It’s time for the Ethereum ecosystem to come together and cultivate our community of power users.

This is an attempt to get non-technical people in the community up to speed on Uniswap, a cornerstone DeFi primitive, by taking them through the journey from v1 to v4.

This writeup will be used as pre-reading materials for an upcoming roundtable discussion in Singapore. Feel free to sign up on Luma and join us.

Solo Stakers Guild: The Math & Mechanisms Behind AMMs · Luma

Our friends at Uniswap Labs are joining us for the next edition of the Solo Stakers Guild! Have you ever wondered how Automated Market Makers (AMMs) actually…

lu.ma/v9tfvuzs

Many thanks to YC from Uniswap Labs for helping to proofread!

TLDR; (1 minute)

1. Simplistic Market Makers:
Simplistic market maker mechanisms with naive automated pools (price = balance ratio) can be easily drained through arbitrage attacks

2. Uniswap v1: The Constant Product AMM
The x * y = k constant product formula prevents pool drainage by making large trades exponentially expensive, enabling permissionless liquidity provision

3. Uniswap v2: Direct token-to-token pairs
Direct token-to-token pairs eliminated constraints of swapping through ETH as the intermediary and added critical DeFi infrastructure (flash swaps, price oracles, routing)

4. Uniswap v3: Concentrated Liquidity
Liquidity providers can specify custom price ranges, achieving up to 4,000x capital efficiency but requiring active management.

5. Uniswap v4: Fully Customizable with Hooks
Platform Transformation: 150+ modular hooks enable unlimited customization (dynamic fees, MEV redistribution, auto-compounding) with massive gas savings

6. How power users use Uniswap & how the math works: Read on to find out 😎

(20 minutes)

Market Makers

Let’s start with some basic concepts.

A market maker is an entity that sells when you buy and buys when you sell. ie. making a market for an asset.

They determine a mid-point price by aggregating information on all buy & sell orders, and then charge some fees to users for facilitating their orders.

Access to large amounts of liquidity is key to being a market maker because you need to first take the opposite position from one user before closing the trade with another.

Simplistic Automated Market Makers

An automated market maker (AMM) does the same thing by automating the price discovery, trade execution, and liquidity provisioning.

It works by allowing any user to deposit 2 assets in a smart contract, forming a “liquidity pool” for the asset pair.

The price of each asset in a pool is determined at all times by the balance of each asset in the pool.

For example, if a liquidity pool contains 1,000,000 USDC and 400 ETH, then:

Price of 1 ETH = 2500 USDC
Price of 1 USDC = 0.0004 ETH

In other words,

Price(ETH) = Balance(USDC) / Balance(ETH)
Price(USDC) = Balance(ETH) / Balance(USDC)

Which generalises to:

P(x) = y/x
P(y) = x/y

When one asset decreases, the other asset increases. When one asset is being bought from the pool, it gets withdrawn, while the other asset gets deposited into the pool.

However, this means that we can drain the pool easily in a few steps:

- Starting pool balance = 1,000,000 USDC, 400 ETH; ETH Price = 2500 USDC
- Deposit 400 ETH in exchange for 1,000,000 USDC 
- Pool balance = 0 USDC, 800 ETH; ETH price = 0 USDC
- Deposit 1 USDC in exchange for 800 ETH 
- Pool balance = 1 USDC, 0 ETH
- Profit = 999,999 USDC + 400 ETH

This is because this simplistic relationship does not account for slippage, which is how price increases as you buy more of an asset and decreases as you sell more—something that happens in the real world!

For example, not everyone who provides ETH in the liquidity pool will want to sell them for 2500 USDC. Some would want to sell for 2600, 2700, 3000 etc.

Similarly, now everyone who provides USDC will want to buy ETH at 2500 USDC. Some might want to buy at 2400, 2300, 2000 etc.

In other words, if you want to sell 400 ETH into the pool as before, you might only get the first 50 ETH that are priced at 2500 USDC, the next 50 at 2400, the subsequent 50 at 2300, and so on.

How do we represent this relationship between the 2 assets?

Uniswap v1: The constant product AMM

Enter a key innovation of Uniswap, the constant product automated market maker.

The relationship between the two assets, x & y, now takes the shape of the famous
x * y = k curve.

Where:

x = balance of asset x
y = balance of asset y

k = a fixed number (constant) that is set when the pool is initially created according to the values of x & y. \

e.g., 400 (ETH) * 1,000,000 (USDC) = 400,000,000

How to interpret:

How do we determine the average price if we want to swap 400 ETH into the pool as before?

Let’s work backwards from x * y = k to build our intuition.

As you can see, only half of the USDC balance is removed from the pool (vs all) by depositing 400 ETH balance under this new curve.

It is also highly unprofitable to do this because the average price is half of the midpoint price of 2500 USDC.

Overall, a great improvement!

Role of Arbitrageurs

The new pool (A) balance is 500,000 USDC + 800 ETH following the scenario above, implying a mid-point ETH price of 625 USDC.

If the price of ETH in another pool (B) is still at 2500 USDC, the logical thing to do is to deposit USDC into this pool (A) to withdraw ETH, and then swap the ETH for USDC on pool (B).

This effectively allows you to buy ETH for a lower price and sell them for a higher price until the prices of both pools converge.

Arbitrageurs play a crucial role in balancing pools on Uniswap v1 & v2 in this way.

By capitalizing on price discrepancies across different pools, they effectively drive prices of all various pairs towards an equilibrium state.

Liquidity providers, swap fees, and impermanent loss

What are Liquidity Providers?

Anyone can create a liquidity pool on Uniswap and provide liquidity in the pool to earn fees whenever users swap one asset with another in this pool.

These users are called Liquidity Providers (LP)

They will need to deposit the pair assets in the same ratio as the pool balance. e.g., providing liquidity in a pool with 1,000,000 USDC and 400 ETH will require Liquidity Providers to deposit both both USDC & ETH in a 2500:1 ratio.

In return, they will receive ERC-20 LP tokens representing their share of the pool. These tokens are fungible, can be freely transferred, and are composable. e.g., used across DeFi as collateral.

How do Swap Fees work?

On Uniswap v1, Liquidity Providers earn a 0.3% fee per swap on the input asset amount. This fee is deducted from the input amount before the swap calculation is performed.

Using the same example from before, swapping 400 ETH for 500,000 USDC will effectively become a swap of 398.8 ETH for 499,248.87 USDC after applying fees.

However, the swapper will still deposit the entire 400 ETH. The 1.2 ETH difference here gets added to the liquidity pool while 751.13 less USDC gets withdrawn from the pool compared to the initial scenario.

This 1.2 ETH swap fee is then distributed to all Liquidity Providers of the pool according to how much liquidity each of them provided.

More liquidity provided = Higher share of fees.

Because swap fees are added to the liquidity pool, the product of both assets in the pool (k) increases over time. i.e., the constant product formula is actually not that constant!

The math works as follows:

Summary:

- User deposits: 400 ETH 
- Fee paid: 1.2 ETH (stays in pool) 
- USDC received: 499,248.87 USDC 
- Net exchange rate: ~1,248 USDC per ETH

Impermanent Loss

When the prices of token pairs in a liquidity pool change from what they were when the liquidity was added, it results in a loss of value for the Liquidity Provider versus simply holding both tokens.

These price changes happen when users swap more of one token for the other (e.g., more buying pressure for ETH), causing the balance the token pairs in a pool to change from the time of deposit.

Let’s look at a simple example below (ignoring the effect of swap fees).

As you can see, some loss is observed when market prices increase compared to simply holding the 2 tokens. The same loss percentage will be observed if prices decrease by the same ratio.

e.g., ETH dropping from $2500 to $2083 would also result in a 0.41% impermanent loss.

However, this loss will be completely reversed if the price of ETH reverts to $2500 on other markets and arbitrageurs bring the pool balance back to the point when the LP deposited the asset pair.

This is why the loss is defined as “impermanent”.

Because LPs also accumulate swap fees over time, they profit if the price of ETH stays the same as or reverts to the point of their deposit.

Some useful data illustrating the impact of impermanent loss from Pintail and the Uniswap docs below.

Mathematical approximation:

Impermanent Loss % = 2√r/(1+r) - 1

Where:
r = ending price / starting price

Example 1: 
If ETH goes from $2500 to $3000
r = $3000/$2500 = 1.2
Impermanent Loss % = 2√1.2/(1+1.2) - 1 = -0.5%

Example 2:
If ETH goes from $2500 to $2083 (same 1.2x ratio in reverse)
r = $2083/$2500 = 0.833
Impermanent Loss % = 2√0.833/(1+0.833) - 1 = -0.5%

Graphical approximation

Graph illustrating the impact of Impermanent Loss from the Uniswap docs

Intuitive approximation:

Fun Fact

In Uniswap v1, all liquidity pools were required to be denominated in ETH. e.g., USDC/ETH, DAI/ETH, WBTC/ETH, etc.

This means that swapping from DAI to USDC must route through two pools.

• Swap DAI to ETH on DAI/ETH pool

• Swap ETH to USDC on USDC/ETC pool

This was inefficient because it incurred gas costs, swap fees, and slippage twice.

Fortunately, this was greatly improved in Uniswap v2, along with a couple of other cool features!

Uniswap v2: Same math with new and improved features

Direct Token-to-Token Swaps

The most notable improvement in Uniswap v1 was that it allowed liquidity pools to be created with any two ERC-20 tokens.

Benefits:

1) Swappers only need to pay gas, swap fees, and slippage once when swapping between two ERC-20 tokens.

2) Liquidity Providers do not have to maintain exposure to ETH if they do not wish to

As you can imagine, this led to a Cambrian explosion of liquidity pools containing different ERC20 token pairs, and trading volumes on Uniswap followed.

Liquidity Routers

Even if there are no liquidity pools between two ERC20 tokens, they can still be swapped through common tokens across pools.

For example:

1) Swapping through wrapped ETH (WETH) as the common token. Note: To prevent liquidity fragmentation, support for native ETH swaps was removed in Uniswap v2 but later restored in v4.

2) Routing through a custom path across multiple pools

Router contracts are used to find the path with the best price (lowest slippage) for the swapper. e.g., direct vs multi-step swaps.

Illustration from Uniswap v2 Docs

Liquidity Pools as Price Oracles

Because the balance of each token pair in liquidity pools implies the prices of each token, they can be used as price oracles.

However, 2 important upgrades were required to minimise price manipulation before they could be used:

1) Measuring End-of-Block Price: Every token pair measures the market price at the beginning of each block before any trades take place. This price is expensive to manipulate because it was set by the last transaction in a previous block.

