AO Economic Model: Time Value of Stake

Author: ArweaveOasis

The original article was first published on: @ArweaveOasis Twitter

Source: Content Guild - News

In the past month, the @aoTheComputer ecosystem has seen tremendous development, with continuous releases including Permaweb 1.0, AO White Paper/Tokenomics, and AI on AO, among other latest developments. And Tokenomics is undoubtedly the most followed content in the entire ecosystem. Since the development of AO Mint, more than $4 billion worth of $stETH assets have been stored in the AO network. The short-term TVL pump undoubtedly demonstrates the industry’s interest and confidence in this new distributed Supercomputer narrative.

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There is already a lot of written content about AO in the community, all written very well, so the author will not elaborate. Today, I would like to talk about the overall economic model after staking AO Token on the AO Mainnet and becoming various roles in the network. How to reflect the time value of stake? How to use these mechanisms to adjust the dynamic balance between roles in the network?

Security Foundations of Mainstream Blockchain

First, let’s compare it to the currently mainstream Blockchain.

The economic models used by blockchain networks such as Bitcoin, Ethereum, and Solana are generally based on the concept of purchasing scarce block space. Users pay money laundering to incentivize miners or validators to package their transactions into blocks and broadcast them to the entire network to complete the on-chain operation. However, this model fundamentally relies on the scarcity of block space to drive fee revenue, thus providing funds to incentivize the maintainers of network security (i.e., miners or validators).

The security architecture of BTC mainly relies on Block Reward and Money Laundering. Let’s assume a scenario where if the Block Reward is canceled and the transaction throughput is assumed to be infinitely expandable, then the scarcity of Block space will no longer exist, which will lead to a drastic decrease in Money Laundering. Therefore, the economic incentives for network participants to maintain security will also significantly decrease, undoubtedly bringing unprecedented challenges to the security of the entire network.

Solana’s primary Consensus Mechanism is a combination of PoH (Proof of History) and PoS. With the increase in network scalability, fee income decreases accordingly. In the absence of significant Money Laundering, the main source of security funds comes from Block Rewards, and the Block Rewards on Solana initially start at 8% inflation, decreasing by 15% per year until stabilizing at a long-term inflation target of 1.5%. This long-term inflation is essentially a tax on Tokenholders, representing operating expenses for holders who choose to stake their tokens, and gradual dilution of ownership proportion in the network for those who do not stake.

AO’s Security Resource Market Model

Like other block chains, whether a network can operate more securely and stably depends on providing a reasonable economic model for the overall security of the network to motivate participants to maintain the network for a long time. Contrary to the above examples, AO does not use a “one-size-fits-all” model, but rather introduces a new approach to the security resource marketplace model, allowing each user to purchase the specific level of security they need for each message. This model similarly allows users to purchase “insurance” for their messages to achieve the level of security deemed necessary by their counterparties, thus facilitating the customization and efficient allocation of security resources. This direct relationship between the security of message supply and user fee expenditure avoids the need to subsidize security through block rewards or collective fee negotiation mechanisms.

In addition, AO’s economic model creates a competitive market for network stake, which becomes the cornerstone of network security. Since security is purchased by messages, a dynamic stake market will emerge, and the security price will be determined by supply and demand, rather than rigid network rules. This market-driven approach promotes efficient pricing and allocation of security resources, providing powerful security tailored to users’ actual needs.

stake exclusive period

An important feature of the AO security framework is the implementation of the “stake exclusivity period”. This security mechanism allows the message recipient to specify a specific time window. During this exclusivity period, the staked assets will be locked and cannot be used for other purposes, ensuring that if the message is later found to be problematic, the staked assets can be slashed rather than subject to “double spending”.

This feature enhances the credibility of the transmission process by allowing the recipient to set a “stake exclusivity period” that meets its specific transaction security requirements. Stakeholders can also customize security measures based on the risk and value of the message. For critical or high-value messages, such as Block Trading in finance, a longer exclusivity period can be set to provide relevant parties with enough time for necessary challenges and verification; whereas for low-value messages, a shorter exclusivity period is sufficient. This arrangement not only enhances security, but also strengthens the integrity and flexibility of the message verification process.

