The Dash blockchain was the pioneer of the Masternode trend. But due to its innovative nature and utility, more cryptocurrencies have adopted the technology. But what exactly are masternodes?
What are Masternodes?
Masternodes refer to servers on a digital currency blockchain that offer specific specialized services for the network. They are also referred to as Bonded Validator Systems and carry out the functions that miners are not able to accomplish.
On the Dash ecosystem, there is the underlying proof of work algorithm operated by miners to support the network. But in addition to this, there is a second tier algorithm referred to as proof of service which comprises the masternodes.
The two operate symbiotically to provide maintenance services on the network. The masternode tier on the Dash network was built specifically to provide anonymization services to users requiring high level privacy in their transactions. It also allows instant transactions within the network.
This was only the first of many digital currencies to implement the system. Subsequent adopters have come up with numerous other applications for the concept using the same basic principles.
How Do Masternodes Work?
Masternodes require operators to stake a specific amount of the network’s currency in a digital wallet. On the Dash network for instance, if you wish to create a masternode, you would need to stake 1,000 DASH.
After getting hold of the required coins, you need to download the core wallet for the network in question. The next step is to use the wallet to create a masternode. This requires that you set your PC up as a server and the wallet will do the rest, integrating your computer into the network as a constituent node supporting its blockchain. Another viable alternative is to use third party server hosting services at a fee.
A crucial point to note is that in addition to staking the required amount of currency and setting up a server, every blockchain has its own set of rules governing the operation of masternodes. If at all an operator fails to live up to these requirements or removes the staked currency, the masternode ceases to function.
Functions and Benefits of Masternodes
Apart from the provision of instant transactions and anonymization mentioned above, masternodes also offer the following services:
- A decentralized governance system on which node operators can make proposals and cast votes on the blockchain’s development (BOScoin)
- A decentralized budgeting system
- A security system protecting a blockchain from network attack
- Compensatory services for limitations in Proof of Work
- A support system for currency exchange platforms by providing oversight and facilitating trading (Escudo, Blocknet)
- Decentralized Ecommerce platforms that offer peer-to-peer marketplaces and instant payment options using blockchain technology (Syscoin)
The main benefits of operating masternodes include:
Dash masternode operators are compensated 45% of the network’s block rewards. Miners also get an equal amount and the remaining 10% is allocated to the network’s treasury for development agendas.
This incentive structure differs from model to model but does not take much to realize apart from the initial capital staked. But the Return on Investment (ROI) also varies from one network to another depending on the number of masternodes in operation.
The payout periods also vary on the different networks offering the feature. Some pay out on daily basis, others several times a day while others still choose weekly or monthly options. Considering that the exercise does not require costly mining equipment, it is quite a reasonable investment.
The amount of money required for staking plays a crucial role in keeping a blockchain decentralized. It is set to be deliberately high so as to prevent monopolization of a network’s nodes. It would be extremely costly to stake enough of a network’s currency to have a majority control over its nodes.
Another important role that this high cost plays is that it encourages honesty from operators. Staking so much money keeps them from shifting from one network to the next depending on profitability. It acts as a sort of security whereby if an operator wants to earn from the high investment they have to live up to their end of the bargain.
The ROI potential of working as an operator and the high investment amount is a clever way of keeping mischief to a minimum.
Masternodes vs. Staking
Staking is also referred to as Proof of Stake and is considered another viable way to earn a passive income on crypto networks. It involves locking up digital currency in a wallet for a specified period of time.
Doing this will earn you the reward of additional coins to your wallet. On certain cryptocurrency networks, you have to keep your computer on and the crypto wallet open so as to get the rewards. But in others like NE, simply having coins in the wallet suffices to generate rewards even with your wallet and PC off.
Compared to masternodes, this is an easier way to earn an income as it does not require any technical knowledge (setting up a server), hardware investment or additional input on your part. The only requirement is to have a wallet and hold your coins.
However, the masternode mostly offers a better reward rate than staking. Additionally, the ROI is predictable as it can be calculated from available data. It also offers the opportunity to participate in a network’s decision-making.
Masternodes vs. Mining
Mining is one of the oldest methods of making money from the cryptocurrency industry. It basically involves solving advanced mathematical puzzles so as to generate new blocks and add to a network’s blockchain. It also involves verifying transactions carried out within the network.
It is in most cases based on a consensus method referred to as Proof of Work where miners get rewards in exchange for their contributions to solving the problems. While it was relatively simple in the early days and could be carried out using a regular PC, increasing mining difficulty requires advanced hardware if at all it is to be successful.
The process also consumes a lot of electric energy. This means that in order to earn from mining, you need to factor in the equipment and energy consumption costs. It also takes time as it is an ongoing competition to see who solves the puzzle first.
Compared to masternodes, mining is a lot more capital intensive, time-consuming and taxing. But the stake that operators have to put up to set up masternodes is also considerable. Overall however, running a masternode seems a lot less involving than mining cryptos.
The Future of Masternodes
The long-term application of masternodes is still highly speculative. But at the moment, the role they play on the blockchain ecosystem is crucial. At the moment, they are still a highly viable investment opportunity.