Staking, Lending, and MEV One Model to Rule Them All - Kshitij Kulkarni

Introduction

The speaker introduces the topic of MEV redistribution and presents a simple model to think about where this revenue should go and how it should be redistributed to validators.

MEV Redistribution Model

• Validators hold a portfolio over different sources of return, including staking, lending, derivatives, etc.

• These different sources of returns compete with each other based on the portfolios that validators are constructing.

• Staking serves as a privileged source of return because it controls the economic security of the chain and competes with other sources of returns for validators.

• Can MEV be used as an incentive to improve the security of the chain or avoid bad economic equilibrium?

Terminologies

The speaker sets some terminologies for a standard model of proof stake protocol.

Proof Stake Protocol Model

• A proof stake protocol holds some token supply denoted by sft.

• It has some reward inflation schedule given by rft.

• It holds some kind of frozen liquidity which might be either protocol-owned or burned depending on Epsilon's value.

• There is an update for how the supply changes over time which is just adding inflated rewards and then adding or subtracting from the protocol.

Validator Side Perspective

The speaker explains how validators view this as a portfolio optimization problem.

Portfolio Optimization Problem

• Validators compute mean return for each source (staking, lending, derivatives).

• They trade off against variance and risk parameter to solve this optimization problem.

• The choice of portfolio updates the returns that validators are accruing from staking, lending, and MEV.

Mev Bonus and Staking Dynamics

In this section, the speaker discusses the Mev bonus and how it can act as a way of bypassing problems associated with inflationary reward schedules or having to inflate tokens too much in order to secure the network. The speaker also talks about staking dynamics and how they depend on certain parameters.

Mev Bonus and Staking Dynamics

• The Mev bonus is any additional value that comes from the application layer, which is then redistributed back to validators in a pro-rata fashion relative to their portfolios.

• Validators receive rewards from inflation of the token, which are redistributed back to them proportional to their portfolios.

• Yield comes from lending protocols and depends on utilization. It is updated according to some risk-free rate at type T serve.

• Portfolio decisions of validators are analyzed by solving an optimization problem. The amount of Med redistributed back into the system affects incentives and helps avoid bad outcomes if not done.

Staking vs Other Sources of Returns

This section discusses how staking competes with other sources of returns like lending endurance or derivatives.

Staking vs Other Sources of Returns

• Staking competes with other sources of returns like lending endurance or derivatives. If there are no inflationary block reward schedules, all validators may move towards lending, leading to network security breakdown.

• Proof-of-stake protocols need to incentivize validators to keep staking and avoid looking for other sources of returns off-chain.

Using MEV Bonus as a Solution

In this section, the speaker discusses using MEV bonus as a solution to incentivize validators to keep staking and avoid looking for other sources of returns off-chain.

Using MEV Bonus as a Solution

• MEV bonus can act as a way of bypassing problems associated with inflationary reward schedules or having to inflate tokens too much in order to secure the network.

• The mathematical question is how these dynamics depend on the parameter Alpha and on the med extraction schedule queue.

• Med extraction schedule is dependent on lending yields, which are roughly correlated with liquidation rates.

Reward Schedule and Incentivizing Validators

This section discusses how reward schedules can incentivize validators to stake and maintain security in proof-of-stake protocols.

Redistributing Rewards as an Incentive Mechanism

• Reward schedules, such as constant inflation or deflationary rewards, can incentivize validators to stake.

• Redistributing application layer value collected by the protocol back to validators can reduce the requirements for necessary device validators to stake.

• Med redistribution sort can act as an incentive mechanism to prevent people from pulling their stake away from the network and incentivize good behavior.

Mechanics of Redistribution

• The mechanics of redistribution matter a ton. Validator pools that smooth out MBD rewards by paying out some proportion based on the amount staked can reduce variance in returns.

• Smoothing allows for predictable recurring revenues, which may cause validators to have less propensity to shift their portfolio allocations radically.

Future Directions for Redistribution Research

This section discusses future directions for research on redistribution mechanisms in proof-of-stake protocols.

Centralizing Tendencies of Redistribution

• A key problem is understanding what centralizing tendencies might arise from redistributing revenue back to validators. It's important to study this problem more.

Cooperative Game Theory of Validator Pools

• The cooperative game theory of validator pools is relatively understudied. It will be interesting to see how this redistribution affects people's propensity to participate in these pools.

Closed Loop Incentive Compatibility

• Can we prove closed loop incentive compatibility of this mechanism?

Improvement Stake Protocols

In this section, the speaker discusses how improvement stake protocols can help avoid inflationary reward schedules and make them better in certain environments. However, there is a risk of centralization and other game theoretic phenomena.

Economic Security Perspective

• Improvement stake protocols can help avoid bad inflationary reward schedules.

• These protocols can make reward schedules constant or deflationary in certain environments.

• However, there is a risk of centralization of validators.

• Off-chain agreements between validator pools or members of the validator pool to defect from redistribution may also occur.

Q&A

• The speaker ends the section by opening up for questions.