2) Updating the Cumulative Price: The end-of-block price is added to a single cumulative-price variable in the core contract, weighted by the amount of time this price existed. e.g., a Time-Weighted Average Price variable

This Cumulative Price variable can then be used by external smart contracts to track accurate time-weighted average prices (TWAPs) of any assets across any time interval.

Flash Swaps

This feature enables anyone to:

1) Execute a swap without having the upfront capital at the start of the transaction,
2) perform additional on-chain actions,
3) and then return the capital, complete the swap, or a mix of both + pay the swap fees at the end of the transaction.

However, Flash Swaps must be repaid in the same transaction or the entire transaction reverts. They are powerful but require careful execution.

Examples where Flash Swaps are useful:

1) Arbitrage between liquidity pools without requiring upfront capital

• Problem:

If ETH price in 2 different pools is $2400 & $2500:

- If require 1,000,000 USDC to balance the price difference
- Arbitrageurs will have to provide the 1,000,000 USDC in order to capture the full arbitrage opportunity of $40,000

• Solution:

With Flash Swaps, you can capture this $40,000 arbitrage and then pay cost of using Flash Swaps after.

2) Lever up on a token in one transaction

• Problem: Levering up on ETH using a DeFi borrowing/lending protocol requires multiple transactions (i.e., multiple gas fees)

- Deposit collateral (ETH)
- Mint USDC
- Swap for more collateral asset (ETH)
- Mint more USDC
- Loop until desired leverage is achieved

• Solution: Using Flash Swaps for leverage

- Flash borrow ETH from Uniswap (without paying upfront) 
- Deposit all ETH (owned + borrowed) as collateral in lending protocol 
- Borrow USDC against the larger collateral position 
- Use borrowed USDC to complete the Uniswap swap (repay the flash loan)
- Result: Higher leverage position in one transaction

3) Executing liquidations: If there are collateral positions on borrowing/lending protocols that can be liquidated

- Withdraw the borrowed asset (first half of a swap)
- Pay off the liquidation amount
- Unlock deposited collateral on borrowing/lending protocol + claim liquidation bounty
- Deposit collateral in the Uniswap pool to complete the swap
- Profit = Liquidation bounty 

4) Preventing self-liquidations: Similar to (3), you can pay off your borrowed amount before you get liquidated and complete the swap using the unlocked collateral

- Cost saving = Liquidation bounty paid

Uniswap v3: Concentrated Liquidity

Concentrated Liquidity

In Uniswap v2, liquidity deposited by LPs is distributed across the entire price range of each token. e.g., from 0 to ∞.

While this covers the maximum possible trading prices of the token pair, it is highly inefficient as swaps occur within a narrower price range most of the time. e.g., ETH has been trading between $2000 and $3000 in recent months.

In other words, the liquidity provided in an ETH/USDC pool below $2000 and above $3000 is underutilised and does not earn swap fees.

Concentrated Liquidity in Uniswap v3 addresses this capital inefficiency by allowing LPs to define the price ranges for their liquidity provided. The v3 positions of each LP for a given token pair are aggregated into a single pool, forming a combined curve for users to trade against.

The current spot price and active liquidity range are determined by “ticks”, which are discreet price points at every 0.01% interval.

Three benefits of v3:

1) LPs can earn the same amount of swap fees using way less capital if prices stay within the LP’s defined range

Illustration of v3’s capital efficiency from Uniswap Docs

2) A concentrated liquidity position also reduces LP’s risk exposure relative to a v2 liquidity position with similar expected APR. e.g., if ETH goes to $0, LPs lose a smaller portion of their capital

Illustration of v3’s stop-loss use case from Uniswap Docs

3) Providing more liquidity depth to a narrower range can increase the absolute profit from swap fees vs deploying the same amount of liquidity in a v2 pool. However, this greatly increases impermanent loss to LPs as well

v3 Trade-offs:

The key consideration of using v3 is that the LP’s liquidity becomes inactive if prices move beyond their defined range, resulting in:

1) No swap fees earned outside of the defined range
2) Greater risk and impact of impermanent loss
3) LP’s liquidity composing entirely of the less valuable of the two assets in the pool

Although all three negative effects are reversed when prices move back into the LP’s defined range, the risks are materialised if prices deviate permanently.

How do power users use Uniswap v3 in practice?

1) Range orders: Limit orders, Dollar-Cost Average (DCA), Take-profit, Primary issuance

- LPs deposit a single token in a custom price range above or below current price

- Swap one asset for the other from start to end price points if market price moves into the LP’s specified range

- Range orders below current price = DCA

- Range orders above current price = Take-profit orders, Primary Issuance

- Primary Issuance: Deposit liquidity in a single asset and specify range of prices to sell their tokens

- Note: Stop-loss or Stop-buy orders don't work because when prices move against you, you end up holding more of the losing token, not less. However, this is made possible in v4.  

2) Periodically rebalancing concentrated liquidity positions

- Rebalance liquidity back to 50:50 when market price moves out of range, causing the LP’s liquidity to consist solely of the less valuable of the token pair

- Realise the impermanent loss but continue earning swap fees

- Usually only makes sense for pools with high swap volumes (i.e., high swap fees APR)

3) Hedging out-of-range downside on centralised exchanges (CEX)
Some sophisticated LPs use external derivatives or CEX positions to hedge their concentrated liquidity risk.

• Problem: If ETH drops below your range, you're stuck with ETH (the losing asset). If ETH price rises above your range, you move entirely into USDC and miss out on further ETH gains.

- Deposit liquidity and define a narrow price range. e.g., ETH/USDC between $2400 and $2600

- Simultaneously open a stop-sell order on Binance for ETH at $2400 and a stop-buy order at $2600

- If market price falls below $2400, CEX profits offset LP losses, as if LP sold ETH at $2400

- If market price rises above $2600, value of LP’s position rises along, as if LP bought ETH at $2600 with USDC

Note: This requires advanced risk management so only use this if you fully understand how it works.

Custom Fee Tiers

LPs can tailor their required swap fees according to the volatility of the token pair in a pool, allowing them to be better compensated by taking on more risk or vice versa.

Non-Fungible Liquidity

Because each LP defines its own price range, LP tokens are no longer fungible in Uniswap v3.

They are now represented by non-fungible tokens (NFTs) instead of ERC20 tokens, and the LP’s swap fees no longer reinvest automatically into the pool.

However, common LP positions can still be made fungible (ERC20) via peripheral contracts or partner (external) protocols.

As more LP positions are made fungible over time, increasingly sophisticated strategies can also be tokenised—e.g., multi-range positions, auto-rebalancing positions, fee reinvestment, lending, and more.

Advanced Price Oracles

This feature is more relevant to DeFi developers, so I will only cover it briefly. Compared to Uniswap v2, v3’s price oracles are:

1) Cheaper to create and use
2) More advanced (beyond just TWAP)—e.g., simple-moving averages, exponential-moving averages, outlier filtering

Uniswap v4: Fully-Customisable Liquidity Pools with Hooks

Hooks

Hooks are smart contracts that can be deployed by anyone to attach custom logic to liquidity pools across their entire lifecycle.

This logic can be executed before or after major operations such as:
1) Pool creation
2) Adding/Removing liquidity
3) Swapping
4) Donations (e.g., Fee rebates for LPs)

To enable Hooks, liquidity pool owners and LPs must allow their selected Hooks to interact with their pools.

Some obvious use cases of Hooks include:

• Limit orders for DCA or take-profit

• Stop-loss & stop-buy orders (previously impossible with v3)

• Auto-compounding of LP fees

• Automated liquidity management for LPs

• Custom price curves beyond x*y=k or concentrated liquidity

• Custom fees: Dynamic pool fees, Fee rebates for LPs, Fees for using Hooks

• MEV fee redistribution to users

• Channeling inactive liquidity onto lending platforms for yield maximisation

• For Solo Stakers: Finding optimal periods to channel staking rewards into liquidity pools with high volume, fees, & incentives

Overall, Hooks encourages developers to build on top of Uniswap rather than forking and building competing protocols.

Curated list of deployed Hooks

GitHub - ora-io/awesome-uniswap-hooks: A curated list of awesome Uniswap v4 hooks resources.

A curated list of awesome Uniswap v4 hooks resources. - ora-io/awesome-uniswap-hooks

github.com/ora-io/awesome-uniswap-hooks

Lower gas costs for everyone

Uniswap v4 brings 4 key gas-saving improvements.

1) Flash Accounting: Swapping, adding/removing liquidity, and donations within a single transaction are netted against one another. Users only pay to settle the final balance change
2) Singleton Architecture: Creating a pool is now a state update instead of the deployment of a new contract (vs v1-v3). Swapping through multiple pools no longer requires transferring tokens for intermediate pools.
3) Bringing back Native ETH swaps: No need to wrap ETH into WETH before swapping

Sources

Uniswap v1

• Programming DeFi: Uniswap. Part 1

• Programming DeFi: Uniswap. Part 2

• Programming DeFi: Uniswap. Part 3

Uniswap v2

• Uniswap docs on Flash Swaps

• Programming DeFi: Uniswap v2. Part 1

• Programming DeFi: Uniswap v2. Part 2

• Programming DeFi: Uniswap v2. Part 3

• Programming DeFi: Uniswap v2. Part 4

Uniswap v3

• Uniswap v3 blog

Uniswap v4

• Uniswap v4 Docs

• Uniswap v4 Whitepaper

There has never been a better time to be a solo staker on Ethereum.

From the lower financial and technical barriers to entry to the abundant opportunities with ETH staking projects, the stage is set for the rise of a new class — the “sovereign staker”.

The lowering barriers to entry

Running your own validator node was historically an exclusive activity.

You needed both the financial (32 ETH) and technical (Linux systems admin) chops to participate, and many individuals did not have one or both components.

This is why liquid staking — abstracting both requirements away from the everyday user — is one of the most popular DeFi use cases today (US$27bn TVL).

However, both requirements are becoming easier to fulfil for individuals today.

On the financial side, liquid staking technologies (LSTs) allow node operators to get started with way less than 32 ETH — e.g.

1. Rocketpool: 10.4 ETH, of which 2.4 ETH is in RPL tokens

2. Stader Labs: 4.4 ETH, of which 0.4 ETH is in SD tokens

3. Diva Staking: 1 ETH

4. Lido Simple DVT: 0 ETH, limited time

5. Lido Community Staking Module: TBC

6. NodeSet: 0 ETH

Sweetening the deal further, hardware grants from the Ethereum Foundation (plus others coming soon!) will offset your fixed costs of US$800.

On the technical side, the level of community support and quality of documentation/guides is unprecedented — e.g.

