yield).
On the other hand, Ⓝ is also used as collateral for storing data on the blockchain. Having 1 Ⓝ on an account allows the user to store some amount of data (the specific amount depends on the available storage but will increase over time).
Medium of Exchange
Because Ⓝ is readily available on the protocol level, it can be easily used to transfer value across NEAR applications and accounts. This monetary function enables the creation of applications that use Ⓝ to charge for various functions, access to data, or performing other complex transactions. Ⓝ is exchanged within the network in a peer-to-peer fashion, across various applications and accounts, without the need for trusted third parties to clear and settle transactions.
Unit of Account
As mentioned in the “Network Usage Fees” section, Ⓝ is used to price the computation and storage of the NEAR infrastructure, which is offered by node operators. At the same time, applications and external parties can use Ⓝ as a unit of account for their application services or to measure the amount of the exchange in cases of Ⓝ as medium of exchange.
Genesis and inflation
At the launch, the NEAR network will have 1 billion Ⓝ. Each Ⓝ is divisible into 1024yocto Ⓝ.
Ⓝ Issuance and inflation
NEAR Protocol’s issuance of tokens, or inflation, is necessary to pay network operators, also called Validators. There is fixed issuance around 5% of the total supply each year, 90% of which goes to Validators in exchange for computing, storage, and securing the transactions happening on the network.
As mentioned above, all transaction fees collected by the network get burned. Therefore, the issuance of Ⓝ is actually ~5% minus transaction fees. This means that, as the network grows in usage, issuance can become negative, introducing negative inflation in the protocol. Since the smallest unit of account for Ⓝ is yocto Ⓝ, the system can keep its exchange price resolution as small as infinitesimal fractions of the U.S. dollar, even with a reduction of the overall supply by two or three orders of magnitude.
|avg # of tx/day||Min Ⓝ in fees/day||Ⓝ mint/day||Annual inflation|
Expected inflation per day given different number of tx
This table includes a few assumptions. But the main point is to show how inflation gets affected by usage.
Note that even though 1 billion transactions per day is a pretty large number for existing blockchains, that’s about ~11k tx per second of sustained load (also these tx are benchmarked as payment tx; more complex smart contract calls will require more gas and cost more).
Bitcoin pioneered cryptocurrencies and the idea of fixed supply. At the same time, constant reduction in security rewards available to miners creates interesting issues long term with the longest chain consensus (for more details read this paper). In NEAR Protocol, we addressed this issue by guaranteeing a constant security reward rate to Validators. And instead of issuance declining independent of the usage, NEAR’s issuance declines with more usage of the network.
Also note that in comparison to Bitcoin and Ethereum, token holders can avoid inflation by delegating/validating with their stake, preserving their percentage or even increasing it (see details in the “Validators” section).
Each transaction takes some amount of bandwidth to be included in the block and computation to be executed. We combine both of these resources into a unified measure called “gas” that Validators must spend to execute a transaction. NEAR uses WebAssembly Virtual Machine (VM) to execute transactions and provides a mapping from each VM operation to the amount of gas it spends. The goal for gas is to represent a unified measure of resources spent to receive, execute, and propagate a transaction on default hardware.
Users who want to send such a transaction must pay a transaction fee, which is computed based on the amount of gas that the transaction will require multiplied by the current gas price.
Gas price is defined systemwide and changes from block to block in a predictable manner. Specifically, if the previous block used more than ½ of the gas limit for that block, the gas price is increased by a small margin. Otherwise, the gas price will decrease. There is also a minimum gas price which provides a floor for the price.
Minimum gas price is selected to provide a cheap transaction price for users and developers, with the expectation of collecting ~0.1 Ⓝ per full chunk (part of the block from a shard, see Nightshade for more detail). This is designed to make blockchain usage more accessible. Instead of the economy of the scarcity of transaction processing (how it works in Bitcoin and Ethereum), the goal of this system is to hit the economy of scale by increasing the number of shards.
Validators when including transactions do not use fees for ordering, instead, there is a deterministic ordering based on transaction hash. As explained in the “Issuance” section, fees that are collected from transactions are burned instead of being redistributed within the network of Validators.
This is done for a few reasons:
- In the Proof-of-Stake network, every validator does the same amount of work by executing and validating transactions; the block producer is not all that special to be rewarded. In the case of a sharded network, it’s even more complicated to distribute these fees, as there are also receipts between shards where gas is bought when a transaction arrives but executed by different Validators.
- Validators are still incentivized from burning transaction fees as that directly increases their yield. For simple example, let’s say total supply is 100, 50 of which is staked. Let’s 5 tokens are paid in epoch reward, then if there are no fees – yield is (55/105)/(50/100)-1~=4.76%. While if there were 5 tokens of fees burned, yield would be (55/100)/(50/100)-1~=10%.
