Calculation mechanism of APR — explanation about staking reward resulted from network inflation
When staking cryptocurrency assets, APR(Annual Percentage Rate) is one of the most crucial factors to consider for optimal efficiency. Staking reward comprehensively includes income from inflation and transaction fee distribution. In this article, Cosmostation explains the mechanism of APR: the inflation income of staking profit. In order to fully explicate the mechanism, we will demonstrate the concepts of annual provision, bonded tokens ratio and the differences between nominal and actual APR.
In staking crypto-currency, users are always keen to the most secure, efficient, highest-income-guaranteed investment route. APR, Annual Percentage Rate, is the most intuitive, important key element in staking because it presents how much interest a user would receive for the bonded asset in one year.
Simply put, your staking APR is calculated as below:
[Inflation * (1-Community Tax)] / Bonded Tokens Ratio
As simple as that! Now we have this formula, let’s look into the details.
To fully understand the calculation of APR, we first need to understand what annual provision and inflation are. Shortly put, annual provision is the number of blocks increased on a blockchain in one year.
Annual Provision = (Current Total Supply) * (Inflation Rate)
Annual inflation rate is the ratio of the amount of blocks increased in one year to the year before’s total block supply. The inflation rate reacts to the status of bonded tokens ratio, which means that the inflation rate is constantly changing without being noticed.
Some chains like Sifchain and Osmosis do not directly show you the annual inflation rate through on-chain params, however if we have the total supply and annual provision, we can derive the inflation rate with simple division calculation.
According to the inflation rate, the number of blocks to be provided in one year is decided: annual provision. Let’s say the current supply of a token is 1000 and the inflation rate is 10%, then the annual provision would be 100 tokens. These 100 tokens are distributed to the staking users as reward, accordingly to the bonded tokens ratio of the network. Basically, in staking APR, the inflation-driven interest is distributed from the annual block provision to staking users.
Now that we have inflation & annual provision in our hands, there are community tax and bonded tokens ratio. Community tax, in most cases, is relatively small, for example: 2% (it’s not much, but it’s an honest contribution to the community).
Then we have to take the bonded tokens ratio into our consideration since the reward is only given to those who actively staked their assets, and not to those who did not. The bonded tokens ratio can be simply calculated: bonded tokens divided by total supply. For example, if 800 tokens out of 1000 total tokens are bonded, the bonded tokens ratio would be 80%. However we should take note that in real life, the total supply is always bigger than the sum of bonded and unbonded assets since there are certain assets that are not taken into calculation such as: community pool and managing module account(governance).
Some of you may have wondered why the actual incoming staking rewards are not as much as the calculated result with intuitively shown APR . Here’s the reason why:
What we’ve discussed above is how the “nominal” APR is calculated, theoretically. On the other hand, there are a couple more things behind the scene that we have to take into consideration for the calculation of actual APR.
Actual Staking APR = (Nominal APR) * [(Actual Annual Provision) / (Annual Provision)]
First, the block-minting speed. The actual observed speed of blocks being minted can be slower than the estimated/predicted value(annual provision) due to the uncertainty of network’s operability: for example, Persistence($XPRT) aims to mint 6,311,520 blocks per year, which indicates that the minting speed per block is supposed to be ~4.99 seconds. In reality, the average block time, as shown on https://explorer.persistence.one/, is about 5.67 sec/block. There are several explainable reasons for the delay: the network might decide to update their mainnet which results in temporary halt in the minting cycle, etc.
Final Staking APR = (Actual Staking APR) * (1-Validator’s commission)
Secondly, don’t forget about the validator’s commission. Whichever APR you have: nominal or actual, multiply (1-validator’s commission) for the final actual staking APR. Validators offer variety of commission rates, so users are able to select their preferred validators for an optimized portfolio.
Summary
To sum up, the APR briefly shows how much the interest will be in staking. The actual APR is slightly lower than the nominal APR shown, since there are other factors to be considered such as community tax, bonded tokens ratio and validator’s commission fee.
However, as mentioned earlier, the APR calculation above only considers the inflation factor on a blockchain, therefore the total profit a user gets could be higher than the actual APR’s prediction when the transaction fee of the network is distributed.
Cosmostation is an enterprise-level validator node infrastructure & end-user application provider based in Seoul, South Korea. Cosmostation runs validator nodes across several networks, specifically focused on networks built with Tendermint & Cosmos SDK. Along with node operation, Cosmostation develops and maintains Mintscan Block Explorer for Tendermint-powered networks and Cosmostation iOS, Android, Web Wallets to support in-depth features for modules specific to each network.
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