1. Community support:

   1. ETHStaker reddit and discord for general community support

   2. Stakesaurus Telegram group for beginner-level support

   3. ETH client teams’ discord for specific questions

2. Step-by-step guides

   1. CoinCashew

   2. Somer Esat

   3. Stakesaurus — I designed this specifically to get laymen from zero to one conceptually and technically 🙂. Do check out the guides of my predecessors above for more technical details.

So, if the free market is making things easier for solo stakers, you can probably guess where the US$27bn liquid staking TVL is headed.

Click to see what the end game for solo stakers looks like!

The abundant opportunities

With an easier time getting started with your own validator node, you will now be able to rack up hands-on experience and an on-chain track record to showcase your proficiency.

This will then enable you to participate in emerging testnet initiatives of new LSTs and other ETH staking projects. Doing this will allow you to build off-chain reputation with the projects you participate in and likely earn yourself a priority when it comes time for them to allocate TVL to solo stakers.

Some testnet initiatives you can participate in today:

1. Lido: Simple DVT, Community Staking Module

2. Diva Staking

3. NodeSet

4. Stader DVT: TBC

PS: You only need a single set of hardware to participate in all initiatives.

For the end game, you could then spin up your own liquid staking pool using Stakewise V3 and start to attract your own TVL 😎 — I describe a way to do that here.

The Solo Staker’s Roadmap

Given the exciting developments, let’s distil them into a roadmap for solo stakers.

So there you go. This is the new meta — The golden age of solo stakers.

Check us out!

Feel free to reach me on Telegram if you’d like to know more about upcoming testnet initiatives you can participate in as a solo staker — https://t.me/samuelclk

Check out our very own Stakesaurus liquid staking pool and consider staking some ETH with us to support our work of growing the solo staking community in SEA — https://app.stakewise.io/vault/0x649955f4189c3921df60e25f58cb1e81070fedb0

*We use only minority clients for the safety of our stakers

For more of my writings or to know more about us, visit our LinkTree — https://linktr.ee/stakesaurus

The origins of staking

Participation in proof-of-stake blockchain consensus is not unlike voting with shares of a company.

Stakeholders vote with their crypto assets to process honest transactions submitted to the blockchain network and are penalised for dishonesty and inactivity. In exchange for the work done, these voters receive rewards in the form of new token issuance by the network and transaction fees paid by users.

In blockchain networks, these voters are called validators, and they put their crypto assets at stake to vouch for the validity of transactions.

However, speculation became the main use case of staking during DeFi and NFT Summer.

In a matter of months, blockchain developers took the “staking” concept to the extreme — spawning Ponzi after Ponzi that issued hyper-inflationary tokens to earlier stakers using cash from later stakers. It’s surprising in hindsight that the market gobbled up this model without a second thought.

But what if there’s a better way to drive adoption in Web3 via staking? Let’s explore a use case that’s based on transacting for something of value rather than speculation.

The Stake-to-Subscribe model

The Stake-to-Subscribe business model proposes that users stake their crypto assets and share a small percentage of the rewards earned with a vendor of their choice instead of paying a subscription fee.

Even though the net effect should be the same for both users and vendors — where users pay some amount of money to vendors — it can make users feel like they are essentially getting the product/service for free. This is because users will have to stake their crypto assets somewhere and pay a fee anyway. Taking ETH as an example, staking pools typically charge a 10% fee on staking rewards for providing infrastructure and convenience.

So why not pay this fee to support their favourite creator instead?

Why is this exciting?

For blockchain networks

More people running validator nodes = a healthier settlement layer.

Most alternative Layer 1 blockchains (L1s) trade-off decentralisation for scalability in their initial stages. However, as they start to mature, they will need to start thinking about making their chains more decentralised by increasing the diversity of their validator node operators.

One way to do this is by coming up with innovative ways of lowering the minimum token collateral requirement to become a validator — which sounds like a favourable trend for individuals looking to participate!

For creators

The stake-to-subscribe model allows creators to tap into the Web3 native users in their audience for monetisation — a segment that is indisputably (to me, at least 😎) set to grow with time.

And although I specifically mention “creators”, this model is extendable to any entity with an audience.

🎥 Creators: Users “stake-to-subscribe” to premium content or as a way to support the work of creators — e.g. Patreon, Buy me a coffee

🏗 Community builders: Enable members to stake ETH with them to support community-building efforts instead of incumbent staking pools

🏛 Decentralised Autonomous Organisations (DAOs): Use staked ETH as a voting mechanism instead of issuing their own tokens. Allows DAOs to signal higher Ethereum alignment and avoid ponzi-like mechanisms and user behaviour that are unavoidable with issuing own tokens

💰️Funds: Hear me out — A US$250bn market cap asset at the current low. 4.2% annual yield with 10% fee rate = 0.42% fee on AUM equivalent without having to take custody (read: licensing). Tell me this is not better than running an ETF.

🧑‍💻 Individuals: Learn how to run blockchain nodes and partner up with any of the above personas. Running 10 validators on behalf of others takes ~30 minutes per month for an additional income equivalent to 33% - 50% of minimum wage in SEA — More details on this here.

Subscription revenues coming from this channel also grow with the price of the underlying crypto asset. For example, both staking rewards and the fee clip increase in USD terms when ETH prices increase.

And the best part? The skillset for running nodes on one blockchain is highly transferrable to another!

Alright, this sounds good on paper, but in reality, being a creator is already a 24/7 job — which means that only a small subset of creators will likely pick up the skills needed to run blockchain nodes.

How do we scale this model then?

How will this actually work in practice?

Scaling this model will require 2 types of players to partner up — the Creator and the Operator.

Operators are individuals who learn how to run blockchain nodes. They do not have their own following, so they take care of all the technical aspects of running the ETH staking pool, such as setting up, maintenance, and scaling. This leaves the Creators free to focus on distribution, which, in this case, is to attract TVL from their followers.

Given this method, there are 4 key components that I am working on — the pooling layer, education, hardware sponsors, and matching layer.

Pooling layer

Ethereum does not have a staking delegation feature on the protocol level. So first, we need a way for individual node operators to spin up staking pools on top of their home staking hardware.

An example of such platforms is Stakewise V3’s liquid solo staking vaults. Their vault marketplace is permissionless, so anyone who knows how to run ETH validator nodes is able to list their infrastructure here. Attracting their own TVL (total value locked), however, is something node operators have to figure out themselves.

Vault Marketplace on the ETH testnet

Education

The next crucial piece of the puzzle is to impart the know-how of running blockchain nodes to non-technical people en masse.

And because I believe this model has the power to uplift the lives of many people in developing markets, we want this know-how to reach less privileged people — e.g. students and low-income earners in Southeast Asia.

At Stakesaurus, we create technical content on node operations and run workshops free of charge for students. However, working adults pay a fee that subsidises students attending for free.

We are currently working with local Web3 communities and universities across SEA to ramp up the reach of our workshops over the next 3 months.

Hardware

Despite the accessibility of being a PoS validator, it still requires an initial investment of US$700 - US$900 into hardware — a non-trivial amount to the less privileged.

Further, the payback period on hardware for new node operators can be extremely long if they are not able to attract sufficient TVL.

We are reducing friction on this front via sponsorship for hardware. Such sponsorships can be awarded to shortlisted node operators retroactively by batches. The selection and reimbursement criteria will be based on on-chain and off-chain performance metrics to mitigate abuse of this good-willed initiative.

In return, sponsors benefit from the PR value of showing Ethereum alignment and helping to improve the lives of underserved communities in SEA.

Matching layer

The heart of the stake-to-subscribe model is the partnership between creators and node operators.

Although the ideal scenario is to let both parties pair up organically, we expect that this matching process needs to be bootstrapped initially. The reason is that most of these new node operators will likely not have the network and credibility to secure a partnership with an already successful creator.

This is why Stakesaurus and our partners will need to serve as a curation layer by systematically selecting the best operators of each batch and recommending them to creators — e.g. by working with local creator communities.

We can also match node operators with TVL directly.

Diversification of yield sources is an important criterion of treasury management in Web3 projects. Tail risk events (e.g. correlation penalty) can instantly wipe out yields earned over a long time or even the entire staked capital. Smaller pools with locally hosted infrastructure are more robust against correlation penalties.

In fact, TVL matching is already being done indirectly if you are staking ETH via Rocketpool, Stader, Diva Staking, or even Lido.

How can you get involved?

As you can tell, this is a novel concept and will require quite a herculean effort to make work. So, any support is welcome and greatly appreciated!

Recapping the 4 key components we are focusing on — We’d love to chat if you are able to support any of the value drivers or fit our potential partner profiles.

That being said, feel free to reach out even if you don’t think you fit neatly into the table above!

Sam | Stakesaurus

You can contact @samuelclk right away.

t.me/samuelclk

Oh, and I’ll call this the Creator-Validators Initiative.

- Sam

Why Zero-Knowledge matters?

Trust, more than money, makes the world go round.

Before you lend money to someone, for example, you’d want assurances that they are not a scammer and that they will be able to pay you back. How can a borrower convince you of both statements without revealing (a) their full identity and (b) their personal net income (income minus expenses)?

Besides, people are inherently untrustworthy. So we bring in middlemen—like banks or escrow services—to bridge that trust gap and pass on the risk of untrusted transactions to them.

To lower these risks, these middlemen demand piles of personal information through the dreaded KYC (Know Your Customer) process, which has spawned issues like high transaction fees and data misuse.

So, what if we could transact without needing to trust the other party or a middleman?

Enter Zero-Knowledge Proofs

Zero-knowledge proofs (ZKPs) solve this conundrum. They allow one party to prove the validity of a statement like the examples above or — “I know where Waldo is” —without revealing the position of Waldo itself or telling a game master.

Spotting Waldo is trivial compared to proving it without revealing his position

If this sounds like magic, well, it almost is. ZKPs work using complex cryptography, which can be summed up as mathematical proofs of truth claims.

It is also worth noting that the original data cannot be reconstructed just from these mathematical poofs.

But I’m not a wizard, so here’s how you would solve the problem without math (or magic) - the video below starts at 0:50 mins. Watch it till 2:30 mins.

By using ZKPs, two parties can confidently transact in an anonymous yet secure manner. They can be sure the other party is legitimate without revealing unnecessary details.

Here, instead of trusting the middleman, we trust the mathematical rigour of ZKPs.

This seemingly simple concept will have massive implications on our world today in the form of:

1. Privacy: Your personal data can’t be misused, sold, or otherwise used against you without your permission if it is not collected in the first place

2. Scalability: A nice bonus effect of ZKPs is that the size of proofs is much smaller than the original data themselves. This means it is computationally much faster and cheaper to verify the proof than the original data.

3. Disintermediation: Removing middlemen from the equation means removing the high transaction fees that they impose.

What can ZKPs be used for?

