Master Nodes are equal parts craze, myth & hope. When you hear a person talk about Master Nodes, there is never a middle ground. They seem to divide opinions into for or against.
Here we are trying to unwind the myth that surrounds this interesting topic & hopefully, for those of us who never went down rabbit hole, this can act as a trusted map that is handy at all times.
Where do Master Nodes fit in the Blockchain Ecosystem?
Blockchain system consists of several computers, called nodes, across the world sharing a common ledger of data that they all agree on.
The data that goes into the ledger is structured in blocks & the method of how the computers agree to add the blocks is called a consensus mechanism.
Consensus methods are varied. The work that Nodes put in help make that Blockchain stay secured & to process the transactions. The nodes incur a cost in doing so. After all, nodes are computers running full speed to provide maximum network capacity to the blockchain. And computers need electricity and maintenance. Both can be expensive. Computer moving parts need to be replaced very frequently if nodes are running 24x7. The latest security suites must be installed to protect the computer itself against malicious actors trying to take control of the node. It may appear to be slightly hostile & harsh. But the reason that the nodes are taking all of these risks is ofcourse to be incentivised / rewarded by the community that benefits from experiencing a smooth, fast & full feature blockchain. These rewards are called various names depending on the consensus mechanism that the node is utilising to stay synchronised with the rest of the blockchain nodes. Let’s term them Node Rewards until we quickly look at a couple of consensus mechanisms.
Consensus Mechanisms
Of the numerous types of possible consensus mechanisms, there are 2 mostly widely quoted / adopted — Proof of Work & Proof of Stake.
The nomenclature gives away the difference.
Proof of Work (POW) :
Nodes are pressed into solving a cryptographically secured mathematical problem. Since it is relatively difficult to unpick the lock by brute force (trying out all possible combinations), it is a race for time between the nodes to solve the puzzle & claim the reward.
The process of solving this puzzle is called mining.
Whenever a new block is mined, the miner that solved it first gets a reward (Block reward, transaction fees). This incentivises the miners to keep mining. At the same time, the complexity of the mathematical problem in juxtaposition to the limited availability of computing power prevents cheating / malintent.
To gain control of the entire network, would need the majority of the nodes to be controlled, ie about 51% of the network.
Attacking the network will call for an enormous amount of coordination, energy, hardware (& loss of mining rewards in the interim). Such a massive scale of resources are very challenging to marshall, though not improbable.
Therefore, the blockchains that use proof of work are secured by complexity, scale & distribution. The nodes that mine are rewarded for their contributions by mining rewards (Block rewards & transaction fees)
An example of a Blockchain that uses POW Consensus mechanism is Bitcoin.
Proof of Stake (POS):
Proof of Stake replaces the necessity of massive energy consumption & computational power with stake.
The Merriam-Webster dictionary defines Stake as :
a : something that is staked for gain or loss
b : the prize in a contest
: an interest or share in an undertaking or enterprise
Stake refers to the amount of currency (native to that particular blockchain) which the individual is willing to lock up for a certain amount of time. The incentive for such involvement is that the chances of being able to decide on the next block to be mined are proportional to the stake. The higher the stake the greater the chances of deciding the next block, and hence greater the probability of reward
The larger the coins being staked, the greater the reward probability.
Imagine an analogy of a bank savings account. The larger the deposited cash, the greater the interest accrued. Or an Equity share dividend.
The Node rewards under POW & POS can now be referred to as Mining Rewards or Staking Rewards.
Drawbacks exist for both POW & POS mechanisms
The most often quoted drawback of POW is that it is resource intensive & environmentally unfriendly (electricity consumption)
The most often drawback of POS is that it flips the spirit of the Blockchain community on its head & turns it into a rich person’s game & closely followed by the associated rich person’s attempt to hijack the network by buying out 51% of the nodes.
A counterpoint to the rich person’s argument is that with the emergence of the pool system, an individual can jointly participate with others to purchase a node
Master Nodes
So what then are Master Nodes?
Master Nodes are nodes but with additional responsibilities of a network function at the cost of requiring a very large amount of coins but with the incentive of being granted even better dividends/rewards than the usual staking / mining route.