- This also incentivizes locking of tokens in other applications by offsetting the issuance.
Storing data on the blockchain has a long-playing role. Networks like Bitcoin and Ethereum misprice storage by only allocating reward to miners who mined specific transactions instead of future miners who will need to continue storing this data while they are mining.
In NEAR, Ⓝ also represents the right to store some amount of data. Token holders have the right to occupy some amount of the blockchain’s overall space.
For example, if Alice has a balance of 1 Ⓝ, she can store roughly 10 kilobytes on her account. This means that users need to maintain a fraction of Ⓝ as a minimum balance if they want to have their account, similar to how checking accounts in banks require a minimum balance.
This allows contracts which are maintaining important state to pay to Validators proportionally to the amount of data they are securing. For example, an important contract of the stable coin that would maintain the balances of millions of users will accordingly need to have a reserve of Ⓝ to cover the amount of storage it will require on the blockchain.
|Storage||Ⓝ locked for Storage||% of Total Supply|
Amount of Ⓝ locked at different amounts of total storage.
For reference, Ethereum is at ~100 GB of storage right now, the USDT contract takes ~100 MB. Contrast that with the total amount locked in Ethereum’s DeFi is ~2.5% of ETH.
There are many ways a developer who doesn’t have a large amount of Ⓝ can still occupy space. For example, a developer can borrow Ⓝ from either off-chain entities or via on-chain lending protocol. Paying back with revenue that his application generates.
Additionally, this can also provide a good opportunity for developers to issue their own token, where they allocate a portion to the Ⓝ token holders who are interested in supporting this application. They attract more support and get Ⓝ required to launch their application and maintain its state, while their token captures revenue from the application usage.
Validators as a group are paid fixed 90% of around 5% of total supply annualized (other 10% go to Protocol Treasury). For example, in the first year Validators will receive around 45,000,000 Ⓝ. Rewards are distributed per epoch — every half a day. Which is on average ~61,640 Ⓝ of reward per epoch to be allocated between Validators.
Each validator receives a reward proportional to their participation. As a validator stakes, how many seats they take is determined via simple auction. After each epoch finishes, the validator will be evaluated based on how many blocks and chunks they produced versus what they were expected to produce.
In the event it’s below 90% of what’s expected, the validator is considered to be offline/unstable, won’t get any rewards, and will be removed from the coming epoch’s validation (i.e., force unstaked). Validators with at least 90% online presence will receive rewards that grow linearly, with 100% of the reward given for those with a 99% or above online presence. Read details of uptime and reward computation here.
For example, if there are 100 seats, a validator that has one seat – will get ~615 Ⓝ per epoch if they are above 99% of uptime. If the validator was 95% uptime, they will receive 55% of their reward – ~342 Ⓝ.
% staked / amount staked
|number of tx / day||100,000,000||250,000,000||500,000,000||700,000,000||900,000,000||1,000,000,000|
Annualized yield at different amounts staked and number of transactions per day.
NEAR is a sharded blockchain designed to scale throughput as usage grows. In the beginning, the system starts with one shard and 100 validator seats. Based on the stake offered, the protocol proportionally assigns these seats, and redistributes the rewards. Therefore, if the protocol will have 40% of the total supply at stake, each seat will require 4 million Ⓝ stake.
However, the number of seats will increase linearly with the number of shards: when 8 shards are running, 800 seats will be available. And every seat will require 500,000 Ⓝ stake, lowering the barriers of entry for more Validators.
A simple auction takes place to actually determine the seat price. Let’s say you observe the following set of proposals (and rollovers from Validators of previous epoch):
Example proposals by Validators and number of seats they would get at the selection process
The seat price given this proposal is determined by finding an integer number that if you divide each validator’s stake with rounding down (e.g., for V5, 20,000 / 20,500 rounding down will be 0), you will get a required number of seats. This determines who will get their seat(s) and who’s funds will be returned back. In the case of the table above, the seat price will be 20,500 if there are 100 seats, and that gives the last column’s number of seats to each validator.
The protocol automatically measures the availability of Validators: if a node fails to be online above a certain percentage when it should be creating new blocks, it loses the status of validator and will be required to submit a staking transaction again. The penalty for low-quality nodes is missing epoch rewards.
In the beginning, a small number of shards will require a larger stake, preferring professional Validators and organizations that will allocate significant resources to NEAR Protocol.
As the network and its usage grow, the number of seats will increase with the number of shards. Therefore, the minimum stake necessary to become a validator will be lower and the seat price selection mechanics will allow for a long tail of Validators to come on board.
