Op-ed: Proof of Stake – Meet the new inequality, same as the old inequality?

The following is a guest post from John deVadoss.

The promise of cryptoeconomics lies in its moon-shot ambition of creating new economic platforms, built on the aspirational ideas of decentralization and democratization and enabling inclusive and equitable governance models, thereby leveling the playing field for the common man.

We are at a decisive fork in the road for the industry, where most of the energy, as well as capital, is being prioritized towards Proof of Stake and staking, liquid staking, re-staking etc.  Let us take a quick look back at history and examine the implications of what this entails for the average Joe.

The History of Capital: Wealth vs Income

In old English the term “capital” appears to have been used as an adjective meaning “of or relating to the head.” It is derived from the Latin root capitalis, meaning “of the head”, and was used to symbolize head of cattle. For ages, cattle have been sources of wealth; both in the short-term milk-related products as well as in the longer-term accrual and growth to the herd.

In its journey from the pastures to the marketplace, the term “capital” began to be used to capture the near-term kinetic dimension of an asset as well its longer-term potential dimension in creating surplus value. In the vernacular, capital is conflated with money and money is too often confused for capital.

Capital may be tracked in monetary terms, and money may be used to facilitate capital transactions, but in and of itself money cannot and does not initiate additional production. In other words, capital is about return while money is mostly about liquidity,

Income is transient; wealth is enduring. But how does wealth endure and grow?

The Mystery of Capital: Growth vs Distribution

The Nobel prize winning economist Simon Kuznets was a pioneer in considering the relation between economic growth and the distribution of income and capital. Kuznets collected data on economic growth and income inequality in the USA, UK, and Germany. His hypothesis was that as countries develop and their GDP grows, inequality first rises, but then it peaks and begins to fall.

Early criticism of the so-called Kuznets Curve was directed at the small data sets that he observed, especially during a time period buffeted by a series of economic shocks – the Great Depression, the World Wars, as well as the onset of the Cold War. However, his theory was consistent with mainstream economics and provided a reassuring platform for accelerated growth.

It was left to the unconventional French economist Thomas Piketty for the definitive dismantling of the Kuznets curve orthodoxy. Piketty studied the evolution of income and capital inequality and collated extensive data, from the 18th century through to the 21st century. His analysis demonstrated conclusively that capital outpaces income; and that there was no decrease in inequality as economic growth matures.

As Piketty says, when he started investigating the theoretical models of economic growth, he realized that there was often very little real data involved in the creation and the project of these models. His judgment is that often economists spend too much time doing theory and too little time on data collection and analysis.

Piketty’s key ideas are the wealth-to-income ratio and the correlation of the rate of return on capital to the rate of nominal economic growth. Over the last two hundred years of data, the only significant weakening of capital’s economic share and the resulting decrease in economic inequality can be ascribed to the impact of the World Wars, which devastated capital.

From Piketty’s analysis, the mid-20th century era of falling inequality was an outlier, resulting largely from the burdens of multiple wars and the concomitant need for high taxation. His analysis demonstrates that, in the long run, inequality arises not from the gap between those who earn high incomes versus those that don’t, but between people who inherit large amounts of capital and those that don’t.

Talking of the concentration of capital, and its inheritance, leads one to the question: what is the distribution of capital in crypto-economic networks?

The Quandary of PoS: Decentralized Proof of Inequality

Proof-of-stake is posited as a way to attest that network participants have placed something of value into the network and which may the be penalized if their behavior is not in accordance with the rules laid down by the governors of the network. Participants receive rewards proportional to their stake for behavior that is concordant with the rules.

Typically, to participate in a PoS network, one must deposit a minimum amount of capital (the “stake”). If you have the capital, then you may play; if you don’t then you find one of a small number of increasingly (already) centralized validator cartels to pool your stake and to be rewarded.

For instance, in Ethereum‘s PoS model, validators stake capital in the form of ETH into a smart contract. The validator is then responsible for verifying that new blocks broadcast over the network are valid and may also choose to create and propagate new blocks of their own accord. If a validator tries to contravene the rules, then some or all of their stake may be penalized.

PoS ensures that capital produces revenue, which ought to put Adam Smith at ease, but, given that the base token holders are too often significantly concentrated, are we then witnessing the preamble of a digital quandary, between the low inequality that is required for systemic stability, and the high centralization reality of most early-stage crypto-networks ?

From the narrow confines of a Scope One emissions perspective, PoS may be seen as being superior to PoW; however, Piketty’s evidence-based insights foretell the inevitable economic crisis resulting from this digital decentralized inequality. Crypto-economists would do well to incorporate Piketty’s data-driven insights.