Contrary to popular belief, Master Nodes are not exclusive to just the POS systems. MasterNodes can equally work in the POW system and there are many POW coins that implement Masternode hierarchy.
Functionally, running a Master Node is similar to staking.
Owning a master node allows generation of Passive income as the rewards are generated for having coins in the wallet. This is a space full of opportunity but also pitfalls. Despite what an amateur investor may hear from a coin promoter that it is as simple as switching on a masternode & watch the wallet fill up, seasoned experts opine that it is hardly the case.
Despite the confusion that can be caused by the vast landscape of MasterNodes, the overarching feature that characterise them are :
- Locking of a minimum number of coins
- Performing certain tasks within the blockchain / ecosystem
- Receiving a reward
Quote : Anonymous
Staking (when done right) is a magical user experience.
1. Participate in consensus2. Secure the network3. Make money 👏💸👏💸👏💸
How much return do Master Nodes generate?
A look at the masternodes.online website reveals the below
(Website : www.masternodes.online)
There are 463 Master Node Coins listed on the website with 235,554 Master Nodes participating having staked more than US$ 1 Billion.
The market cap is US$ 2.25 Billion & the DASH coin dominates it similar to how Bitcoin dominates Cryptocurrencies
A detailed list of the coins are available further down the page.
Each masternode coin is detailed with its individual price, volume, Market Cap, Return of Investment, # of nodes, and # coins required to stake
(Website : www.masternodes.online)
Usually when a coin with Master Node system is launched, most of the coin holders in the initial days are likely to be Master Node stakers. And this directly contributes to the coin inflation issue.
At a simple level, the ROI is calculated as (MN rewards per Node / Master Node collateral)*100
Using simple logic from this formula, it is easy to arrive at a conclusion that ROI will go down as increasing number of MasterNodes join the Network
The ROI can range from a few percentage points to well into the tens of thousands of percent. ROI is, with all things being equal, a snapshot measurement of your return on investment over the next 1 year (365 days).
As a team creates a Master Node coin, they usually do a pre-sale/ICO to raise money. The team then applied for listing the coin on an exchange.
With a limited number of nodes initially, the rewards will be high & ROI will skyrocket. This causes the coin to be noticed by return hungry traders / investors. They quickly jump in with an aim to make as much returns as possible. As rewards roll in & initial expenses are covered, Master Node holders sell some of their coins to buy more nodes.
The team thinks that it is a success as more investors keep joining the network.
The price increase tapers off. Early investors will seek to sell their newly minted coins to avoid losses. These sell orders set off a resultant downward spiral where price dips. This results in increased selling by investors to ensure they avoid losses. And this sell pressure leads to another drop etc. The team wonders where it went wrong. They realise it is Hyperinflation! Reward structures / incentives are hastily changed to make the system more sustainable. But the damage was long done. Excess supply set off a chain reaction that the coin pass on to the sell side. The demand moves on to better alternatives in the market.
HyperInflation
Inflation is merely supply of the coin. As explained earlier, In a constant supply scenario, the high ROI caused an influx of new investors which cause new coins to be implemented. As the cycle of coin creation (supply) increases exponentially, the inflation in the system grows proportionately.
Let us pick an example to understand Hyperinflation.
In an instance where a master node coin has a market cap of 5million. Assume rewards of 120% per year with about 80% of the coins locked up in Master nodes.
This leads to an effective annual inflation of 96%. Divided into 12 months of a year gives 8% inflation rate per month.
8% of 5 million is 400k. This means that a fresh influx of US$ 400,000 is needed every month to just keep the prices within the system ‘stable’. If lesser amount of money enters the system, the coin price starts to fall.
It is unrealistic that a project will continue to attract US$ 400,000 every month as more Master Nodes are launched. Devaluation will begin to kick in with full effect sooner or later
So how does one choose which coin to invest in?
It is a daunting sight to be presented with over 400 masternode coins, the promise of 10000% ROI & to be in complete control of the purse strings at the same time. Many a newbie has succumbed to the lure of stellar returns, only to be burnt.
A massively high ROI doesn’t mean a good annual return. A high ROI is guaranteed to cause super high inflation and erode any meaningful gains. It is more than likely that the price will tank & soon the coin will become a ghost town.