1. Trust-less KYC: Proving that one is not a sanctioned person of any country without revealing actual identity

2. Trust-less identity provenance: Proving that one is a member of some group or an actual human being and not a bot without revealing actual identity - e.g. Worldcoin

3. Trust-less and secure digital voting system: Prove that one’s votes are legitimate without revealing who they voted for

4. Improve patient privacy in healthcare: Proving the validity of medical conditions for insurance claims without revealing entire medical history. Or proving that one does not have any excluded medical conditions when purchasing insurance plans.

5. Transparent supply chain: Brands can prove that their raw materials are ethically sourced without revealing trade secrets.

6. Transparent bug bounty: White-hat hackers can prove the existence of bugs and vulnerabilities in a software system without revealing the actual solution, protecting them from non-payment by the owner of the software system

7. Scaling blockchains: Because the space for blocks on a Layer 1 (L1) blockchain is limited and expensive, ZK Layer 2 (L2) scaling solutions batch multiple transactions into one and generate a ZKP for independent verification before posting the verified proof back to the L1 blockchain

   • Recall that the size of proofs is much smaller than the original data, so each transaction takes up way less space and is much faster to process

How do ZKPs work under the hood?

In general, there are 2 parties involved in a Zero Knowledge protocol - The prover and the verifier.

The verifier verifies a proof computed by the prover that satisfies the following conditions:

1. Completeness: If the underlying statement is true, then an honest verifier can always be convinced with the proof

2. Soundness: If the underlying statement is false, then it will be near impossible to convince an honest verifier otherwise with the proof

3. Zero-Knowledge: The verifier learns nothing else about the underlying statement from the interaction other than whether it is true or false

How do they interact?

A Zero-Knowledge Proof is made up of 3 components.

1. Witness: This is the underlying statement. It is the secret information that the prover wants to prove that they are in possession of.

2. Challenge: The question(s) a verifier asks a prover to test if they really have the secret information.

3. Response: The prover’s answer to the Challenge questions.

Wait, isn’t this just an interview? Well, not really, because we ask a bunch of questions and request documents that reveal substantial information about the candidate beyond just the statement of “I am qualified for the job”. In other words, it violates the Zero-Knowledge condition.

These non-trivial conditions imposed on a ZK protocol mean that there is a cost to prove and a cost to verify. Moreover, these costs from the ZKP interaction will need to be replicated if another person wants to verify the prover’s claim.

The cutting edge: Non-Interactive ZKPs

Now let’s make this even more exciting - what if we only have a single round of interaction (instead of multiple rounds) between the prover and the verifier to complete the ZKP process?

This is made possible using a shared key, a proving algorithm, and a verification algorithm.

With non-interactive proofs, the prover only has to compute the proof once, and anyone else will be able to verify it using the shared key and the verification algorithm - greatly reducing the cost of using the ZK protocol.

SNARKs & STARKs

The 2 leading implementations of non-interactive ZKPs are zk-SNARKs and zk-STARKs. To begin understanding each of them, let’s first define the acronyms in simple terms and their key characteristics.

zk-SNARKs

1. Zero-knowledge (zk) - no other information needs to be provided other than proof that the prover’s statement is true

2. Succinct (S) - the size of the proof is very small compared to the original raw data

3. Non-interactive (N) - does not require multiple rounds of interaction between the prover and the verifier. i.e. no further questions are asked when the first proof is provided and verified

4. Argument (AR) - A prover can make the verifier believe a lie if the prover has enough computational resources - i.e. it is a probabilistic process. This is in contrast with an actual proof where a prover can never convince a verifier of a lie even with unbounded computational resources

5. of Knowledge (K); Or knowledge-soundness (Ks) - A prover must know the solution to prove his/her statement. In simpler terms, it ensures that the prover isn’t just bluffing or producing proofs for false statements

The most important property of some SNARKs is the requirement for a trusted setup ceremony. Recall that a shared key is necessary for non-interactive ZKPs - this ceremony is where this shared key is created.

The secrets used during these ceremonies will need to be destroyed after the shared keys are created. Otherwise, these secrets can be used to create false proofs, and it would be impossible to verify that these false proofs are indeed false.

Fortunately, having just one person out of everyone who participated in such ceremonies destroying their secret will greatly increase the security of trusted setups. On the same note, the security level also increases with each additional secret destroyed, which is why trusted setup ceremonies are usually run with many participants.

SNARKs uses pairings-based cryptography (vs hash-based) that generate proof sizes orders of magnitude smaller than those of STARKs, leading to faster and cheaper verification of SNARK proofs.

The trade-off of using pairings-based cryptography is that they are not quantum resistant and result in slower and more expensive proof generation across all throughput levels.

zk-STARKs

1. Zero-knowledge (zk) - no other information needs to be provided other than proof that the prover’s statement is true

2. Scalable (S) - Used in a blockchain scaling context - the proving computation and data storage can be done off-chain to circumvent block space constraints. Zk proofs of these off-chain activities are then submitted on-chain for interested parties to verify.

3. Transparent (T) - Uses publicly available randomness to generate parameters, removing the need for a trusted setup.

4. Argument (AR) - Same as SNARKs above.

5. of Knowledge (K); Or knowledge-soundness (Ks) - Same as SNARKs above but uses quantum-resistant algorithms.

STARKs, on the other hand, do not require a trusted ceremony setup to generate a shared key.

Instead, they make use of publicly verifiable sources of randomness that are used by both the proving and the verification algorithms so that both can arrive at the same output. This means that we don’t need to trust STARKs for it to work.

STARKs uses hash-based cryptography (vs pairings-based), which is quantum resistant, enables lower cost to generate proofs, but result in larger proof sizes. Larger proof sizes leads to a higher cost to verify at low throughput levels.

Summarising SNARKs vs STARKs in a table

Conclusion

This wraps up our ZK dinner party!

For my next issue, we will dive deeper into how Zero-Knowledge Proofs help blockchains to scale (this is a Web3 newsletter after all 😀) alongside other types of Layer 2 scaling solutions.

Credits

This newsletter issue is co-authored with The Whitepaper Reading Club - a high-signal collective who are enthusiastic about understanding how Web3 technologies work under the hood. We read whitepapers and meet up to debate our understanding once every two weeks.

This is an open initiative where anyone is welcome to join us. DM if you are keen!

Subscribe | WhitePaper Reading Club

We are veterans and enthusiasts, engineers and thinkers, united by the shared curiosity to dive deep into the mechanics powering the Web3 revolution.

rongxins-newsletter.beehiiv.com/subscribe

Zero-knowledge makes the world go round,

Sam

How do we define a good impact investment? To me, it first has to be a good business model in and of itself, and then, one that benefits from the impact it is creating.

In other words, it needs to fulfil 3 criteria:

1. Sustainable source of income - i.e. non-ponzi and non-charity sources

2. No stakeholders should be worse off than before - i.e. on par with the status quo or better off, no one is actually doing charity

3. Impact goals function as flywheels of the business

To back my bold claim, let’s look at how a hypothetical business model based around Ethereum staking fares against these tests.

The business model

An ETH staking service with validator nodes operated by people in underserved communities. More proficient operators get allocated more ETH to put to work and draw fees from.

There are 2 main benefits to this model -

1. Improving decentralisation of the Ethereum network via geographical and jurisdictional diversification of nodes, leading to stronger censorship resistance for the network and lower slashing risks for stakers

2. Enabling people in underserved communities to earn a fee from running nodes

Test 1: Is there a source of sustainable income?

First, we need to identify where the money is coming from.

As economic activity on the Ethereum network continues growing with each cycle, the income that goes to validators will also increase collectively. To recap, the source of this income is the transaction fees that users pay when interacting with businesses built on top of the Ethereum network.

Today, solo node operators enjoy 6.0% of real yields per year on average this way. Meanwhile, people without the know-how to run their own nodes pay a service fee of between 10% to 25% (out of the 6% yields) to platforms that do it for them.

This annual service fee - e.g. 0.6% on asset value staked - is the source of sustainable income in this example.

Test 2: Are any stakeholders worse off than before?

Let’s introduce the stakeholders.

1. Users: These are the people who pay transaction fees to interact with the Ethereum network. Smart contracts make their tasks cheaper by removing layers of middlemen and reducing trust assumptions, which means they are likely to continue paying.

2. Stakers: These people are sitting on ETH and want to put them to work, earning yield. They pay a service fee for the convenience of doing so without having to run their own nodes. This fee will be split amongst all subsequent stakeholders below.

3. Node operators: These will be the people from underserved communities that will be maintaining the validator nodes.

4. Hardware sponsors: Because we are dealing with underserved communities, hardware costs will be a challenge for them. This is where hardware sponsors come in. They can be any individual or company who wants to contribute to the cause of uplifting these underserved communities - i.e. making an impact investment.

5. Service sponsors: Someone will need to train, certify, and guide new node operators because they will be handling large amounts of assets.

6. Insurance sponsors: Because the node operators are not the asset owners themselves, there will always be a fear of negligence or dishonesty on the part of the node operators - leading to slashing events.

   Even though these risks can be mitigated using tools such as Distributed Validator Technologies (DVTs) and remote signers, the most effective method will still be to have an insurance fund that acts as the first line of defence against any slashing events.

   Standing on the shoulders of giants - using a ratio of 4:28 ETH (Insurance: Stake) sufficiently covers tail risks as described in a study conducted by Stader Labs, but we can increase this ratio as needed.

7. Platform: These are the players providing the tech infrastructure that enables this business model to work in a low-friction and trust-minimised way (“Vaults”). Existing liquid-staking projects are best positioned to power this - e.g. Lido V2, Stakewise V3, Rocketpool, Stader Labs

8. Marketing / Distribution: As with any product, reaching and engaging the intended audience - i.e. the Stakers - is paramount. The message here is that staking with this Vault helps uplift underserved communities. The hardware, service, and insurance sponsors will also want publicity for supporting this cause.

Putting it all together in a value chain -

Economics of each stakeholder

Now let’s put the economics of each stakeholder to the test.

A) Defining the assumptions:

*The overarching caveat is that all stakeholders need to be long ETH

B) Economics breakdown

*SWV = Scales with volume

C) The test - Is anyone worse off than before?

1. Node operators: They learn a new highly scalable knowledge-based skillset. Their earnings scale with ETH price and volume (as they display higher levels of proficiency)

2. Hardware sponsors: Because we need to consider the lifespan of hardware, let’s first convert the 20.52% annual yield into an equivalent IRR of 9.20% using the median lifespan of 6.75 years.

   Now we can compare this 9.20% yield against the current 1-year treasury yield of 5.25%.

   Naturally, this is not risk-free, but in exchange, the yields of the hardware sponsors increase proportionally with the price of ETH.