This long tail of non-professional Validators might individually have higher risk of failure. But together, they will provide greater decentralization and fault tolerance. At the same time, Validators with a larger stake will need to commit more computational resources when they have to validate multiple seats across different shards.
Validators can receive Ⓝ to stake from third parties via Delegation. NEAR Protocol enables delegation via smart contracts. Validators that want to accept delegation can create a special contract and allow users who don’t want to run their own nodes to deposit their Ⓝ into it. By doing so, funds deposited to that contract are available to the creator of the contract to use as part of their stake.
In the beginning, there will be a reference delegation smart contract. In the future, we can expect Validators to come up with their own staking contracts that provide various taxation benefits, liquidity, and yet-to-see features. The goal is to allow professional Validators who might not have funds to participate, increase the total stake and thus the security of the protocol, and improve the redistribution of rewards across the ecosystem.
We believe in sustainable development. We allocate 10% of epoch rewards to the treasury. This treasury account is designed to continue sponsoring protocol and ecosystem development. Over the long term, it should be managed by a decentralized governance process.
Before that is fully established, we allocate the custody of this to the NEAR Foundation. As decentralized governance progresses and clearly shows that it can effectively manage execution, we strongly suggest for the network to hard fork and change the custody of the treasury to a new entity.
As one of the steps to create a sustainable path for contract independent operation and possibly developer income, NEAR Protocol allocates 30% of transaction fees to the contracts these transactions touched.
For example, if Alice sent a transaction to smart contract A with 0.0001 Ⓝ fee, and contract A doesn’t call any other contracts, it will receive a reward of 0.00003 Ⓝ (which is 30% of 0.0001 Ⓝ). On the other hand, if contract A is using contract B for 50% of its functionality (measured by gas usage), A and B will split the contract reward, each one receiving 0.000015 Ⓝ. This way popular libraries can receive a flow of funds from all the client applications that are using them.
Developers of the contracts can program various ways how these funds can be used. For example, they can be kept on the contract to allow it to allocate more storage space. DAO managing this application can decide what to do with these funds. Or there might be some third-party token buy-back & burn mechanics for contracts that have their own token.
Account Name Auction
NEAR Protocol uses human-readable account names. This allows for much better user experience for regular blockchain use cases. We also expect that these accounts will be used across various novel use cases (e.g., DNS, certification, and applications) as they represent the user’s digital identity that is also connected to finances, data ownership, and cryptography—and, in the future, supporting more of Decentralized Identifier (DID) standard.
We split account names into two groups by length: those longer than 32 characters and those shorter. We expect that shorter accounts names will have way more value for users compared to longer ones. Longer account names can register on a first-come-first-serve basis.
To give everyone a fair chance to acquire short account names, a naming auction will start shortly after MainNet launch.
Each week’s account names—such that sha256(account_id) % 52 is equal to the week since the launch of the auction—will open for bidding. Auctions will run for seven days after the first bid, and anyone can bid for a given name. A bid consists of a bid and mask, allowing the bidder to hide the amount that they are bidding. After the seven days run out, participants must reveal their bid and mask within the next seven days. The winner of the auction pays the second-largest price.
Proceeds of the auctions then get burned by the naming contract, benefiting all the token holders.
NEAR Protocol provides a powerful cryptocurrency Ⓝ, which links together Validators, developers, users and token holders into one ecosystem.
Each role has different goals:
- Users want security for their assets and data.
- Developers want more adoption and capture a sustainable source of revenue.
- Validators want to receive higher income for providing validation services.
- Token holders want their tokens to hold value long term.
The goal of the economic design is to align these interests and incentivize the growth of the ecosystem. For example, as the price of Bitcoin grows, so does the security of the network. In other words, BTC becomes a better store of value as it becomes more expensive, and more people want to store their money there. On the other hand, Bitcoin is missing developers and hasn’t yet attracted active development.
With NEAR Protocol, as demand for tokens grows from new users and developers and increases usage of applications, we see the alignment of incentives between everyone.
Validators will receive a higher income in Ⓝ because there is less staked and more tokens burned (increasing their yield). As more people use the network, their individual usage fees can be kept low while validators are still compensated for storing more data overall, which leads to the network becoming more secure and users (who are also token holders) receiving more security for their assets and data stored on the chain. The network also becomes more attractive as a place for developers to store data and assets because it has higher security and more users.
Add it all up, and growth of the demand from users and developers and the reduction of supply via staking, transaction fee burning, and state staking leads to the NEAR token balancing good utility for users and developers with what validators need to help make the network increasingly more secure.
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