Masternodes became famous in 2017 as the accelerating price of dashcoin translated into multi-thousand percent returns for people in the Dash system. Those returns weren’t sustainable, but masternodes still offer another way for people to earn coins without mining or trading.
This guide to masternodes will help you understand how they work and what to look for as you decide whether this is an investment strategy for you.
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What Are Masternodes?
A masternode-based blockchain adds another layer on top of the bitcoin-style miners in order to provide a better cryptocurrency. At least, that’s what the developers of these platforms claim. Better is in the eye of the beholder, but there’s no doubt that adding a masternode layer can let a blockchain platform offer unique features.
Let’s take a look at how the concept came about in the first masternode-based blockchain, Dash.
Dash is a hybrid blockchain that combines a Bitcoin-like Proof-of-Work layer of miners with what it calls a Proof-of-Service layer of masternodes.
At its heart, Dash’s mining operation is not that different from Bitcoin’s. The miners run computers that calculate complex algorithms in an effort to win the right to add blocks of transactions to the blockchain. The X11 algorithm Dash uses is different from Bitcoin’s SHA-256. X11 was supposed to be too difficult for ASIC-makers to design for, but Dash miners only had a brief run when they could us traditional CPU and GPU-based computers.
The big difference between Dash and Bitcoin comes at the layer above the miners. Bitcoin’s blockchain relies on a network of “full nodes”. These are computers running the full Bitcoin Core software that provide the essential validation of the miners’ work and help link the peer-to-peer network together. Anyone can become a full node simply by running the Bitcoin Core software on an internet-connected computer.
Dash’s equivalent, masternodes, perform the same function but they also perform other network services essential to Dash’s privacy features. They also let Dash record transactions much faster than Bitcoin. But what is the key feature that lets this happen?
Dash masternodes get paid for their work. Bitcoin full nodes do not.
Of course, nothing is ever free. Unlike Bitcoin, you can’t just add yourself to the Dash network. You have to have some skin in the game. Namely, you must provide collateral in the form of 1,000 dashcoins which must remain untouched in a dedicated wallet in order to keep your masternode running. At current exchange rates, that 1,000 dashcoin stake will cost you $160,000.
It sounds steep, but you can’t lose the dashcoins and you can withdraw them from that wallet anytime you want. As long as the coins are in the wallet, they will earn you new coins as a reward for your support of the network.
This extra revenue stream earned Dash a huge amount of support in its early years and laid the foundations for relationships the Dash team developed with crypto exchanges and other services. The confidence among the Dash faithful helped propel dashcoin’s market cap above the $1 billion mark by the end of 2017.
Dash is more private and faster than Bitcoin
To understand why Dash took this approach, you have to stand in the shoes of the blockchain’s founder, Evan Duffield. A software developer who caught the Bitcoin bug early on, Duffield soon began to see the cracks in the Bitcoin system. “I was watching and waiting for the Bitcoin team to do something about the fungibility issue,” Duffield recalled in a 2016 interview with CoinGecko, “but it never happened. I was messing around with the core client and decided that I will launch an altcoin.”
Privacy and fungibility
What Duffield referred to as the “fungibility issue” was a consequence of Satoshi Nakamoto’s decision to make Bitcoin’s ledger pseudo-anonymous. All of the transactions recorded to Bitcoin are associated with an address rather than an identity. Anyone can trace transactions made by that address through time, but they can’t use the address to identify its owner. If at any point in that history the address can be linked to a person’s identity, then that person’s entire Bitcoin history becomes public.
It would be like buying a cup of coffee with cash and letting the barista see all of your bank account statements.
Privacy isn’t just about making anonymous transactions. It also goes to the heart of what a currency is. In fiat land, all cash is the same. A ten dollar bill is a ten dollar bill. At some point in that ten dollar bill’s past, it may have passed through a criminal’s hands but that can’t be linked to you.
It can in Bitcoin land. If you hold a bitcoin that “belonged” to a criminal, it makes that bitcoin worth less than a clean bitcoin — especially if you are a business, a charity or a politician.
Volunteering isn’t a business model
The other aspect of Bitcoin that Duffield wanted to fix with Dash is the way Bitcoin’s miners get all the money. The people who provide the blockchain’s other services have to do it as volunteers.
The people who run full nodes on the Bitcoin blockchain have a variety of reasons for doing it. For some, it’s security and peace-of-mind, while for others it’s out of a desire to contribute to Bitcoin’s success. But the developers of Bitcoin can’t expand the blockchain’s capabilities easily, since the burden of implementing any new features falls on these volunteers.
