Economic Analysis of Q Protocol Proposals: Understanding Different Approaches
In response to the recent article from Nomadic Labs, we’d like to offer our perspective on the ongoing discussion about protocol upgrades.
Summary
The ongoing discussion around Tezos’ Q Protocol proposals represents different approaches to a shared goal: optimizing network security while maintaining healthy tokenomics. Each proposal — Quebec and Qena42 — offers thoughtful solutions to these challenges, with different philosophical approaches to implementation. This analysis examines the economic implications of each approach to help bakers make informed decisions based on their specific circumstances and vision for the network.
Important Note
It’s crucial to understand that neither proposal is inherently superior or flawed. They represent different approaches to solving complex economic challenges in blockchain governance. Quebec emphasizes controlled issuance through an adaptive maximum curve, while Qena42 focuses on realistic targeting and simpler mechanics. Bakers should evaluate these approaches based on:
- Their view of optimal network security
- Their perspective on economic incentive structures
- Their assessment of market dynamics
- Their long-term vision for Tezos
- Their specific operational context and needs
The Economic Framework
Understanding Incentive Structures
The current adaptive issuance mechanism functions as a market-driven system where supply (staking rewards) responds to demand (staking participation). Quebec’s proposed “Adaptive Maximum” effectively introduces a price ceiling on these rewards, which economic theory suggests could lead to market inefficiencies.
The Risk of Premature Optimization
Quebec’s approach assumes we can accurately predict the optimal staking equilibrium and artificially enforce it through protocol parameters. However, economic history teaches us that markets often defy such predictive models, especially in nascent systems. Some key considerations:
- Market Discovery Process: The current adaptive issuance mechanism hasn’t had sufficient time to find its natural equilibrium. Introducing additional constraints now could interfere with price discovery.
- Time Value of Security: Quebec’s assumption that lower issuance near the target is optimal overlooks the time value of network security. Early-stage protocols often benefit from higher security incentives to establish robust fundamentals.
Why Qena42 Makes Economic Sense
Realistic Target Setting
The shift from 50% to 42% in Qena42 isn’t merely a numerical adjustment — it represents a more pragmatic approach to market realities:
1) Natural Equilibrium: 42% appears to be closer to the natural staking equilibrium when considering:
- Liquidity requirements for DeFi
- Operating costs for validators
- Risk-adjusted returns for participants
2) Gradual Adaptation: Unlike Quebec’s curve-based approach, Qena42 allows for natural market forces to drive staking participation, reducing the risk of market distortions.
Economic Stability
Qena42’s approach provides several stability advantages:
- Predictable Incentives: Without the additional complexity of an adaptive maximum curve, market participants can better predict and respond to protocol incentives.
- Reduced Volatility: The simpler mechanism is less likely to create unexpected oscillations in staking participation.
Delegation Weight Reduction and Staking Economics
The shift from Paris’s 1X/0.5X staking/delegation weight ratio to a 1X/0.3X ratio in both Qena42 and Quebec creates an important economic dynamic that often gets overlooked in the broader debate. Under Qena42’s preservation of the original issuance curve, this delegation weight reduction effectively increases the rewards for direct stakers without introducing additional complexity. Here’s why this matters:
When delegation power is reduced to 0.3X while maintaining the original curve, direct stakers naturally receive a larger share of the rewards pool. This creates stronger incentives for direct participation without artificially suppressing the overall issuance rate as Quebec proposes. The math is straightforward: with delegators counting less toward the total staking ratio, the protocol needs to issue more rewards to reach the target percentage, but these rewards are distributed more heavily toward direct stakers. This organic shift in reward distribution achieves several goals:
- Increases the appeal of direct staking versus delegation
- Potentially accelerates the path to the target ratio through stronger incentives
- Maintains clear, predictable economics without the need for Quebec’s additional curve
- Creates natural pressure for current delegators to consider transitioning to direct staking
This mechanism demonstrates how Qena42 achieves its objectives through simpler means — using the delegation weight adjustment to enhance staking incentives rather than introducing a complex maximum curve that could potentially work against these same incentives.
Early Participation and Decentralization Dynamics
Quebec’s approach of reducing rewards as we approach the target creates an unintended centralization pressure by front-loading benefits to established players. In contrast, Qena42’s maintenance of consistent incentives until reaching the target creates a more equitable environment for decentralization. Economic theory suggests that when early participants in a system receive substantially higher returns, it tends to create lasting power structures that are difficult to disrupt later. By maintaining stronger rewards until reaching the 42% target, Qena42 extends the window of opportunity for new participants to enter the system with favorable economics. This approach encourages a broader distribution of stake over time, as latecomers aren’t immediately disadvantaged by diminishing returns. The result is a more organic path to decentralization, where the distribution of stake is determined by market participation rather than being implicitly shaped by a declining reward curve that favors early movers.
Premature Protocol Modification and Market Discovery
A critical concern with Quebec’s proposal is the timing of its implementation. The Paris protocol’s Adaptive Issuance mechanism, activated on June 25th, 2024, was implemented as a foundational economic feature but has had less than four months to demonstrate its effectiveness. Economic systems, particularly in blockchain networks, typically require multiple market cycles to reach equilibrium and generate meaningful data. Based on historical precedents from other Layer 1 protocols, a realistic timeframe for evaluating such fundamental economic mechanisms is typically 12–18 months, encompassing multiple market cycles and varying network conditions.
