TL/DR

This article explores the role of Solana validators, detailing their contribution to network security, governance, and ecosystem support, alongside the economic aspects of being a validator, including costs and revenue sources. It discusses the operational challenges faced by validators, such as high costs and the need for continuous performance optimization. Additionally, the significance of liquid staking pools and the criteria for attracting delegations from these pools are highlighted, pointing towards the importance of validators in maintaining a secure, efficient, and decentralized blockchain environment.

Introduction

Solana is a high-performance blockchain platform designed to host decentralized, scalable applications, including finance, NFTs, payments, and gaming. Solana is with striking resemblances to Ethereum—in fact, it’s frequently referred to as an “Ethereum killer.” Solana operates as a single global state machine and is open, interoperable, and decentralized.

Solana’s co-founder, Anatoly Yakovenko first proposed this innovative idea in 2017 and launched Solana in March 2020. Yakavenko has a background in building cell phone networks. He and other co-founders believe that for people to build projects that will get the public using blockchain technology, they need to make it energy efficient, lightning fast, and extremely inexpensive.

What Makes Solana Unique?

Solana enhances scalability and throughput in blockchain technology by integrating proof-of-history (PoH) with proof-of-stake (PoS) in its consensus mechanism. PoH allows validators to agree on transaction order and timing, enabling simultaneous processing and significantly boosting transaction capacity.

This architecture supports parallel processing, where transactions are confirmed concurrently across different network shards, facilitated by PoH for maintaining transaction order. Rapid confirmation times are achieved by timestamping transactions before block inclusion, speeding up consensus on transaction orders, and reducing confirmation time.

Additionally, Solana's approach contributes to lower transaction costs due to high throughput and efficient resource utilization, allowing it to handle increased demand without significant congestion. Using a Delegated PoS (DPoS) consensus further optimizes network efficiency and scalability, ensuring a limited number of elected validators produce blocks, thereby enhancing overall network performance.

Understanding Validators in the Solana Network

What are validators?

Solana Validators keep track of all accounts on the Solana cluster and validate transactions being added to the network. Without validators, Solana would not be able to function. The current number of validators on mainnet is 1,638 and the staking APY is about 7%.

Validators contribute to the Solana blockchain in the following ways:

Network security: By operating autonomously, validators play a vital role in enhancing the decentralization of the Solana network, eliminating any single point of failure or control within the ecosystem. Their independent operation is essential for the network's resilience and security, aiding in the prevention of attacks and upholding the blockchain's security.

On-chain Governance: Validators play a special role in the governance system. Being the pillars of the system, they are required to vote on every proposal. It is essential since delegators who do not vote will inherit the vote of their validator.
Ecosystem: Solana Validators are rewarded with transaction fees and protocol-based rewards. Besides, many Solana validators also provide RPC service to users who want to interact with the Solana blockchain. This essential infrastructure support makes the ecosystem more robust and user-friendly.

Becoming a Solana Validator

Operating a validator is an interesting and rewarding task. It demands technical expertise as well as involvement in community engagement and marketing activities. Here is a list of some of the requirements for being a good operator:

Hardware: Validator operators need to have reliable computer hardware and a fast internet connection. You can find a list of hardware requirements here. Solana helps facilitate data-center server rentals through the Solana server program
Validator Operation and Monitor: As a validator operator, your daily responsibilities include overseeing your server, routinely updating software (this includes both the Solana validator software and the Ubuntu software), and administering your stake and identity accounts. Mastering these tasks is essential. It's important to avoid inadvertently causing an extended downtime of your validator while it operates on the mainnet.
Security: To ensure the security of your validator, operators must adhere to the operating system's security protocols and safeguard the validator's keys. It’s recommended to store keys in cold storage like a hardware wallet.
SOL Holding: Validators must also stake Solana tokens (SOL) as a form of security and investment in the network’s well-being. The more tokens you hold, the more likely you are to be chosen as a validator.

