Aligning Incentives through EOS Block Producer (BP) Reward Deferrals
Two key concerns surrounding the EOS mainnet are 1) the perceived inequity in Top 21 BP representation due to vote buying and/or trading among registered Block Producers, and 2) as a result, the potential adverse effects of “BP freeloading” and short-termism at the expense of the long-term health of the blockchain.
Incentives are tools to drive behaviors. Currently, EOS’ BP reward system is overwhelmingly short-term in focus, where vote and block rewards may be claimed daily without any coded restrictions on transfer or sale. While logical and harmless at first glance, the system’s short-term focus has fostered and continues to exacerbate these key concerns today.
EOS has been referred to by some in the community as a Decentralized Autonomous Corporation, a play on the more popularized term Decentralization Autonomous Organization. The comparison is relevant on many levels, but the most apparent are: 1) both BPs and corporate board members are elected by tokenholder or shareholder vote, 2) BPs, board members and executive management each receive rewards or compensation for their time, experience and expertise, and 3) BPs, board members and executives each have a powerful role as fiduciaries of their respective entities, as well as a duty of stewardship to facilitate organizational growth in value for the stakeholders (regardless of your definition of “value”).
However, when it comes to remuneration, one of the key differences between BP rewards earned on EOS and corporate compensation is what’s known in the “industry” as pay time horizon. Simply put, this refers to the weighted average duration an executive or board member must wait to receive all compensation associated with performing their positional duties. Typically, for executives, this duration ranges anywhere from 1 to 4+ years, although there is some variation based on the company and situation. Base salary and cash-based bonuses are typically short-term in nature and earned over the course of one year, but long-term incentives (which are usually equity or phantom equity awards) are earned over multi-year timeframes before they become fully vested and income is realized. For senior executives, long-term incentives often comprise 40% to 80% of the total compensation package, bringing the need for sustained long-term value creation into razor sharp focus for executives whose livelihoods depend on it, and in the process creating greater alignment with shareholder interests.
Based on the foregoing, and the threat that vote-buying and BP freeloading pose to the long-term development and optimization of the EOS blockchain, I am proposing a shift in time horizon to the BP block reward schedule to further align Block Producer, tokenholder and mainnet interests.
The alignment of interests among key EOS stakeholders could be greatly enhanced with the addition of two relatively simple (from a non-technical standpoint) features when compared with the complexity and uncertainty associated with other proposals seen to-date, including 1token:1 vote and/or those involving the establishment of on-chain biometric IDs:
1. Coded BP Block Reward Deferrals
Mandatory deferral of 60% to 80% of daily block rewards earned by Top 21 BPs into a separate EOS deferral account. Each registered Block Producer would have their own EOS block reward deferral account to which only they have the keys. Deferrals of block rewards into this account are automatic and, once deferred EOS tokens (DEOS) enter the account, they are locked, become non-voting and are non-transferable per a predetermined vesting schedule.
2. Deferral Vesting
Once transferred, DEOS are subject to vesting conditions before the are unlocked and are without restrictions on voting, transfer or sale by the BP. The vesting schedule may vary but could reasonably be up to 36 months (or longer). To soften the impact on BP budgeting in the short-term, a phased vesting schedule of 12 months during year 1 after implementation, 24 months during year 2, and 36 months during year 3 (and thereafter) may be appropriate.
These simple design adjustments to the incentive time horizon will support the following outcomes:
1. All else equal, BPs’ near-term ability to buy votes and the relative impact of vote trading is reduced. It also disincentives vote sellers who will be less able to command the same fee for votes
– If we assume EOS tokens are the vote trading currency, and that there is some fixed cost of BP operations, reducing short-term EOS earnings for limits the ability for BPs to operate, pay for votes AND be profitable in the short-term. All else equal, the capacity to buy votes among aspiring (or incumbent) Top 21 BPs diminishes over during the initial three-year deferral period. From a vote seller’s perspective, selling votes is disincentivized since the theoretical maximum fee they can command in the short-term is reduced.
2. Irrespective of its effects on vote-buying/trading, deferral of block rewards provides greater assurance to those in the community that Top 21 BPs’ focus is truly long-term in nature, and that decisions made today are in the best interests of stakeholders in the future
– Deferred vesting acts as a counterweight to decisions made for short-term gain. A longer incentive time horizon fosters a much greater sense of care and accountability for our collective actions today. For example, major BPs in the ecosystem, including those who partake in vote buying/trading or those who simply watch it go on, will likely spend more time considering whether it’s worth the potential long-term reputational harm to EOS given that a meaningful portion of their income is tied to a future token price. If nothing else, a balancing of the the incentive time horizon will force BPs to “show their hand” in terms what they think will be most beneficial for the long-term success of the EOS blockchain.
3. There will be a continued focus on healthy BP competition and outperformance
– The incremental increase in compensation as a Top 21 versus Standby BP would remain significant, and so the incentive to outperform in the near-term would remain strong. And, good work today supports value creation in the future which, in turn, drives future income. Moreover, while compensation is deferred, it is not lost — assuming a resale market for the tokens exists in the future, the discounted present value of future deferred rewards should always be a non-zero amount
The analysis above is based on approximate current BP earnings for the top 35 EOS BPs. Certain key parameters, such as a deferral percentage, vesting scheduled and future token price are illustrative but necessary for presentation purposes.
The proposed adjustments to the BP block reward schedule are simple in design but would be powerful in practice. While the precise parameters around deferral can be debated, and BPs are asked to trade-off short-term compensation for a more assured mainnet in the long-term, the concept of stronger alignment between stewards of the network and long-term value creation for stakeholders is undeniably compelling.
There is no single “silver bullet” solution to the issues discussed in this article; rather, this proposal should be one of several targeted and strategic tweaks to the incentive system over time that have reasonably assured outcomes. I believe other proposals, including those involving 1 token:1 vote and on-chain biometric IDs, come with much greater uncertainty and unpredictably — something which I’m keen to avoid.
With more skin in the game, BPs at both ends of the spectrum will be driven to “think twice,” not only due to the shift in reward economics and the ability to buy votes, but because their actions today affect their earnings tomorrow. Only by recalibrating the incentive system can we shift BPs, tokenholders and dApp users into much greater alignment, and in doing so ensure a much healthier and secure EOS mainnet in the future.
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About BlockchainKid: I am a long-time EOS supporter and advocate for decentralized technologies. As a compensation and corporate governance consultant, I regularly consult with private and publicly-traded companies on items such as executive pay and incentives, compensation risk, shareholder rights and board structure, and help them ensure compliance with (or an understanding of) disclosure and governance best practices enforced (or encouraged) by the Securities Exchange Commission (SEC), Institutional Shareholder Services (ISS) and Glass Lewis. Contact me on Telegram @theblockchainkid