What it means
In a blockchain the participants do not know or trust each other, so the system needs a reason for them to behave honestly. Proof of deposit does this by asking validators to put up a deposit that is held in a locked account for as long as they take part.
The deposit acts as a security bond, like a rental deposit that is returned only if you follow the rules. When blocks are due, the network selects validators from among those who have deposited coins, usually with a chance proportionate to the size of their deposit.
A validator who creates valid blocks earns rewards, while one who cheats by approving false transactions can have their deposit seized. The idea is close to proof of stake, and in many descriptions the two are almost the same.
Where a difference is drawn, proof of deposit places the emphasis on a fixed, locked deposit with explicit penalties, whereas proof of stake is a broader family with many variations. Readers should check how each project uses the terms.
The economics are straightforward for a participant. The cost is the opportunity cost of tying up the coins, since they cannot be spent or sold while locked, and the risk of losing part of the deposit through penalties or technical faults.
The benefit is the reward earned, which is usually paid in new coins or transaction fees. In banking, the same words have an unrelated meaning.
A proof of deposit might be a bank receipt, a statement or a letter confirming that a customer has paid a sum into an account, and it is often requested by landlords, lenders and suppliers as evidence of funds.
In practice
Real-world examples.
Example
A validator on a small blockchain locks $20,000 of coins for six months. She receives a regular reward for producing blocks, and the network can seize part of her deposit if her server signs two conflicting blocks.
Example
A supplier asks a new customer for proof of deposit before shipping a $60,000 order. The customer provides a bank letter confirming that $60,000 was paid into an escrow account.
Example
A fund manager reviewing a blockchain investment compares the reward rate with the risk of penalties. She decides that the 7% annual return is not enough to cover the risk of losing part of the deposit and the inability to access the coins during the lock-up.
Formula
Calculation
In a simple model, a validator's expected number of blocks is its share of the total deposits:
Expected blocks = (Your deposit / Total deposits) x Blocks per day
Annual return = (Daily reward x 365) / Deposit
Suppose you deposit $50,000 and the total deposited by all validators is $2,000,000. The network produces 200 blocks per day and each block pays a reward worth $2.
Your share = $50,000 / $2,000,000 = 2.5%.
Expected blocks per day = 2.5% x 200 = 5 blocks.
Daily reward = 5 x $2 = $10, and the annual reward = $10 x 365 = $3,650.
Annual return = $3,650 / $50,000 = 7.3%, before any penalties, technical costs or changes in the coin price.Case study
Seen in the real world.
Cobalt Ledger is an illustrative, fictional blockchain network that required validators to deposit a minimum of $10,000 of its coins. The founders wanted every validator to have something to lose if they misbehaved.
In the first year, one validator's server malfunctioned and signed two conflicting blocks by mistake. The network applied a penalty of 10% of her deposit, which was $1,000, and removed her from the validator set for a month.
She complained that the penalty was harsh, but the other validators supported it because it showed the rules were enforced. She improved her backup setup and later rejoined. The illustrative lesson is that a deposit only protects the network if penalties are real, which also means honest mistakes can be costly.
Watch out
Common mistakes.
- Assuming deposited coins are always safe, when validators can lose part of the deposit through penalties for errors or dishonest behaviour.
- Ignoring the lock-up period, which can prevent a participant from selling coins during a market fall.
- Confusing the crypto meaning of proof of deposit with a bank document that confirms funds have been deposited.
Questions
People also ask.
Is proof of deposit the same as proof of stake?
They are very similar and sometimes used interchangeably, although some writers use proof of deposit for designs that stress a locked deposit and explicit penalties.
Can I get my deposit back?
Usually yes, after you leave the validator set and any waiting period has passed, provided you have not been penalised.
What does proof of deposit mean in banking?
It is a document, such as a receipt or statement, that shows money has been paid into an account and is often used as evidence of funds.
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