Dash is digital cash
The Dash approach of paying both miners and masternodes for the work they do lets the blockchain build additional services beyond what Bitcoin’s full nodes provide.
Dash’s PrivateSend service, for example, runs through the masternodes. The masternodes shuffles the dashcoins in your wallet with an equal amount of dashcoins in someone else’s wallet. Repeat that enough times and nobody can tell that you own those dashcoins or where the coins came from.
Another service, called InstantSend, lets dashcoin owners get transactions recorded almost instantly. When the masternodes receive an InstantSend request, they vote on the transaction’s validity and then push the transaction to the front of the line of the next block.
In exchange for providing the computing and bandwidth resources to validate the blockchain transactions and provide these extra services, the masternodes get a share of the block-generation rewards. Dash gives the miners 45% of the rewards and gives the masternodes 45% of the rewards for the blocks they add to the blockchain. The remaining 10% goes to reward other contributors to the project, such as developers.
This is where the 1,000 dashcoins collateral comes in. As long as you’re running the masternode, those coins have to be locked up in the wallet. You can withdraw the coins at any time, but then your masternode will go offline. As long as you’re running the masternode, though, you’re earning payouts for the work.
For people who bought into Dash in the early days when dashcoins traded for $5 or $10 each, this turned into a great deal. By the end of 2017, when dashcoins were worth more than $1,500, the masternode owners that invested $5,000 or $10,000 in dashcoin collateral were generating returns of several thousand percent.
Things have settled down dramatically since then. With dashcoins trading at about $160, the annual returns on masternode are now in the 6% range.
Other masternode blockchains
The huge payouts Dash masternodes were getting soon inspired the creation of more blockchains that used the masternode architecture. Some of these were shakier than others, as you can see by reviewing the 399 blockchains in Masternodes Online’s listing.
Dash still has the highest 24-hour trading volume at more than $200 million. The trading volume of its next-closest competitor, Z-coin, is two orders of magnitude smaller at $2 million. The $10 million in combined trading volume of all of the other blockchains is only 5% of Dashcoin’s.
Scams and bogus masternodes
Like the ICO market, the promise of a quick payday attracted a lot of masternode projects that did not have the talent or resources to actually deliver. It also attracted a fair share of scammers.
These people would set up bogus projects and allocate large blocks of coins to themselves. The people who bought masternodes and locked up their collateral created an artificial scarcity that drove up the price and created triple-digit or quadruple-digit “returns” for the masternodes. Of course, the masternodes had to keep their coins locked up, so they couldn’t cash out. As the frenzy reached its peak, the scammers would dump their coins on the market and walk away. Prices collapsed and the masternodes were left with worthless coins.
How to Become a Masternode
Let’s say that, despite the risk of scams, you’re interested in becoming a masternode for a reputable blockchain. Before going any further, ask yourself these questions:
- Can I afford to buy the collateral?
- Do I know how to set up a Linux server?
- Do I know how to maintain a Linux server?
- Can I handle a DDOS attack?
- Does my ISP give me a static IP address?
If the answer to any of those questions was “no”, then you may want to skip to the next section about masternode pools.
Masternodes are servers
If you aren’t familiar with server setup and maintenance, then running an actual masternode may not be for you. The process for setting up a masternode server will vary from project to project — and so will the quality of the instructions.
Dash has a fairly detailed walkthrough of the process. You can either set things up on your own hardware or create a virtual private server (VPS) with a VPS provider such as Amazon EC2, Digital Ocean or Vultr.
The advantage of going the virtual route is that you can take advantage of the VPS provider’s anti-DDOS systems. In early 2017, Dash’s masternode network was the target of a massive DDOS attack that knocked 12% of the masternodes off the network. Even some of the stronger nodes went dark, but the VPS providers’ counter-measures helped others stay up-and-running.
Funding your masternode wallet
You will need to purchase your collateral on a crypto exchange. You will find Dash listed on many of the world’s largest exchanges like Binance and Huobi as well as popular regional powers like Kraken and CEX. The cryptocurrencies for more obscure masternode blockchains may only be available on even more obscure exchanges.
Once you’ve bought the coins, you need to transfer them into a dedicated wallet that supports the full blockchain. Usually, that means the wallet created by the blockchain platform’s developers. In the case of Dash, you can use the project’s own Dash Core wallet.
For the most secure storage of your dashcoins, however, Dash recommends using a hardware wallet from Trezor, Ledger or KeepKey. These devices store your private keys in protected chips and are nearly impervious to traditional hacking techniques. They can remain connected to a computer through a USB port with little risk of the coins being stolen.