Time Value of Stake

In the AO model, every message passed requires users to compensate ‘stake time value’ for the service provider, which is the opportunity cost of locking up capital for a specific period to ensure message security. This mechanism plays a critical role in determining the pricing dynamics within the AO system.

We will provide a 15-minute exclusive period of stake for a message that a user hopes to be valued at $1 million. The cost of ‘insuring’ this message - the time value of the stake payment - can be modeled as a function of the expected annual return rate that the staker anticipates. For example, if the staker expects an annual return rate of 10% on their invested capital, the cost of providing security for this message can be derived based on the proportion of the expected return during the exclusive period.

The formula for the price P that provides security for exclusive period E within a given unit (such as minutes or seconds, etc.) is as follows:

P=I*(R/Tan𝑛𝑢𝑎𝑙)*E

Among them:

I is the collateral value provided for this insurance.

R is the annual return rate expected by the pledger,

E is the exclusive period for staking

T_annual is the total number of time units considered within a year’s exclusive stake period (e.g., minutes as 525,600)

For a stake amount of 1 million US dollars with a 15-minute lock-up period and an expected return rate of 8%:

𝑃=$1,000,000⋅(0.08/525,600)⋅15=$2.28

In this example, the staker stakes $1 million worth of time value at a price of $2.28. The message receiver can choose their preferred ratio of excess stake and stake exclusivity period to effectively balance between risk and service access cost. Service providers can also flexibly customize their time value strategies for each valuable message.

This flexibility embodies the basic economic principle of the network: providing a customizable environment for users and services to adjust parameters such as collateral amount and time to meet the specific needs of their operations.

Supply and demand relationship in the stake market

The equilibrium of the AO stake market is influenced by the interaction between security demand (driven by the value of messages and exclusive time of mortgage) and the supply of stake capital (influenced by stakeholder return expectations).

Security stake requirements: can be expressed as a function of the transaction quantity Q and its average value overline{V}, adjusted by the average exclusive mortgage period overline{E}.

D=QVE/Tannual

This formula reflects the total capital demand for active average economic value stake in message security at any given time.

Capital Supply for Staking: Its economic utility S is modeled as the product of the total available stake amount K and the expected return rate R:

S=K⋅R

This equation reflects the total economic value that stake capital hopes to generate in a year. Where K represents the number of AO Tokens actively input into securing the network security (because all stakes require AO Tokens to complete), and R is the annualized expected return rate of these stake tokens.

When the pledging market is balanced, D=S, that is, supply and demand reach a balanced matching state. The above formula can also be transformed into:

Q·V·E/Tan = K·R

To solve for the required yield R, we can balance the supply and demand relationship of stake utility, and obtain:

R=QVE/K*Tannual

This formula calculates the equilibrium rate of return R. If the calculated R is higher than the current market rate of return, it indicates that the stake capital is relatively insufficient for safety requirements. Therefore, there will be more capital flowing into stake, and the K value will increase until a new equilibrium is reached. Conversely, if R is lower than the market rate of return, it indicates an excess of stake capital, and some stakeholders will withdraw funds, thereby reducing the K value until equilibrium is restored.

Based on the above analysis, we can have a detailed understanding of the future economic model of AO Network in terms of Token stake. It can be said that this new customizable secure resource allocation model makes the overall network more flexible and scalable.

The decentralized peer-to-peer market structure of the AO network essentially allows Nodes to independently set the cost of their stake messaging services, without enforcing global pricing. This flexibility enables them to dynamically adjust to market demand and supply changes, promote competition, and improve response speed. Nodes offering competitive rates and terms will naturally attract more long users, optimize their returns, and lead to efficient market equilibrium.

This mechanism promotes market efficiency while laying the foundation for a clear Token valuation indicator. By analyzing the number and value of secured messages, as well as competitive returns, a comprehensive real-time Token valuation framework is established, which depends on network security, utility, and demand.