3. Service sponsors: Because there is no lifespan to the training and certification service, we can compare the 8.11% yield directly with the current 1-year treasury yield of 5.25%.

   Similar to hardware sponsors, the yields of the service sponsors increase proportionally with the price of ETH

4. Insurance sponsors: As insurance sponsors also stake ETH without running their own nodes, we can compare their yields against those of the Stakers - i.e. 6.36% vs 5.40% - or an 18% boost. They are effectively enjoying leverage on their yields in exchange for the additional slashing risks they are underwriting.

5. Platform: Because the industry is actively trying to decentralise itself, this model enables platforms to capture a new market and retain their current shifting market.

6. Marketing / Distribution: Earnings scale with volume and ETH price - nuff said.

Test 3: Do impact goals function as a flywheel of the business model?

First, let’s measure the impact by using the minimum wage of each country in SEA, by comparing the additional income node operators can earn each month against this benchmark.

*Monthly income is net of electricity costs

Aside from Singapore and Brunei, this additional income is a non-trivial boost of at least 19% to minimum wage earners.

And this is assuming ETH price stays at the current level. What will the impact look like as the Ethereum network continues growing?

Now imagine if we increase the number of validators managed per node operator from 10 to 20 as they become more proficient..

The flywheel

Okay so if the impact this model can create is significant, it means there will be sufficient motivation for more people to take up the mantle of node operator. This solves the supply side of the business equation.

As more people from underserved communities aspire to become node operators - e.g. to create better lives for themselves and their families - the selection pool becomes larger and more diverse.

The effect is a likely better overall performance from the selected node operators and a reduction of risk for the other stakeholders.

As demand increases, more impact can be created. Now loop it.

Closing thoughts

Because users of blockchain (i.e. payers of transaction fees) tend to be from the more developed countries today, this model effectively transfers wealth from those who are better off to those who are worse off in a non-charitable way. To me, this is the most sustainable method of helping people.

I recognise that some logistics are not addressed here - e.g. who holds the validator keys, how to prevent MEV theft, etc - and I have some thoughts on them as well.

In fact, this is a project I am currently exploring!

I am actively having conversations with parties that are keen to participate as stakeholders under each category and I’d love to have a chat with anyone who would like to be involved!

NFTs are stupid.

NFTs are pointless and a scam.

NFTs are 100% based on the greater fool theory - Bill Gates.

We hear this all the time but I love being a contrarian prick so here’s the thing -

NFTs make as much (or as little) sense as why people buy luxury/branded goods

And because I like playing with a handicap, let’s go ahead and restrict this argument to the “stupidest” form of NFTs of them all - the Profile Picture NFTs or PFPs.

These types of NFTs typically have almost zero direct utility besides giving you access to some arbitrary perks or pseudo-voting rights on the future direction of the project (i.e. Meme governance).

To spoil the ending - When used in the right way, NFTs can offer better ROI than luxury goods

First, let’s think about the nature of luxury goods. Do we think that a middle-of-the-line Rolex is actually worth $20k? What about Birkins at $20k?

The cost to produce (ie. labour + materials) is probably 20% of what you are paying for and if this is the case, why would anyone pay for the crazy markup?

When we decompose the nature of luxury goods, it is basically something with low extrinsic value compared to its intrinsic value. As we move up the luxury spectrum, the proportion of extrinsic value compared to its total value approaches zero percent - e.g.

• The most expensive Rolex watch ever sold is Paul Newman’s ‘Exotic’ Rolex Daytona 6329 at $17.8M; or

• The average price of a monkey NFT profile picture is $70k

At the end of the day, value is retained if other people are willing to pay for it. And people will pay for something if they think they can get more value out of the price they are paying.

Here’s what you are paying for when you buy luxury goods...

Shortcuts to associating yourself with a certain “image”

When you buy a Rolex or a Birkin, you benefit from the cumulative marketing and branding efforts of the company. This benefit manifests itself in the form of the impression you give people who see you with these items.

Not to mention that an immediate rapport is also formed if these people are also owners of the same luxury items. These association shortcuts are useful because they help you capture attention which you can then use to deliver your message.

NFTs work the same way.

Each NFT project carefully curates the “image” (brand) they want to portray through marketing and branding efforts, and buyers choose which “image” and community they want to identify with.

NFTs have lower cost-per-impression than luxury goods

Now let’s think about how many people will actually see you with your Rolex or Birkin in your lifetime. A thousand? Perhaps two thousand? - That’s $10 per impression for a $20k luxury item.

What about NFTs, which thrive in the digital world? I reckon you can reach 1,000,000 digital eyeballs in your life if you put your back into it - i.e. a cost-per-impression (CPI) of 7 cents for a $70k monkey profile picture.

Naturally, the value (ROI) you get out of these “impressions” you bought still depends on what you do with them so let’s look at a more obvious analogy - Investors are often willing to pay large premiums above a company’s book value because the company has a strong brand.

This is because consumers are more easily convinced to buy products that this company produces - i.e. having a strong brand lowers customer acquisition costs.

Closing thoughts

Do I think everyone who buys NFTs goes through this thought process Absolutely not. Most buyers are driven by FOMO and just jumping on the bandwagon.

But the Attention Economy is worth $7.1 trillion today and NFTs are a way to grab a piece of the pie.

So perhaps we don’t need to pick the winning NFT projects from the sea of noise, but instead, invest in the creators that are using these NFTs the right way.

Luxury goods are stupid,

Sam

Welcome to a new series on using the neglected science of value chain analysis to inform early-stage investing decisions.

In my previous issue, I talked about how value chains are packed with alpha and how inspecting them enables you to bootstrap intuition rapidly.

But how do you actually do this?

Let’s dive in and inspect the Web3 value chain, but first..

A recap of the 5 key components

1. Flow of goods/services: → What do they do and how do they do it?

2. Flow of cash → How do they make money and who do they sell to?

3. Gross margins → How much of the cash do they get to keep? 

4. Total addressable market → How big can this get?

5. Funding momentum → Is this the right time?

The Web3 value chain

3 verticals should stand out at first glance based on the congregation of the Flow of Cash - i.e. Content & Community, Primitives, and Tooling Infrastructure.

But let’s break this down further and inspect the first 2 components of each vertical in this week’s issue.

*Note: examples provided are non-exhaustive.

**No gifs and memes today because we’ll need to focus :(

Hardware infrastructure

1. What do they do?

   Similar to how Web2 requires data centres to host them, Web3 needs a similar place to live in - i.e. distributed blockchain nodes.

   These are the people selling the actual hardware.

2. How do they do it?

   Hardware infrastructure players develop and sell hardware to node operators. These hardware are often off-the-shelf CPU devices but can sometimes be specialised devices (e.g. ASIC miners for the Bitcoin network)

3. How do they make money?

   Aside from ASIC miners whose prices fluctuate with the current Bitcoin prices and hash rate, hardware infrastructure is typically sold for fixed prices. Purchases are also one-off in nature.

   This means that their revenues do not scale directly with increases in transaction volumes or asset prices. But it also means their revenues are less sensitive to these factors. It is a low beta exposure to the Web3 space akin to selling picks and shovels during the gold rush.

4. Who are they?

   • Bitmain, Bitfury, Canaan - Develop and manufacture mining and mining-related hardware. Mainly focused on the BTC network. Also develops their own software for mining use cases

   • Dappnode, Avado, Stereum - Develop node-in-a-box hardware + software for the ETH network

   • Traditional electronics manufacturers - Most blockchain nodes (especially for Proof-of-stake) are assembled with off-the-shelf components

Node operators

1. What do they do?

   These are the people who buy the hardware required to run blockchain nodes.

2. How do they do it?

   Node operators procure hardware to run blockchain nodes for the protocols (network) of their choosing. They process transactions and provide security to these networks.

   They also allow Primitives, Dapps, and Wallets to access the Web3 world via their nodes. This is similar to how Web2 servers work today.

3. How do they make money?

   In exchange, they receive transaction fees from the protocols and these originate all the way at the top of the value chain - i.e. users who use Dapps that are built on top of this network.

   These transaction fees are not a function of the transaction size but are instead subject to supply & demand for blockspace at the point of the transactions.

   Primitives, Dapps, and Wallets also pay per use to access these nodes.

4. Who are they?

   • Infura, Alchemy, Pokt - Nodes-as-a-service similar to AWS, Google Cloud, Azure of the Web2 world

   • Blockdaemon, Figment, Bitcoin Suisse, StakeFish - Node operators facilitating non-custodial staking (yield generation) for institutional clients.

   • Individual/community/project node operators - These are your solo validators or those who run nodes for a community. Developers also run nodes to get private and quick access to their desired blockchain

Protocols

1. What do they do?

   When people talk about blockchains, this is what they are referring to. It is the base layer where everything else on-chain is built on (eg. BTC, ETH)

2. How do they do it?

   The guys at Bankless summarise this well - Blockchains sell blocks. Or more specifically, they sell the available space in each block (i.e. blockspace). Blockspace is in turn powered by the execution “engine” of the blockchain and governed by its consensus algorithm.

   Developers can then build applications that use these block spaces.

3. How do they make money?

   This is where things diverge from the traditional world. Most protocols do not have direct cash flows and instead function as a foundation (e.g. the Ethereum Foundation), making money in one of two ways:

   • Issuing a portion of the governance tokens to the foundation and selling these tokens over time to cover operating expenses

   • Operate in other verticals to provide additional services. e.g. Foundations of protocols are often node operators and developers (Primitives, Dapps) as well

4. Who are they?

   • Layer 1 chains (L1s) - BTC, ETH, Cosmos, Near, IPFS (storage)

   • Side chains (to L1s) - Polygon, Gnosis

   • Layer 2 chains (L2s) - Lightning, Optimism, Arbitrum, zkSync, zkStart, Scroll, Base (by Coinbase)

Primitives

1. What do they do?

   These are players that develop the “immediate” applications on top of protocols. Primitives create a strong foundation for richer use cases (Dapps) to be built on top of themselves. In the Web3 world today, users often bypass the Dapp vertical and use primitives directly.

2. How do they do it?

   Primitives are basically Dapps that focus on doing one thing very well.

   They are designed to be interoperable so each primitive can be joined with another. When you hear terms like “money legos”, this is what they are referring to.

3. How do they make money?

   Primitives typically charge both Dapps and users a fee for interacting with their smart contracts.

   These activities include minting of tokens (incl. NFTs & stablecoins), swapping & bridging tokens, lending & borrowing tokens, staking, providing and buying insurance, and market-making.