Masternode Hosting Services and Pools
If setting up a server is not your thing or if you can’t afford the collateral needed to buy a masternode, then a hosting service or pool might be a better choice for you.
Masternode hosting services set up the servers and software. All you have to do is provide the full collateral. Dashmasternode.io, Node40.com and Masternode.me provide this service to people in the Dash ecosystem. You connect your wallet to their system, deposit your collateral and then start the server. The hosting service handles all of the maintenance and security in exchange for a flat monthly fee. Node40, for example, has plans that start at 0.3456 dashcoins and drop as low as 0.27648 dashcoins with a yearly commitment.
If you can’t afford to buy into the collateral, you can look into joining a masternode pool such as CrowdNode.com. For as little as a single dashcoin, you can get fractional ownership of a masternode. The pool divides the rewards the masternode earns proportionally among the members of the pool in exchange for a slice of the pie. In the case of CrowdNode, it charges a 15% fee.
Other masternode pools, such as 2MasterNodes.com, let you buy into a number of different blockchains. Dash isn’t available on 2MasterNodes, but you can buy into masternodes for PIVX, Zcoin and others.
Do Your Own Research
As with everything else in crypto land, your decisions are your responsibility. Buying into a masternode involves risks that you need to understand ahead of time. The blockchain project itself could be weak or a scam. Likewise, the hosting service or pool could have issues as well.
Even with a solid project and reputable service provider, the volatile state of the cryptocurrency market creates considerable risk. In a down market, you only get a return on your collateral if the coins you earn are worth enough to cover the fall in coin pricing.
Articles like this can explain things and point to resources, but they don’t substitute for your own due diligence. Here are some tips that may help you find your way to masternode earnings.
Finding masternode blockchains
There are several sites that provide masternode comparisons. Sites like Masternodes Online and MasterNodes.pro will give you summary data on each blockchain. Use multiple listing services to make sure the data you’re getting is consistent. Among the data in the listings, you’ll find cryptocurrency’s performance, the number of masternodes on the blockchain, the collateral requirements to join each blockchain’s cryptocurrency and an estimate of the return on investment.
Don’t get greedy. If something looks too good to be true, then there’s a good chance that it is. 1000% returns on investment don’t happen naturally. Dash crossed that line in the middle of 2017’s hypergrowth. What reason explains those kinds of numbers today? That’s where your research into the blockchain’s business plans comes in helpful. It will help you filter out the bad options.
Know the players
Use LinkedIn, Crunchbase and other sources to research the major players in the blockchain project as well as with any service providers you want to do business with. Their profiles should list their affiliations. In the case of the lead developers, check out their presence on GitHub to see if they have any history in development.
If the blockchain’s site doesn’t mention its leadership (in the case of centralized projects) or have prominent, active development teams (for decentralized projects), then consider that a red flag. Use Google’s image search function to see if the pictures of executives are real or stock photography.
Does the blockchain have a purpose?
A purpose other than scamming you, that is. Read through the blockchain project’s white paper and other documentation. It needs to be driven by some kind of business purpose. If it doesn’t, then there may be less to the project than meets the eye. The quality of writing can also give you an indication of how legitimate the project might be.
Take a look at the project’s Github repository — it does have one, right? Even without a coding background, you can figure out how actively the code is being worked on. If it looks like everything was posted at one time and then never touched again, it may be a scam.
Search the Web
If a project has a high enough profile, it might have gotten picked up by the news-oriented crypto sites like CoinDesk and CoinTelegraph. You can usually tell if an article is a straight copy-paste from a press release. Articles that combine original research will give you a stronger indication of the project’s legitimacy and interviews with the project leads are even better sources.
Due to the scammy nature of masternode blockchains and the ecosystem that’s built up around it, the forums on Reddit and BitcoinTalk can be a mixed bag. On the one hand, you have people with a vested interest in trying to pump up their favored project. On the other hand, you have honest crypto enthusiasts who call out the scams and flawed projects for what they are. The challenge is separating the gold from the iron pyrite.
The Proof-of-Service concept offers an interesting evolution beyond Bitcoin’s Proof-of-Work approach to consensus. If projects like Dash succeed in building out features that run quickly and cost-effectively, they could occupy a unique niche in the crypto landscape.
Allowing people to share in the benefits through masternodes will be a big part of that success. However, the risks that uninformed crypto investors face could lead to a backlash. With careful research, though, you can find legitimate Proof-of-Service blockchains and take advantage of the earnings that running a masternode generates.