Solana Validator Economics

Cost

Voting Transaction Cost

Solana’s consensus mechanism relies on vote transactions to achieve consensus. Vote transactions live within a block but are prioritized so as not to be drowned out by regular transactions. But the votes themselves cost the same as any other transaction. Each vote transaction costs about 0.000006 SOL,

According to the doc, an epoch is 432,000 slots, each of which should at a minimum take 400ms. As a result, every validator has to spend up to 2.6 SOL every epoch. Given that block times are variable and epochs take between 2 to 3 days, it costs roughly 378 SOL a year or just a little over 1 SOL a day. At the current price rate, it costs ~$100/day

Server Costs

Validator operators, depending on the data center you are using, expect to spend ~500 USD a month on their primary server. One popular offering that ~14% of Solana validators use is Latitude’s bare metal offering, which starts at $373/month. Latitude’s c3 large costs anywhere between $373-$638 per month, depending on the region, with the following specifications (not including data egress costs):

Bandwidth Costs

Solana Validation is very bandwidth intensive and data centers that charge by the gigabyte of in and out traffic are likely to get expensive quickly. It is recommended that you consider bandwidth costs as well as server costs when choosing a data center provider.

Solana Validation is required to have 1 GB of network bandwidth and 100% uptime to maximize data throughput and minimize a validator’s skip rate. Bandwidth costs are the next significant challenge for validator operators. Bandwidth is often priced as a variable cost, but the specifics would depend on one’s internet service provider.

Like most providers, Latitude does not charge for any marginal ingress cost. Instead, they charge per TB on egress on the order of $0.64 - $3.60 per TB, depending on the region.

By comparison, AWS egress costs can be over $70 per TB, depending on the area and usage. Estimating egress data bandwidth cost is also dependent on the amount of stake. This is because higher stake weight means being the slot leader more often, resulting in more data to propagate and more transactions to forward.

Opportunity Cost of Capital and Resources

When someone delegates their SOL to a validator, they are essentially using their capital to secure the network. However, this means that they are also giving up the opportunity to earn other rewards, both inside and outside the cryptocurrency ecosystem.

In addition to voting costs and server rental, validators must also consider the opportunity cost of capital when staking. To make sure that their validator continues to perform well, validators need to spend time and resources on monitoring its uptime and skip rate. This is a time-consuming process that is often a full-time occupation for the most active contributors to the ecosystem. When evaluating the profitability of staking, it's important to consider other relevant metrics such as the risk-free rate on the US dollar and other crypto networks' staking APYs.

Revenue

There are four sources of revenue for a validator.

Staking Inflation Rewards

Solana uses inflation to pay staking rewards, this means new SOL is created every epoch. Inflation was first activated on mainnet-beta at the start of 2021 at a rate of 8%, decreasing at a rate of 15% per year (that’s 15% of 8%) until it will eventually settle at a terminal rate of 1.5%.

Solana uses inflation as a means of compensating validators and delegators, which leads to the creation of fresh SOL tokens every epoch. Inflation was introduced on mainnet-beta at the beginning of 2021 and was set at an initial rate of 8%. The rate of inflation will decrease by 15% every year (i.e., 15% of 8%) until it eventually reaches a terminal rate of 1.5%.

In theory, a slot should take 400ms and an epoch is 432,000 slots, which means there should be 180 epochs per year. Inflation is calculated based on epochs, not on calendar year. In reality, we currently see slot times of 600ms and about 130 epochs per year, this leads to slightly lower returns. The current inflation rate as of writing this article is 5.461%. It changes every epoch and you can verify it using Solana’s JSON RPC API.

If we have a total active stake on Solana of 385m SOL, we’d expect to see these figures for the current epoch:

385,801,124.5 SOL * 0.05461/180
= 117,176 SOL

We’d see 117,176 new SOL being created from inflation. These would then be added to all the active stakes in all the stake accounts.

