Despite being well-intentioned, the Delegated Proof of Stake (DPoS) consensus mechanism of the EOS blockchain has shown signs of manipulation by centralized players on the network. Now that EOS’s decentralized governance model is maturing, many critical shortcomings are becoming increasingly apparent, and as a result, early supporters of EOS, the world’s seventh-largest blockchain by market cap, are increasingly losing faith.
The Background of EOS
The EOS project was developed with a lofty mission to deliver fast, seamless, plug-and-play blockchain solutions that would help anyone, quickly and cost-effectively, to bring a fast, safe, secure, decentralized, and high-performance application to life.
To make it happen, network participants are allowed to vote for 30 block producers (BPs) to maintain the network, thereby incentivizing good performance, integrity, and transparency. Unfortunately, issues with centralization and insider trading within the EOS community have been highlighted on numerous accounts.
Voting Issues and Centralization
Larry Sanger, a co-founder of Wikipedia, expressed concern over the centralization of EOS voting powers in the hands of BPs operating in China in his tweet. Centralization of this nature seriously undermines the integrity of the network and raises questions as to whether or not the network can, or indeed will ever, be able to operate with the interests of everyone on the network in mind.
Mr. Sanger’s recent tweet, echoing posts and comments from other thought leaders in the market such as Spencer Bogart, a General Partner at Blockchain Capital, who posted the same warnings over a year and a half ago in a Medium article, do not seem to have deterred market manipulators from continuing to look only for short-term gains.
We have already learned during EOS’s tumultuous beginnings, as described by EOStribe on their Steemit page – covering non-compliance by BPs, a misalignment of interests, and centralization of votes – has effectively rendered the constitution of the network and the EOS Core Arbitration Forum (ECAF) to be useless from the outset of the EOS project. In essence, this was because protocols could only be implemented as long as the top 21 block producers complied with those rules, which they refused to do.
This non-compliance was compounded by various BPs anonymously ceasing execution of ECAF orders, and this governing body, that was so critical to the early success of EOS, was eventually dismantled.
Daniel Larimer, of BitShares, Steem, and Block.one fame, has also highlighted issues with EOS governance, such as misaligned incentives and higher costs to the network. He did so in a recent tweet while simultaneously teasing solutions that will remove the incentive to buy votes by large miners and improve decentralization.
There are even more subtle yet equally sinister factors in play in the background as well, such as a latent east-west divide between Chinese BPs and others across the globe, as outlined in this Coindesk article, and BPs running network operations despite not even qualifying to perform them, as highlighted by Tarnish Verma on Twitter.
One of the reasons EOS vote trading and manipulation have become rampant is because of the way mining rewards are structured.
EOS Mining Rewards Incentivize Manipulation
EOS network maintainers or block producers receive 0.25% of the annual EOS inflation as network maintenance and consensus rewards, otherwise known as mining rewards. This amount can be valued in the tens of millions of dollars, depending on the market supply and price of EOS. However, waiting in the wings behind the 21 voted BPs are about 50 or so candidates vying to become a BP based on votes cast by other token holders. As these potential BPs receive less than 1% of the annual inflation rate, voters are incentivized to make insider trades that split these benefits between voters and would-be BPs. As this leads to the centralization of nodes and further insider manipulation, underqualified nodes gain the seal of approval from the network as a whole, eventually and unfairly becoming fully-fledged block producers.
In short, sad as it is to say it, we must agree with Dean Eigenmann, a thought leader in the crypto-space who is a developer on the Status project, the Ethereum Name Service, and Yeezy Ethereum, when he says:
“The entire model of EOS seems like an oligarchy veiled in a democracy that can be easily corrupted through various means.”
Resolving These Issues
The EOS platform has two ways to overcome these issues. The first approach would involve attempting to fix the hottest issues first, keeping the model more or less intact the way it was at the very beginning of the project.
The second approach is one in which EOS’s libertarian philosophy gives way to a real business model where the market, customers, and profitability have the upper hand. This was talked about by Ashe Oro in a recent podcast on Layer 1. In that discussion, Mr. Oro, the CEO of TokenYield.io and an early BP on the EOS network, explained the importance of decentralization and small player voting to the maintenance of the EOS network. If enough people vote, it becomes increasingly difficult for “sock-puppet” BPs (i.e. potentially malicious BPs who purchase votes with personal interests in mind) to gather the votes they need to sway network decisions one way or another to the detriment of the network. This is the true essence of the term “delegated” when we talk about DPoS systems – it only works if enough token holders vote, and it only works as long as votes are spread across all members of the ecosystem – not in the hands of a centralized few. Indeed, if everyone holding any amount of EOS was to vote for a certain proposal, there may not even be enough EOS float or liquidity available on the market for malicious BPs to purchase tokens to stake for a certain negative proposal. This democratic spread of votes is what essentially saves the network over the longer run.
