11/26/21
Figure 1. Comparison of smaller stake pools to larger stake pools.
What is Considered to be a Small Stake Pool?
A small stake pool is generally considered to be one with less than 3,000,000 ADA delegated to it. The reason why these pools are considered 'small' is that currently it takes at least 3,000,000-5,000,000 ADA to mint one block per epoch on average (1 epoch = 5 day period) [1].
Rewards for a Small Stake Pool Compared to a Large Stake Pool
Because a larger stake pool with may mint blocks regularly, it may be attractive to think that going with larger stake pools would allow a potential delegator to have a higher rate of return on their delegation, however this is not always the case.
For larger stake pools, consistent rewards from minting blocks must be paid out to a larger 'pool' of delegated ADA. This means that rewards either get distributed to more individuals delegating to the stake pool, or fewer individuals with a larger quantity of ADA compared to a smaller stake pool. This means that the rewards an individual would receive from delegation to a larger pool would be smaller, but more frequent, than if it was delegated to a smaller stake pool. Conversely, rewards given out from a smaller pool would be larger, but less frequent, resulting in approximately the same annual return over the course of a year compared to a larger pool. See Figure 2 below as a visual example.
Figure 2. Rewards that an individual delegator might expect if delegating to a smaller stake pool (shown in blue) compared to a larger stake pool (shown in orange).
Instead of quantifying individuals reward payouts over time, another way to think about this is through comparing the return on ADA (ROA), the annualized return of ADA paid out at each epoch if the rewards trend were to continue, as shown in Figure 3 below.
Figure 3. ROA of smaller vs. larger stake pools (kindly provided by RJMCOIN of ADA HEART Pool).
As you can see, larger stake pools have more frequent and consistent rewards paid out, while smaller stake pools have less frequent, yet higher rewards paid out when blocks are minted. In the end, the ROA of smaller vs. larger stake pools become fairly comparable over long time periods.
Reasons to Delegate to Smaller Stake Pools
With all of these things in mind, there does appear to be a minimum threshold of ADA delegated to the pool that is required to deliver maximum returns to delegators (assuming 340 ADA fixed fees, 0% margin, and no additional rewards given out to delegators). A pool with approximately >8,500,000 ADA delegated will yield the maximum ROA, which appears to be ~4-5% currently [1]. However, smaller stake pools can still deliver good ROA that in some cases can even rival that of larger stake pools. In fact, currently our pool ENVY is yielding an annualized 6.66% ROA with a total stake of ~45,000 ADA since we minted two blocks in Epochs 298 and 301. This is certainly due to a high degree of luck, but also demonstrates that small pools can yield competitive returns compared to larger pools.
In addition to pool performance, there are a few reasons to consider staking with a smaller pool over a larger one, which are highlighted below:
1) Supporting small stake pool operators. There are a multitude of small stake pool operators who spend their time, energy, and quite a large sum of their own personal money maintaining servers, hardware, social media, etc., in order to provide quality stake pools for the Cardano network and promote decentralization. By delegating to these pools, delegators get close to the same rate of return while also supporting these small individual operators.
2) Decentralization. Delegating ADA to smaller stake pools allows for more decentralization of the network. This is especially important to protect the network against malicious attacks, such as a 51% attack, where a bad actor who can gain majority control of the network can rewrite parts of the blockchain, reverse their own transactions, etc.
3) Community engagement. Small stake pool operators are very motivated in trying to grow their stake pool operation. Because of this, they generally are active on social media, are quick to respond to direct messages, and keep up with current events throughout the Cardano community.
4) Mission-driven stake pools. There are some stake pools that take delegator feedback for causes where stake pool operator rewards should go, so delegators can have a direct say in the stake pool's charitable donations!
5) Native tokens. Smaller stake pools will sometimes give out native tokens that they have created for their delegators as a fun and creative way to give additional rewards. Sometimes these tokens can be used as a currency to be exchanged for additional staking rewards or saved as collectibles.
References
[1]https://www.reddit.com/r/cardano/comments/mxmigd/chance_of_zero_blocks_per_epoch