Each validator’s reward is calculated based on several factors:

Voting Performance: Validators with more vote credits (1 vote credit is earned from each successful vote on chain) earn more SOL per stake amount for themselves and their stakers.
Commission Rate: Charged by validator-clients, this fee is part of their income for maintaining the network. It is charged as a percentage of the total inflation rewards directed to their validator. The validator can change their commission rate at any time and it can range from 0% to 100%.
Validator Participation: This includes the uptime and the percentage of slots in which the validator successfully voted, affecting their overall earnings.

Block Reward

When the validator is the leader they collect 50% of the transaction fees generated by the network activity during that leader slot, the other 50% is burned. The more delegated stake you have the more often you are the leader. Block rewards are relatively small compared to staking rewards and commission

Storage Rent Fees

Like transaction fees, storage rent is given out to leaders during their leader slot. All rent is collected at the beginning of an epoch and is paid out as the leaders are voting on and processing transactions. The income from this source is also a function of the leader slots the validator is scheduled for and is therefore dependent on the total delegated stake. Storage rent fees are also relatively small compared to staking rewards and commission.

MEV

MEV, or “Maximal Extractable Value”, refers to a validator’s profit that can be made via their ability to arbitrarily include, exclude, or reorder transactions within the blocks they produce. Jito Labs is the leading MEV infrastructure for Solana. They build high-performance systems to maximize the performance of the Solana blockchain and have a great approach to maximize the benefits of MEV to the network and minimize the negative externalities of MEV to the rest of the users and applications running on Solana. I will share more insights about Jito MEV solution in validator case study section.

Challenges Faced by Solana Validators

High Operational Cost

As previously discussed, there are four types of costs associated with validators, with the most significant being the voting transaction cost. A validator has to pay about 378 SOL every year. Most validator operators rely on inflation rewards to break even. It is possible to break even with a 0% commission rate. However, 0 commission rate is not a sustainable practice.

To increase revenue, validator operators can follow these suggestions to increase block rewards:

Follow best practices to decrease skip rate
Deploy MEV solutions to boost income (detailed discussion in the following section)
Deploy in the popular regions

Most of the staked SOL as of November 27, 2023 was placed with validators based in the United States, 31.28% to be precise. Deploying in the same region can improve the performance.

Attract Delegations from Liquid Staking Pools

What is Liquid Staking?

The idea behind liquid staking is to enable people to stake without losing access to the liquidity of their tokens. When participating in liquid staking, holders stake their SOL to a smart contract — instead of directly to a validator. In return, participants receive a different type of token that represents their staked assets.

This new token — referred to as Liquid Staking Token (LST) or Liquid Staking Derivative (LSD) — can be traded, used in DeFi applications, or transferred, all while still earning staking rewards. All this provides flexibility and liquidity for token holders.

Moreover, the stake pools of LST providers often distribute assets among various validators outside of the superminority, thus promoting a more resilient and secure network.

How to Attract Delegations from Liquid Staking Pools

There are already some popular liquid staking pools like Marinade, Lido and Jito. You can check their requirements about how to get a delegation here. Operators need to focus on the following to have better chance with delegation:

Performance Metrics: Almost all pools require validators to meet specific performance criteria, such as good performance history (e.g., Marinade requires 3 epochs of good performance), low commission rates, and adherence to certain security or decentralization standards (e.g., Socean and EverSOL have specific requirements related to the concentration of staked SOL and data center concentration).
Ongoing Evaluation: Validators are subject to ongoing performance evaluation, and stake allocation may be adjusted based on this performance. MonkeDAO, for example, tracks validator performance and may reduce stake if a validator becomes delinquent.
Community and DAO Involvement: Many pools, like MonkeDAO and Lido, emphasize the importance of community or DAO involvement in the decision-making process for validator delegation. This approach ensures that the values and goals of the validators align with those of the community or DAO.