4. Who are they?

   • Liquidity/market-making/swap - Curve, Uniswap, Sushiswap 

   • Borrowing & lending primitives - Aave, Compound

   • Staking primitives - Lido, Rocketpool, Stader

   • DeFi/NFT insurance - Armor.fi, Risk Habour, Nexus Mutual 

   • Stablecoins - USDC, USDT, Maker 

   • Cross-chain bridges - Hop, Synapse, Layer 0

   • Derivatives - Dopex, Lyra, Perpetual Protocol

   • NFT Primitives - NFTX, Collection.xyz, Fungify, Jpegd, Taker, Bridgesplit

   • Social media - Lens

   • Identity - ENS, Unstoppable Domains, Spruce, BrightID, Hashkey DID

   • Storage - Arweave, Filecoin, Storj

Dapps

1. What do they do?

   These players build applications that more closely resemble the “apps” in Web2.

2. How do they do it?

   Dapps typically wrap 1 or more Primitives into familiar user journeys and increase their range of functionalities - e.g. Web3 games, decentralised social media/content, DeFi/NFT vaults

3. How do they make money?

   Similar to Primitives, Dapps charge users a fee for interacting with their (wrapped) smart contracts and they are free to set their own prices.

4. Who are they?

   1. Web3 games - Axie Infinity, NBA Topshot, Cryptokitties, Star Atlas

   2. Decentralised social media/content - Buttrfly, Chromadin, DiverseHQ, DumplingTV, mirror.xyz, primitives.xyz

   3. Defi/NFT vaults - Balancer, Yearn, Beefy, Fractional Art, Nftfy, Unicly, Altr

   4. Tokenised Real World Assets - HomebaseDao, artemundi, CitaDao, OpenEden

Wallets

1. What do they do?

   Wallets store users’ crypto assets and act as gateways for users to access the Web3 world. Think of it as “accounts” in Web2.

2. How do they do it?

   Wallets are a type of Dapps that make it easy for users to generate their public keys (blockchain address) and private keys securely. They typically do not hold custody of these keys and also often provide services for users to convert from fiat to crypto and vice-versa.

   Wallets have also begun to wrap Primitives into their own interface - e.g. swapping tokens within the Metamask wallet.

3. How do they make money?

   Since Wallets are a type of Dapps, they monetise in the same way - by charging a fee when users interact with their (wrapped) smart contracts.

4. Who are they?

   1. Hot wallets - Metamask, Station, Phantom

   2. Cold wallets - Ledger, Trezor, GridPlus, Ngrave

   3. Smart Contract & Multi-sig wallets - Safe, Argent, Soul

   *Note: If you realise, I seem to classify everything on-chain as a Dapp. This is because they are all smart contracts at the end of the day but that’s a story for another time!

Tooling infrastructure

1. What do they do?

   This is a diverse group of players that provide off-chain products and services to almost every other vertical, including end users.

2. How do they do it?

   They develop tools to standardise smart contract development, audit smart contracts for security, extract & analyse blockchain data, enable projects to better run their token-based governance process, Web3-based messaging, custody & self-custody solutions.. the list just keeps getting longer!

3. How do they make money?

   Because most of their products/services are rendered off-chain, their pricing models usually resemble that of traditional subscription or usage-based fees. Their paymasters depend on the type of products/services they offer. This means that it is easier to apply conventional valuation methods on this vertical!

4. Who are they?

   1. Smart contract standards & security - OpenZeppelin, Certik, Code4rena, Consensys, Slowmist

   2. Data & analysis - Bloxroute, Blocknative, Dune Analytics, Chainanalysis, Covalent, Nansen, Token Terminal, Etherscan, Coinmarketcap

   3. Governance tooling - Sybil, Snapshot, Tally, boardroom

   4. Messaging - XMTP, Swarm, Matrix

   5. Custody / Self-custody - Bitgo, Fireblocks, Liminal, Atato, Propine

Content & Community

1. What do they do?

   These platforms generate Web3 content (e.g. written, podcasts, video) for end-user consumption. They also organise Web3 communities via events and social media channels.

2. How do they do it?

   Examples of Web3 content include the latest developments, narratives, and research in the space. Most players cover all forms of content as they can be easily repurposed. Events are organised to connect the various verticals with one another and to bring these verticals closer to their users.

3. How do they make money?

   Their goal is to establish themselves as a thought leader and build a large audience - which they can then monetise via sponsorships/ads, ticketing & merchandising, premium subscriptions, or even being a delegate (Which I covered in a previous issue here).

4. Who are they?

   1. Written - Coingecko, Bankless, Decrypt, Coindesk, theblock, Coinbureau

   2. Podcasts & Video - Uponly, Bankless, DailyGwei, Unchained

Users (+Investors & MEV Searchers)

These are the people like you and me who use DeFi, NFTs, or off-chain services. However, the Web3 space is unique, as users are often also investors in the projects (companies) offering these services.

Another group of users are the MEV searchers. They peer into the blockchain (Mempool) and perform on-chain arbitrage to balance prices across different Dapps.. or at least the good guys do this (once again, story for another time!)

Observations so far

1. Hardware Infrastructure, Node Operators, and Tooling Infrastructure provide low-beta exposure to the Web3 space

2. Protocols often do not directly generate cashflows. Their success and failure are amplified by all other verticals

3. Value seems to be migrating towards to Primitives vertical. Is it time to move away from the Fat Protocol Thesis? 

4. If the trend in (3) can be extrapolated, Dapps and Wallets will be next to shine on stage

5. Content & Community businesses have broad and interesting monetisation options despite their relatively boring business models

To be continued..

Phew that was a lot to get through and we’ve only really covered the first 2 components of the value chain analysis.

The latter 3 components will require extensive research to get them right so I might pause on this topic until I have sufficient data gathered - stay tuned!

Okay I lied, here is a cat gif for making it to the end

Keep diggin’,

Sam

Welcome to a new series on using the neglected science of value chain analysis to inform early-stage investing decisions.

I do not yet know how many issues it will take to cover everything as I am trying to distil my VC experience into bite-sized 5-minute reads but this will become clearer along the way!

To kick things off,

Early-stage investing is hard…

Why is this relevant to you? Because anyone putting money into Web3 is technically an early-stage investor.

I am talking about proper OG investing where you are willing to hold your bags for at least 5 years (if not forever) and not just dump them on retail the first chance you get.

Anyway back to my point. It is hard because the opportunities here are super diverse, noisy, and distracting.

1. Diverse: There are 4 main layers (i.e. Protocol, Infrastructure, Application, Access) with many verticals in each layer and even more business models under each vertical - How do you decide which areas to focus on as your thesis?

2. Noisy: Even after defining your thesis in (1), there are a ton of imposters to sieve through because of how much capital has entered the space over the recent cycle.

3. Distracting: A year in Web2 is 10 years in Web3. The space moves very quickly and new narratives are popping up every day. How do you avoid FOMO and devolving into a spray-and-pray strategy?

These 3 problems often lead to one of two outcomes as investment teams are usually very lean.

1. Missed opportunities - Spending too much time to come to a decision

2. “Bad Satisficing” - Prematurely coming to a half-baked conclusion because of time, resource, and intellectual constraints. This is likely what happened if you have a large portfolio of shitcoins 💩 

As you can imagine, the problem is even worse if you are a retail investor acting solo.

Intuition is a win condition for early-stage investing

Given limited resources and a vast universe of opportunities to explore, the key to success is to consistently choose the right segments or verticals to focus on. ie. Which verticals are most likely to bear fruit?

Sure, you can brute force this problem with strong intuition but intuition tends to be volatile if it is not honed. Consistency is a key ingredient here.

Honing intuition, in turn, requires accumulated experience in the relevant domain.

In other words, intuition takes time to build, which makes it a luxury most retail investors do not have.

How then would you bootstrap a proxy to this intuition?

Option 1: Expert interviews

This is where you speak to domain experts of the industry you are planning to invest - leveraging their intuition to inform your decision on where to focus your time and resources on.

But even though this might seem like an obvious solution, it is often not feasible to most investors as it is often expensive. That being said, the economics of this method improves as your investment amount gets larger.

Besides, this method is still lacking in completeness as vertical-specific perspectives are often inadequate to capture nuances of the entire industry.

Opinions can also be biased based on individual experiences as there are no downsides to them leading you down the wrong direction.

This means that expert interviews are at best a tool that can be used to test specific hypotheses you have in mind further down your investment process.

Option 2: Inspecting the value chain

A value chain describes how each player in an industry interacts with other players. Inspecting value chains gives you a good sense of where value tends to accrue.

It is a feasible method for all investors because it is cheap to perform - only requiring desktop research and logical reasoning to form your initial view.

That being said, a refined version will require you to speak to industry practitioners (eg. founders, sales, operations) to corroborate your understanding. What you are trying to drill down for each vertical at this stage is (i) who they sell to, (ii) who they buy from, and (iii) how they go about doing (i) and (ii).

It is a complete method because you can capture the whole industry in your analysis. Biases are also better mitigated because you, the one taking the risk, generate the opinions.

Bootstrapping intuition by inspecting value chains

There are 5 components I focus on when running a value chain analysis:

1. Flow of goods/services: This will give you a sense of the cost structure of each vertical - e.g.

   • Who buys from whom, nature of “item” bought & sold (eg. recurring vs transactional, products vs services), how these “items” are bought & sold (eg. 1:1 vs 1:Many, direct vs indirect relationship with customers).

2. Flow of cash: Helps you identify which vertical has a chokehold on the industry. You want to be close to the money and invest in where value tends to accrue.

   • Closely tied to the flow of goods but may not always match

   • Who pays whom, recurring vs transactional payments, direct vs indirect payments.

3. Gross margins of each vertical: Simply knowing the flow of cash is incomplete. You need to understand the quality of these cashflows - i.e.

   • Which verticals can better retain these cashflows (value)?

   • All things equal, you should pick the vertical that has the highest gross margins

4. Total addressable market: Reveals the size of cashflows going into each vertical. Combining size with direction (flow) and quality (gross margins) will give you a complete picture of the most lucrative verticals.

5. Funding momentum: Timing is often a key consideration in investing and being too early can be as bad as being wrong. However, you should use this information to test 2 hypotheses - (i) Are you too early and (ii) is this vertical somehow just overlooked?

   • If 1 - 4 points to a certain vertical, it should be the most well-funded as well

   • If it is not, maybe your analysis is wrong, or maybe you found alpha and valuations are likely to be cheap - Congrats!

   • The next step is to verify your hypothesis with primary research -i.e. Speaking to people in each vertical to corroborate your views - e.g. founders, investors, or product guys

Coming up next

In the next issue, I will be walking through an example using the process described above so keep a lookout for it same time next Saturday!

Get dat crystal ball fam,

Sam

“What powers does my node even have?”