Mr. Oro also talked about how whale-backed BPs who have short-term gains in mind (i.e. profits from FUD, pumping and dumping, or other short-term network decisions that are not in the interest of the community at large) can lead into what is called “a race to the bottom.” This occurs when the inflationary rewards for staking EOS tokens and maintaining the network are not reinvested into the EOS ecosystem in the form of wallets, DApps, multi-sig solutions, and other improvements and are instead leaked from the ecosystem at the expense of EOS holders on the whole. The alternative, according to Mr. Oro, is taking the egalitarian and democratic approach in which everyone within the EOS ecosystem stakes i.e. votes for certain proposals, making it harder for malicious actors to execute unfavorable network decisions, while simultaneously helping to keep value generated from staking inside the EOS ecosystem itself. This will help promote the creation of fast, efficient, and low-cost applications, systems, and enterprise software – all of the things that EOS was built for.
This egalitarian approach is also in line with what EOS governance expert Colin Talks Crypto puts forth in this post when he discusses the importance of trust and how proxy actions must (necessarily) be in line with the desired actions of voters themselves, otherwise proxies will have their votes removed. This is how trust is developed and maintained and security of the network is maintained (as exemplified by CTC getting the regproducer update approved).
The first step required to implement the second approach is to restrict the ability of whales to vote for the BPs they want. In terms of pure egalitarianism, this makes perfect sense; banning the tradition of exchanges using their inventory for voting, a practice that is simply not fair is something that needs to be enforced. It is worth noting that Newdex, for example, pays a 3.62% annual rate for votes, but the platform earns more on other things so Newdex can afford to do it, meaning it is not incentivized to harm the network to generate earnings since it already generates earnings from its own platform. This is not the scenario facing whales when they pool votes for BPs to steer network decisions a certain way for their benefit and to the detriment of all other participants. Furthermore, Newdex payments for votes are done transparently, thereby doing away with issues of underhanded tactics and malicious behavior that should be flagged by the community were it to occur. Such behavior cannot be reliably identified in EOS BP vote stacking in the current setup. Also, in buying votes, Newdex is restricted by price and supply, so there are no real conflicts of interest in this case, so perhaps a Newdex model of transparent payments for votes is worth looking into. This will become clearer when we talk about the second requirement of the voting process, as below.
As for the second step needed to implement our chosen approach, the voting process needs to be more transparent. An example of how this “market-driven solution” can be achieved is demonstrated in the use case of EOSDT, a decentralized stablecoin project on top of the Equilibrium DeFi framework – they are looking to launch a real-time voting process for EOS BPs to replace the current model in which time delays can lead to insider trading and selling of votes. Transparent distribution of BP rewards on the Equilibrium EOSDT proxy represents the strong system of checks and balances: 90% are distributed to initial EOS liquidity providers, 10% goes to NUT voters who have voted for BP to get on the proxy. On one hand, it incentivizes users to put EOS to the EOSDT collateral pool, simultaneously NUT holders have skin in the game as well.
Another improvement can be taken once again from the Newdex model. BPs could, for example, be allowed to attract or pay for votes however they wish (the way Newdex pays a 3.62% annual rate for votes), but as soon as the BP performs actions that are to the detriment of voters themselves (ie. the EOS community at large), they will be stripped of their votes the next time around, in line with the CTC circular system of generating trust and then acting honorably after-the-fact. This is only possible when it is clear and transparent where votes are going and which BPs are voting along which ‘party lines’ – either in favor of the network or to its detriment.
Finally, BP powers need to be limited and corrective action must be taken swiftly. For example, BPs who are suspected of manipulating votes or those who are not efficient at doing their job can be banned.
To overcome the issues with EOS voting in its current form, the preferred approach is the one in which the free market, customers, and a profit-driven balance are given preference over decentralized governance. A market-aligned model, implemented in conjunction with effective governance and rules similar to those typically found on centralized exchanges, can help bring back the order that was lost when the ECAF was dismantled by BPs working with a visible disregard for the well-being of the EOS ecosystem as a whole. When votes can be bought and sold by large players, when EOS holders, by and large, do not vote, when the voices of indie BPs are drowned out of the market, and when malicious BPs are not banned via general consensus of the community (consensus which is then executed at the protocol level), then we will continue to see a pooling of votes and centralization that can be detrimental to the success of any decentralized blockchain initiative.
With new proposals being voted on by enough people and across a large enough section of the EOS community, price fluctuations will then depend on events and inner mechanisms on the market (in this case, the EOS voting market). Regulations will come from de facto regulators, not the community because this will once again encourage deceptive behavior wherever there are private profits to be made at the expense of the social good. To maintain the rights of everyone, whales will still have all the rights that they are fairly entitled to as they are large players/customers and members of the EOS community, and they can still buy and sell votes on a public exchange platform. However, doing so will drive the price up or down based on supply and demand, and whales – and, indeed, all members of the EOS community – always face the risk of losing the trust of voters in subsequent rounds of voting, thereby forcing their hand to maintain voets by doing what is right for everyone. This is the essence of checks and balances within the DPoS system when egalitarianism and free-market forces weed out malicious action, and long-term horizons incentivize voting by everyone and encourage reinvestment of staking rewards into the ecosystem. When this happens, we will no longer be faced with a race to the bottom, but with a race to the top.
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