Validator Case Study

Jito Validator and its MEV Solution

Who is Jito

Jito is a fast-moving and ambitious team who are building infrastructure to increase the performance of Solana and maximize rewards for stakers and validators. They have experienced massive growth across multiple products in 2023, gaining market share faster than our competitors. Jito has deployed 2 validators and also created a liquid staking pool with the token JitoSOL, and is currently delegating to 80+ vote operators (validators):

Jito-Solana, its MEV validator client for Solana, has gained more than 50% of stake on Solana. As of the writing, JitoSOL has acquired 8.1m+ SOL in their stake pool. Jito’s pool already earned 21k SOL as staking rewards and 4.3k MEV rewards (yes, just 50). Jito’s differentiator is that they only stake validators running the jito-solana client to ensure stakers are receiving MEV. Part of that gets restaked into the stake pool, so JitoSOL stakers get additional MEV yield on top of stake rewards. There are two major players:

Searcher: someone who scans the queue and finds an opportunity, like arbitraging across different DEXs. They then submit potential transactions that would execute that arb, with a bid (a bribe) to get the right ordering.
Builder: someone who actually builds the blocks, with all submitted transactions in consideration.

How does Jito MEV work?

Similar to Flashbots’ MEV-boost solution, Jito-Solana addresses issues in the Solana network by providing benefits such as less spam from MEV bots and higher revenue for validators. It introduces a Flashbot-like auction mechanism that allows traders to submit bids for bundles they believe will be profitable. The Jito MEV-client creates a pseudo-mempool and conducts auctions every 200 milliseconds. As Solana usage increases, so will the MEV opportunities, leading to higher income for validators. The Solana ecosystem is engineered for scalability and efficiency, making it easy to use for developers and users. There are 4 key components:

Bundles: Bundles are finally here! Bundles allow one to send a list of transactions that get executed sequentially, atomically, and all-or-nothing. Bundles can be used for atomic arbitrage, liquidations, batching defi operations atomically, and more.
Jito-Solana: Jito-Solana is an open-sourced and audited validator client based on the work of Solana Labs validator client. It unlocks more efficient transaction processing, bundle processing, MEV payment collection, and direct shred sending.
Jito Relayer: The relayer acts as a transaction processing unit (TPU) proxy. It filters and verifies transactions for multiple authenticated validators on a separate server to ensure validators can devote resources to executing transactions.
MEV Payment: Take a commission and distribute MEV to stakers in a custody free manner

Adoption

The weekly active deposits are increasing at a fast phase. It's a clear indicator of the growing trust and enthusiasm among users and investors alike. This uptick is more than just statistics—it's a narrative of confidence and a burgeoning ecosystem.

Jito has integrated with a lot of Defi protocols. This integration allowed users to seamlessly leverage their staked assets as collateral for loans, directly within the DeFi protocol's interface. The result was a notable increase in user engagement, as participants could now access liquidity without sacrificing their staking rewards, thus enriching the Solana ecosystem's utility and attractiveness.

Challenge and Opportunities

The landscape for MEV on Solana is currently smaller than on Ethereum. However, as Solana usage increases, so will the MEV opportunities, leading to higher income for validators. LST’s like JitoSOL will continue to play a pivotal role in reviving Solana DeFi, such as in Drift v2, marginfi, Kamino Finance, and more.

Conclusion

The intricate analysis of Solana validators and the fee economics framework reveals the critical role these validators play in maintaining the network's security, efficiency, and decentralization. Validators, by validating transactions and participating in governance, ensure the resilience and smooth operation of the Solana blockchain. However, they face significant operational costs and challenges, such as high voting transaction costs and the need for efficient resource management. The evolving landscape of liquid staking pools presents both opportunities and challenges for validators, emphasizing the importance of performance, community engagement, and alignment with liquid staking pools' criteria to attract delegations. These ecosystem dynamics underline the necessity for validators to adapt to the changing environment, optimize their operations, and engage with the community to sustain their crucial role in the Solana network.

Enhancing the Solana Ecosystem

A Comprehensive Guide to Validator Economics and Network Dynamics

Web3Yaso