Even without locking up any ETH, an Ethereum node still plays 2 very valuable roles:

1. Provides computational power - spreads the load of processing transactions out to a larger number of nodes

2. Relays information to other nodes - propagate transactions throughout the network.

The former prevents any node from becoming overloaded and leading to network congestion. The latter helps honest transactions be “processed” quicker, which gives users a better experience. Both outcomes will benefit you if you hold any ETH!

But more importantly, these roles act as weapons against 51% attacks.

Wait how does this work again?

Preventing 51% attacks as a node operator

By propagating honest transactions to other nodes, your node also alerts other nodes of dishonest blocks being “pushed” by another malicious node. In other words, you help to identify and weed out malicious validator nodes ASAP, preventing them from growing and taking over the network.

More specifically, there are 3 weapons at your disposal as a node operator:

1. Weapon 1 - For the more technically adept, you can run a Slasher on your node to direct punish these malicious validator nodes - by slashing and claiming a portion of their staked ETH.

2. Weapon 2 - Otherwise, your node can relay this information to the Slashers and this can happen quicker with more honest nodes in the network.

3. Weapon 3 - Finally, your node can refuse to build and forward these dishonest blocks to other nodes. By doing this, you are basically saying you do not recognise the legitimacy of these transactions, which delays their propagation speed and eventually causes them to fail to finalise.

But won’t this lead to censorship via Sybil attacks?

Let’s look at the other (dark) side of the coin of the information relayer role.

If nodes can choose which transactions to propagate and ignore, what’s stopping Dr Evil from spinning up a gazillion nodes on the cloud and stealing everyone’s ETH by choosing to only propagate their own dishonest transactions?

(Now that hardware requirements are cheap after the move to proof-of-stake)

Well fortunately for us, there are 2 limitations to this plan.

The first limitation - only validating nodes (i.e. those with 32 ETH staked) can propose and attest to blocks.

Non-validating nodes can only relay these blocks to other nodes, which means the heist will likely cost more than the loot.

The second limitation - complete censorship can only be achieved if you continue to do it at every block.

This is extremely difficult and expensive.

Because if valid blocks don’t make it into the current time period, they will compete to get into the next time period, and the next, and so on.. Further, honest nodes can once again choose to only propagate valid blocks and ignore the blocks that are produced by Dr Evil.

This means that as long as there are honest nodes out there, valid transactions will be recognised eventually. It’s a continuously steepening uphill battle for Dr Evil!

(You can read more on the cost of continuous censorship here. Its a different issue but with similar effects to our thought experiment above)

What happens when a 51% attack somehow succeeds?

Alright let’s say that by some stroke of genius, Dr Evil somehow succeeds in pulling off a 51% attack and steals everyone’s ETH - Can your node still make a difference at this point?

Yes.

Recall that your node basically provides computational power to some blockchain network and relays information (blocks & transactions) to other nodes.

When a catastrophic event with a clear adversary like this happens, all honest nodes (yourself included) can rally together to fork the blockchain into a version where Dr Evil’s heist never happened. All of his stolen ETH will now be worthless because no one recognises their legitimacy.

At this point, you have the power to decide which is the true chain for your node to provide its services to.

Closing thoughts

I hope I managed to convince you by now that running an ETH node is not only for those of hold >32 ETH. I see it as a way to retake control of your fate as long as you hold some ETH and intend to continue accumulating it.

There is definitely a learning curve to picking up this skill set. But this is what we at Stakesaurus are here for! Get in touch with us to join the cause

Thank you for reading part 4 of a 4-part series on the real and tangible benefits of running your own node. Click on the linked titles if you missed the previous issues!

1. Running validator nodes is the most secure way to put your crypto assets to work

2. Take your Web3 skills to the next level and boost your earnings

3. Reclaim your self-sovereignty and privacy

4. Use your node powers to make a difference

If you enjoy reading this, feel free to share the link with anyone who would find it helpful! - https://stakesaurus.beehiiv.com or get to know us better here 🕸️

Welcome to part 3 of a 4-part series on the real and tangible benefits of running your own node. Click on the linked titles if you missed the previous issues!

1. Running validator nodes is the most secure way to put your crypto assets to work

2. Take your Web3 skills to the next level and boost your earnings

3. Reclaim your self-sovereignty and privacy

4. Promote decentralisation and make your vote count!

If you enjoy reading this, feel free to share the link with anyone who would find it helpful! - https://stakesaurus.beehiiv.com or get to know us better here 🕸️

What is it?

The idea of self-sovereignty and privacy is rooted in freedom. Freedom from trust assumptions and censorship.

It means individuals have sole ownership and control over their accounts (e.g. assets & access to services) and data. They are able to choose to whom and for what purpose they give permissions to their accounts - i.e. their assets and data. No one should be able to confiscate or misuse your assets and data without your explicit permission. 

These properties should be freely portable and cannot be easily censored, allowing individuals to “go anywhere” they want to.

Why does this matter?

Because trust assumptions are dangerous.

Now, of course, there are many constraints to solving this in reality. For one, this is still a high-friction process today. In most use cases, it makes sense to opt for convenience. But choosing this trade-off knowingly differs from assuming the “convenient” methods have the best of both worlds (ie. trust assumptions).

When you know what you are getting into, you know what to look out for and you can design a process to monitor changes to your risk exposure. Trust assumptions on the other hand, often lead to catastrophic losses because you are blind-sided when this trust is betrayed (e.g. FTX, Celcius, and even the recent banking sector meltdown).

Before the dawn of Web3, we had little choice but to trust centralised entities to deliver on their promises.

In today’s world, however, we have the option to verify the prevailing states of our accounts and any subsequent changes for ourselves if we need to.

Because censorship is oppression.

We’ve all seen this movie. Having your data used against you to shape how you think. Transactions being denied because it does not conform to arbitrary rules that can change anytime. The banning of useful infrastructure or services because it threatens the status quo.

It is easy to think that censorship does not affect you as long as you are a law-abiding citizen. But you are only a law-abiding citizen today (Fight me).

Because what happens when the rules change? Now you are on the other side. Your assets are frozen even if they are still yours (which is a form of censorship) and you are cut off from basic financial services.

How does running my own node help me achieve this?

To clarify, running a node is not a panacea to the problems arising from trust assumptions and censorship. It is, however, a powerful tool to improve your position.

Before we dive in, let’s first do a recap on what blockchain nodes do:

With that out of the way, let's now review our two objectives - freedom from trust assumptions and censorship; and see how running our own node supports each.

1) Removing trust assumptions

Being able to verify transactions yourself gives you the option to be “hyper-secure” for the times that matter - e.g. by verifying the state of the blockchain before making a large transaction. More specifically, you can ensure you are interacting with the right smart contract address or verify the on-chain metrics of a project before making a large investment.

Kudos to the Etherscan team for building an awesome product and putting Malaysia on the Web3 map but we would still be relying on a 3rd party to verify the true state of the blockchain by using this method.

But once again, if we know the trade-offs, we can enter with our eyes open and implement measures to mitigate these known risks.

2) Preventing censorship 

Running a node gives you a personal access point into the world of Web3. This means you cannot be censored because of your location, use case, or other discriminative profiling.

Recall from my previous issue that you can configure the RPC endpoint of your wallet (eg. Metamask) to connect to your own node to beat the queue for claiming token airdrops.

This action also prevents censorship as (i) you won’t have to rely on an external service (eg. Infura, Alchemy) to process your transactions for you and (ii) your data cannot be collected and used against you without your permission.

Closing thoughts

Trust assumptions and censorship are messy problems that cannot be easily unentangled. The industry is making progress every day to solve these problems from the tech angle (eg. Zero-knowledge Proofs). However, we as users need to first care about our self-sovereignty and privacy, and spare the effort to pick up the necessary skills to improve our own positions.

Reclaim your self-sovereignty and privacy,

- Sam

Welcome to part 2 of a 4-part series on the real and tangible benefits of running your own node. Click on the linked title if you missed last week’s edition!

1. Running validator nodes is the most secure way to put your crypto assets to work

2. Take your Web3 skills to the next level and boost your earnings

3. Self-sovereignty and privacy should be basic human rights

4. Promote decentralisation and make your vote count!

If you enjoy reading this, feel free to share the link with anyone who would find it helpful! - https://stakesaurus.beehiiv.com/ or get to know us better here 🕸️

Take your Web3 skills to the next level 🎮

You can think of running nodes as the next evolution of a self-sovereign Web3 user

If you are reading this, you most likely believe that Web3 is here to stay. Given this belief, it makes sense to develop a “hard” Web3 skillset to secure your future in this new world. However, the extent of most users’ participation in Web3 today is merely clicking a few buttons to farm tokens.

I’m oversimplifying, of course. But the point here is that we normal users can “level up” and get rewarded while we are at it. You can think of running nodes as the next evolution of a self-sovereign Web3 user after creating your non-custodial wallet and knowing how to interact with smart contracts.

Earn incentives for testing out new projects and one-up basic airdrop hunters 💰️🥇

Traditional airdrop hunting will become increasingly crowded as Web3 participants rush in to take a bite. More participants = less rewards per participant. Doing what everyone else can’t or won’t do will give you an edge.

Here’s how.

Players like Lido, Rocketpool, StaderLabs, IndexCoop, etc are called Liquid Staking Protocols. They abstract the technical process of running validator nodes and pooling assets from users via layers of smart contracts.

Now that withdrawals for ETH validators are live following the Shanghai upgrade (12th April 2023), the already red-hot Liquid Staking Derivatives (LSD) narrative is likely to get even hotter due to increased confidence levels from stakers who were previously sitting on the fence.

More players are bound to enter the space to grab a share of the pie when demand increases. These newer players will introduce novel ways of optimising the trade-off between convenience vs security and will most likely involve individual node operators in their business models.

Current ETH staking options has a security vs convenience trade-off

New LSD players will attempt to solve both security and convenience

Why will new LSD players need to involve node operators? Building something that has the best of both worlds will be inherently complex and require rigorous testing to make sure things work during actual deployment.

How will new LSD players involve node operators? These new players will want to tap into the existing network of node operators to rapidly acquire real world data points and bootstrap their own initial network. This means they will need to allocate a portion of their marketing budgets for node operator incentives.

One such example is the upcoming ETHx LSD project developed by Stader, a multi-chain liquid staking player with $128m in total value locked (ie. the Web3 equivalent of AUM) and $16.5m of total funds raised. The team launched a $725k incentive programme for node operators who participate in the testnet and become early adopters on the mainnet.

Link to tweet

This will be a good way to get a feel of setting up a validator node as the Stader team have abstracted a good chunk of the complexities into a simplified graphical user interface. Reach out to us for a guided setup to get started!