The trusted way to mitigate risk is to look for some real world controls such as:
- Team: Who is behind the coin? Is the team experienced? Are they solvent? Who are the founders? Have they any prior experience running such a operation? If yes, What happened to their previous project? Are the team active & openly communicative? Try & ascertain that this is not a Pump & Dump operation. Participate in Reddit & telegram community conversations to keep yourself updated about the latest information.
- Make sure a coin is Master Node supported. However, if the coin announces that they will support Master Nodes after they start trading, the coin’s price will shoot up extremely high as investors will scramble to get Master Nodes set up. This in turn causes a drop in ROI
- Study how the coin facilitates the Master Node: A Master Node may provide better yield when mined in conjunction than compared to just mining or just running a masternode
- ROI: It is not the sole determinant of a successful investment & is extremely hard to calculate accurately. Yields & prices are always in a constant flux.
- Liquidity : Find out which exchanges, the coin is going to be listed / is trading. Masternode Coins usually seek out non-Premium Exchanges. Popular within the Masternode Community are Graviex, Cryptopia & CryptoBridge. The liquidity on these exchanges are not so encouraging.
- Wallet : Make sure that the wallet being provided is safe & has a functional user interface. With master node coins, the wallet interfaces leave a lot to be desired. But never compromise on the security aspect. Wallets of lesser known coins can be sometimes laced with viruses. If you must down load such a wallet, always scrub the file for virus / malware. If possible, run them in a sandbox / virtual machines where possible.
- The crux of Master Node investment is to find a coin before it goes big. Dash Master Node, when they first launched in 2015, cost about US$ 3000 & is today valued more than US$ 200,000 (basis price US$200 in September 2018).
A special mention about DASH
Being one of the top 10 Cryptocurrency by Market Capitalisation (aprx US$ 1.62 Billion as of Mid September 2018 — source CoinmarketCap.com), DASH deserves special mention in the context of this article. It is the only consistently featuring top 10 coins (by market cap) to operate a MasterNode system.
A master node on the DASH network performs tasks such as ‘Private Send’ & ‘Instant Send’. A vast majority of the master node coins operating today had at some point forked off from DASH.
So if a new coin is trying to market ‘Private send’ & ‘Instant send’ as a feature, please discount it as it is already inbuilt into the DASH network & not a new feature developed by the new network
Good Practices
- Always ask yourself if you would invest in the coin even in the absence of Master Nodes. Do you see a fundamental reason behind the coin’s existence. Is it solving some crucial issue in the ecosystem? Is there any flaw in the basis of the coin’s use case?
- Staking & Master Node coins usually involve Hot Wallets. If you are a newbie, please read up as much as you can about Wallet Security prior committing any funds. Ask, Ask, Ask.
- Look to balance Long term sustainable value with returns.
Mistakes to avoid
- Buying at inflated prices. This is one of the easiest ways that can lead to a loss. It could mean that the horse has already bolted & the market is scrambling to buy masternodes. If the going price for a masternode is skyhigh, take it as a signal that it needs further investigation. Do not purchase/invest unless you have done further research.
- Ignoring Inflation : This has been discussed many times here but the only direction that your investment can go after investing in coins with 5 digit ROI is DOWN
- FOMO: See that ad about getting your original investment back in 14 days? Read #1 (Buying at inflated prices)
Further research / information:
www.Masternodes.online — General Trends for MasterNode coins, rewards & statsBitcointalk — Tons of forums to research about MasternodesTelegram — Lots of conversation in Master Node Groups
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Disclaimer: Nothing in this article constitutes or is intended to constitute financial advice. This is not an investment document. Please do your own research (DYOR) prior making any investments. There are no affiliations with any project mentioned in this article
Written by: Suraz Kottakki & Dr. Joel Palathinkal
Finally, a word about Genesis Block Holdings:
Genesis Block Holdings is a blockchain venture capital firm, crypto quant hedge fund, and mining company focused on investing in blockchain projects within the ecosystem. We are laser focused on bringing the power of capital, network, and expertise to frontier technology teams to solve the world’s biggest problems