Quebec proposes adding a complex adaptive maximum curve before we’ve even completed a single quarter under the current system. This is akin to adjusting the thermostat settings before the heating system has had time to reach its initial target temperature. Given that Paris activated in June 2024, we would expect to see definitive results and clear market patterns no earlier than Q3 2025.
This timeline would allow for:
- Complete market price discovery
- Multiple cycles of baker participation adjustments
- Clear data on staking ratio trends
- Understanding of seasonal or market-driven fluctuations
- Natural equilibrium finding between liquid and staked supply
Adding another layer of complexity through Quebec’s adaptive maximum curve now risks creating a confounded system where we can’t distinguish which mechanism is driving what behavior. Qena42’s approach of adjusting the target while maintaining the core mechanics of Adaptive Issuance provides a cleaner experimental environment for understanding system dynamics. This makes future optimizations more precise and data-driven, rather than speculative.
Addressing Nomadic Labs’ Arguments
Source: https://research-development.nomadic-labs.com/adaptive-maximum.html
On Simplicity
While Nomadic Labs argues that Quebec’s approach is simpler, from an economic perspective, adding another layer of control (the adaptive maximum curve) actually increases system complexity. Qena42’s straightforward target adjustment is more aligned with the principle of economic simplicity.
On Security
The argument that lowering the target reduces security ambitions misses a crucial economic point: effective security comes from sustainable, market-driven participation rather than artificially maintained targets.
On Moderation
Quebec’s adaptive maximum might appear to offer better moderation of inflation, but it could actually create more instability by:
- Forcing premature reduction in incentives
- Creating artificial pressure points in the staking market
- Potentially triggering unstaking cascades if rewards drop too quickly
Addressing Common Concerns
An important aspect of this analysis that deserves attention is how certain criticisms raised about Qena42 are actually shared challenges that affect both proposals:
Target Achievement: While concerns have been raised about reaching the target in Qena42, the same uncertainty exists for Quebec. The addition of an adaptive maximum curve doesn’t inherently make the target more achievable — it might actually make it harder by reducing incentives before reaching the goal.
Governance Overhead: The argument about potential future adjustments being needed isn’t unique to Qena42. Quebec’s more complex mechanism might require even more frequent adjustments if the curve parameters need fine-tuning based on market response.
Economic Predictability: Both proposals face challenges in predicting long-term economic outcomes. Quebec’s additional curve adds another layer of complexity to these predictions, while Qena42’s simpler approach makes outcomes more straightforward to model.
System Complexity: While Qena42 adjusts the target percentage, Quebec adds both a new curve and maintains the existing target. From a system complexity perspective, adding new mechanisms (Quebec) could be considered more complex than adjusting existing parameters (Qena42).
Adaptability to Market Conditions: Both proposals attempt to address market conditions, just through different mechanisms. Neither approach can claim definitively superior adaptability until tested in real-world conditions.
Long-term Economic Implications
Market Efficiency
Qena42’s approach better supports market efficiency by:
- Allowing natural price discovery
- Maintaining consistent incentive structures
- Reducing governance overhead
Adaptability
The proposal’s flexibility to adjust targets through future governance makes it more adaptable to changing market conditions without introducing complex mechanisms.
TezosX and Layer 1 Economics
The planned transition to TezosX, which will move DApps and daily transactions to Layer 2 through enshrined rollups, fundamentally changes the calculus of this debate. Quebec’s aggressive push for lower issuance seems premature when considering this architectural evolution. In a future where L1’s primary function is consensus and L2 orchestration, maintaining robust security through appropriate staking incentives becomes even more critical than minimizing inflation. Qena42’s more conservative approach, with its 42% target and traditional incentive structure, better aligns with this future state. It provides the necessary security guarantees for a backbone layer while allowing natural market forces to determine appropriate staking levels. The flexibility of Qena42’s design also means it can better adapt as the transition to TezosX progresses, rather than locking in assumptions about optimal issuance levels that may not hold in an L2-centric future.
Conclusion
From an economic perspective, Qena42 represents a more measured and market-aligned approach to protocol evolution. While Quebec’s goals are admirable, its implementation risks introducing market distortions that could undermine long-term protocol health. Qena42’s combination of realistic targets and simpler mechanics provides a more sustainable path forward for Tezos’ economic system.
This analysis has explored various economic implications of both proposals. The final choice depends on each baker’s unique circumstances and vision for Tezos’s future. Both proposals offer valid paths forward, and the strength of Tezos’s governance lies in the community’s ability to evaluate and choose between different approaches thoughtfully.
Note: This analysis is based on economic principles and current market observations. As with any economic system, actual outcomes may vary, and continuous monitoring and adjustment through governance remains essential.
Helpful Links
Qena42 Source Code > https://github.com/tez-capital/tezos/commit/7b22aea3c98323a47c2867eb9494d2addb5d4d43
Tez Capital Website > https://tez.capital
Tez Capital Discord > https://dsc.gg/tzc
Tez Capital Telegram > https://t.me/tezcapital
Tez Capital Documentation > https://docs.tez.capital (find out more about our tools here)