Beat the queue for token airdrops 🪂 

Now lets imagine you qualified for a highly anticipated airdrop after diligently completing tasks and using a new project for several months. You run some quick analysis and realise it could make you mid 5-figures if you sell within the first 15 minutes of the airdrops being released. You start to think about all the things you could do with this windfall and feel the excitement well up in your stomach. The countdown on the screen is showing 48 hours remaining before you can claim your airdrop.

But there’s a problem - everyone will be claiming their airdrops at the same time as you. All public endpoints will become bottlenecks as everyone floods them at the same time. It’s now down to luck whether you are able to claim yours quicker than others.

This was what happened during the recent Arbitrum airdrop. Most users were not able to claim their airdrops until the next day and those who managed to claim earlier got to sell theirs at a much higher price.

ARB/USD price chart on airdrop release day

So how do we claim our airdrops quicker? One way to beat the queue for future token airdrops is to connect your wallet’s (e.g. Metamask) RPC endpoint to your own private node - essentially a direct access point to the world of Web3 that no one else can access!

Admittedly, there’s more to be done for the entire claim >> transfer >> sell workflow but running your own node is a key step.

Reply to this email with “beat the queue” if you are keen to learn the full workflow so I know whether or not to spend time writing on it!

Collaboration with large Web3 projects for longer term opportunities 🏦 

As you build an on-chain track record of your proficiency in running a node, your eligibility to work with large Web3 projects increases. e.g. -

1. Liquid staking projects:

   Selected node operators get to work with Lido, Rocketpool, and Stader without needing to stake their own ETH. Instead, the projects themselves provide these tokens from their user base and split the revenues with the node operators.

   Currently, the most exciting initiative in my opinion is the Staking Router by Lido, which expands their current gated node operator set to individuals and grassroots communities. With more than US$12 billion worth of ETH and 300k stakers, being able to work with Lido will greatly boost your income.

2. Node-as-a-service projects:

   These are companies such as Infura, Alchemy, and Pokt network. Think of them as the Web3 equivalent of cloud service providers of today (e.g.. AWS, Google Cloud etc).

   Infura is the bellwether on this front with their “Decentralised Infrastructure Ecosystem” initiative, which allows Web3 developers and users to pay you to access the Web3 world through your node. Given this precedent, I expect the other players to follow suit in the near future.

By leveraging these partnerships, node operators can build scalable recurring income streams on the side while helping Web3 become more decentralised! But wait, there’s more..

Become a Delegate by building a brand around your new skill 🧑‍🏫 

For those of you looking to max out this skill tree and have the chops to build an audience, you can consider the path of a Delegate. Delegates are node operators who are directly chosen by users to stake tokens and perform blockchain governance voting on their behalf. As you can imagine, this is also a highly scalable model as you can take a fee from helping to put a way larger pool of assets to work. It is also the most self-sovereign model as you are not beholden to any intermediaries who might change the rules anytime.

It does however, require you to build a brand (which is arguably the hardest thing to do) and win “votes” from your audience - just like a politician.

While this feature is not available on Ethereum (or perhaps not yet), many alternative Layer 1 protocols operate under this Delegated-Proof-of-Stake (DPoS) model - e.g. Cosmos, Near, Tezos, Elrond.

Feeling excited and think this is a skillset you want to pick up? Reply to this newsletter to say hi or drop me an email at sam@stakesaurus.com and I will get in touch for with you for our next free workshop!

Level up and stay ahead of the curve,

- Sam

Welcome to Part 1 of a 4-part series on the real and tangible benefits of running your own node.

1. Running validator nodes is the most secure way to put your crypto assets to work

2. Take your Web3 skills to the next level and boost your earnings

3. Self-sovereignty and privacy should be basic human rights

4. Promote decentralisation and make your vote count!

If you enjoy reading this, feel free to share the link with anyone who would find it helpful! - https://stakesaurus.beehiiv.com/ or get to know us better here 🕸️ 

Running validator nodes is the most secure way to put your crypto assets to work 🔐 

Enter the Four Horsemen of yield generation risk 🏇

Yield farming opportunities in DeFi are great places to start putting your assets to work, and the yields can often seem very lucrative, but they require you to underwrite smart contract, counterparty, asset, or price risks. There is no free lunch in the world. Even in Web3, we are always trading something for another.

Smart Contract Risks: When you use a Dapp to generate yield (e.g., as a liquidity provider in an ETH-AssetX pool), you are interacting with some smart contract of said Dapp and are hence exposed to any vulnerability that can be exploited in this smart contract. We see this all the time with liquidity pools, bridges, and users’ wallets being drained by attackers—the most recent example being the $3.3M Sushiswap exploit that occurred on 9th April 2023. At this point, it’s almost as if we hear of a new smart contract exploit every other week.

Counterparty Risks: Despite Dapps being the short-form of “decentralised apps”, many Dapps we interact with today are still far from being decentralised. This risk can materialise in the form of Dapp developers holding a majority or all of the multi-sig keys that allow them to make any changes to the smart contract you are interacting with at any time, including changing your account balances. This is usually how rug-pulls are performed.

Asset Risks: Many yield farming opportunities in DeFi require you to take exposure in a separate asset on top of the asset you want to put to work (eg. being a liquidity provider in an ETH-AssetX pool). This means that you need to be bullish AND indifferent to both assets for this strategy to make sense. “Pure” yields are possible with borrowing/lending protocols (eg. Aave, Yearn, Compound) but boy are these yields measly most of the time. Further, many Dapps artificially juice their yields with their own inflationary governance tokens.

Price Risks: “Pure” yields can be achieved with strategies such as single-staking covered call options vault (eg. dopex) or basis trading (eg. buying spot + selling futures in an upward trending market) on the desired underlying asset. However, these strategies subject you to the possibility of ending up with less of the underlying asset than you started off with (ie. risking your underlying asset). Lets call this property “stability” for the sake of our argument here and unless it is otherwise intentionally part of our strategy, we want to achieve both purity and stability of yields,

The presence of these 4 categories of risks means you either (1) have to constantly monitor the developments of not only the main Dapp that you are using to generate yield but potentially ALL other Dapps that interact with this main Dapp, or (2) can only deploy what you are willing to lose completely.

Or you run your own validator node 🤖 

Running your own validator node bypasses all 4 categories of risks described above and enables you to extract yield directly from the protocol layer (e.g., Ethereum, Cosmos, Gnosis etc).

Other than the protocol itself, there are no additional smart contracts or counterparties you interact with. Naturally, not all protocols are created equal, and you will have to make an assessment of which protocols are sufficiently secure and decentralised.

There are no asset risks because validator rewards are issued purely in the native asset staked and are (ideally) paid by the transaction fees of users. There are no price risks because you don’t have to risk your underlying asset (other than slashing events, which can be easily avoided).

One of the main drawbacks of running your own validator node, however, is the minimum capital requirement (eg. 32 ETH), which limits participation by most Web3 users. The other is the technical know-how required to operate nodes in a highly effective manner to maximise rewards.

Well, the good news is that we are making huge progress on both fronts today. On the capital requirements side, Rocketpool lets you spin up a validator node with just 17.6 ETH or 10.4 ETH and StaderLabs lets you get started with just 4.4 ETH. Projects like Stereum and Avado lower the technical barriers to entry by selling pre-configured validator node devices with a graphical user interface set up so even non-technical people can participate.

However, let’s remember that there is no free lunch in the world—in return for the lower capital and technical barriers, higher levels of smart contract and counterparty risks need to be accepted (which we will cover in detail another time!). 

Although these levels of risk are likely much lower compared to yield farming, a good grasp of how validator nodes work under the hood is still needed. Otherwise, we will not be able to properly assess our risk exposure as changes are implemented over time by the protocol or project we are relying on.

This is why our approach at Stakesaurus is to increase the technical abilities of Web3 users to meet the lower capital and technical barriers halfway. We handhold our community through a guided setup of their own validator node and operate it non-custodially while facilitating knowledge transfer over time. Our goal is for the community to be able to run their own validator nodes if they want to!

Journey to Self-Sovereignty

Of all the yield generating opportunities arising from DeFi Summer, the safest is to put your crypto assets to work by running a validator node. There are virtually zero smart contract and counterparty risks involved as this method interacts directly with the protocol layer. The yield mechanism was sustainable as validators perform real and valuable work of processing transactions on the Ethereum network in exchange for issuance rewards. Though it provided a measly 4.2% APR at that time, it was the “risk-free” equivalent yield during DeFi Summer. It was December 2020 and the beacon chain had just launched.

Being a paranoid Web3 user, this “risk-free” property appealed to me. I was working as an investor at a venture capital fund and the job demanded extensive time and headspace. I couldn’t constantly monitor the latest developments (*ahem drama) across all of the inter-related DeFi protocols to evaluate if my assets were at risk.

I was not prepared for the journey, however, as I quickly became overwhelmed by the technical requirements of running your own Ethereum validator node. Sure, there was information available online but they were mostly catered toward the more technical crowd. I was just a finance bro with no real hard skills (oof) so I decided to resign to the convenience of smart contract-based staking like Lido.

Fast-forward to Q1 2022, the DeFi world was imploding. There was a new smart contract exploit or “rug-pull” incident every other week. And then, large and seemingly credible centralised staking platforms started blowing up one by one. They were taking on excessive leverage with customer assets without their permission - basically a betrayal of the trust their customers put in them.

I got caught up in some of these blow-ups but largely managed to get out in time. However, the mental stress of the experience made me realise that there are no shortcuts to achieving self-sovereignty. Trust assumptions lead to rekt-nation but the paranoid survive. The only way I was going to generate yield on my assets and still be able to sleep soundly at night was to run my own validator node.

I would go on to spend many late nights learning all aspects of running my own validator node over the next few months. From the basics of how the Linux operating and file system works, how to secure my physical devices, home networking, and how validator nodes work under the hood. It was dry and painful at times as it dealt with many boring topics (eg. try reading up on networking). I was fumbling but it brought me closer every day. And so I persevered.

In April 2022, I was a sleep-deprived but proud owner of my very first Ethereum validator node. Humming along in a corner of my home was this small device that symbolised my progress in achieving self-sovereignty - I was confident enough in my own skills to put a large amount of my own capital at stake.

The Dawn of Stakesaurus

It wasn’t long before people I know started reaching out for help on setting up their own validator nodes and over time people I did not know started reaching out as well.

It was then I had a thought -

I figured there could be more of us out there and I can help them get started in a more efficient way - not just for the Ethereum network, but for node operations across all chains. Individual node operators play an important role in the health of decentralised networks but these activities are mostly still run by institutions. This has posed a centralisation risk for the longest time and I could help make a difference to the budding Web3 ecosystem in my own small way.

And so Stakesaurus was born in February 2023 to build a grassroots community of self-sovereign node operators.

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