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What are masternodes?

Can a masternode make money while you sleep?

Masternodes are operators on a blockchain network who get more responsibilities, but also more rewards, than other node operators.

Masternode operators will generally look at their role in two different ways.

For some, it’s an important way of helping to secure and manage a cryptocurrency network, taking on an important job in exchange for fair pay.

Others see it more as an investment, where they pay a certain amount up front to buy a masternode and then receive ongoing cryptocurrency income as their masternode pays out dividends.

But first, what actually is a masternode and what does it do?

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What is a masternode?

Masternodes are a feature of some cryptocurrencies. They’re similar to a type of miner with special privileges and responsibilities, and extra rewards, and will often run alongside regular nodes.

For example, Dash (which was the first cryptocurrency to introduce the masternode system back in 2014) has a system that uses proof-of-service masternodes alongside regular proof-of-work miners.

The functions and responsibilities of a masternode can vary between cryptocurrencies, but often include the following:

  • Enabling instant transactions. Masternodes give a blockchain a network of trustworthy high-speed servers to verify transactions, rather than relying on a system such as the one bitcoin uses, where miners expend all their energy fighting for the right to verify a transaction.
  • Being a source of information. Masternodes are expected to remain synchronized so they can collectively serve as an ongoing font of information for anyone who wants to use the blockchain.
  • Monitor network state. Masternode operators are expected to be the first to know if something goes wrong on the blockchain.
  • Protect the blockchain from attacks. Similar to miners or stakers, masternode operators are expected to collectively act as a majority force that can retain honest control of the network.
  • Responsively deploying updates. Masternodes are expected to be tuned in to new developments and deploy updates quickly to create a more responsive and flexible blockchain.
  • Voting. Masternode operators, as serious network participants, will often get a say in the future of the network and will be able to vote on certain motions where other participants can’t.

Operating a masternode will generally require a certain amount of time, money and know-how.

In return for providing these, a masternode will be rewarded with cryptocurrency. These rewards are partly to compensate for the cost of running a node and partly to act as payment for the job.

Because masternode operators are important and powerful elements of blockchain networks, both the payments and collateral requirements encourage node operators to act honestly and in the best interests of the network.

How to host a masternode

At a minimum, masternode operators will typically need to do the following:

  • Have a certain amount of cryptocurrency held as collateral.
  • Have an always-online virtual private server (VPS) or full server with a dedicated IP address.
  • Keep a full copy of the blockchain.

Beyond that, there is usually little requirement for a masternode to do anything other than keep their server running, their collateral available and their node up to date.

It primarily runs itself once it has been set up, which is part of the reason why many people see masternodes as a “set and forget” scheme.

Can I earn an income hosting a masternode?

Although it’s possible to earn a passive income hosting a masternode, the returns will depend on the following:

  • Your chosen cryptocurrency.
  • How much it costs in upfront collateral.
  • How much it costs to operate per month.
  • How its price changes over time.

One of the main upsides might be that you don’t have to actually spend the collateral to start a node. You just have to have it, and you can sell it whenever you want. As such, losses will typically only be incurred if the value of a cryptocurrency falls between the time you buy collateral for a masternode and the time you sell that collateral as long as the masternode runs long enough to offset the hosting and similar costs.

One of the simplest ways of looking at it is to ask whether the monthly returns of a masternode are enough to cover the cost and hassle of hosting.

Dash masternode profitability

Assuming zero other expenses and DASH prices remaining stable, it will take someone almost 14 years to make back the value of their collateral by running a Dash masternode. However, you don’t have to spend or permanently lock in your collateral to start a node. You just have to have it, and you can sell it when you want. This changes the risk/reward picture.

A Dash masternode requires 1,000 DASH in collateral. As of January 29, 2019, that’s about $66,000 in collateral the bare minimum upfront cost. In return, node operators earn an average of $400 per month, or $4,800 per year at current prices.

This is currently equivalent to an average return of about 0.6% per month or 7.2% per year on a $66,000 investment.

Now let’s factor in the time and monetary costs of running a node. Let’s assume you use a mid-priced third-party masternode host at $10 per month and just provide the collateral.

This doesn’t do much to affect the overall picture, except it bumps your monthly returns down to about $390 equivalent, or about 7.1% per year. Factor in the costs of converting your Dash to fiat and withdrawing it, and you might expect to lose about 1% of earnings in the process depending on which exchange you use and how much you withdraw at once.

On the whole, the returns on Dash masternodes are within a couple of percentage points of high-risk traditional investments.

But at the same time, Dash prices have swung by over 3% within the last 24 hours at the time of writing (January 2019). Cryptocurrency is so volatile that the exact time down to the hour that you cash out your masternode earnings has a bigger impact on profitability than any other factor.

Typical cryptocurrency volatility is the most significant factor when considering masternode profitability. If crypto prices rise, masternodes are more profitable. If they fall, masternodes are less profitable.

In the case of Dash at least at the time of writing the average returns are more than enough to cover the cost of a VPS, and even the hassle can be accommodated for by using a third-party masternode hosting service.

These tend to run for far less than the masternode payouts, often going for around $10 per month, and you will usually be able to keep your collateral in your own cold storage wallet while using a third-party host.

If you don’t have the required collateral, it’s also possible to find pooled masternode services where individuals contribute a small amount of the whole, pooling their collateral and dividing the earnings accordingly. Note that these might require you to give someone else access to your collateral, which should always be approached with extreme caution.

That you are able to sell your masternode collateral as desired, and generally don’t have to lock it in for any set period, makes a crucial difference to the risk and reward picture of masternodes.

Masternodes list

The following are some of the world’s most popular masternode cryptocurrencies.

CryptocurrencyRequired collateralHow it worksLearn more
Dash1,000 DASHDash masternodes earn 45% of Dash block rewards for facilitating additional network features such as instant transfers.Learn more
Stratis250,000 STRATStratis masternodes earn rewards by expanding network functionality. For example, by acting as tumblers to allow for more private transactions.Learn more
Zcoin1,000 XZCZcoin masternodes, known as Znodes, verify transactions on top of miners for additional network security. 30% of the reward from each block goes to one Znode at a time through a rotating queue system.Learn more
ChainLinkVariesNo collateral is required to run a ChainLink masternode, but having collateral will allow a ChainLink masternode to serve as a more trusted node, offer additional functions and earn more.Learn more
PIVX10,000 PIVXPIVX masternodes serve as consensus nodes alongside regular stakers, but earn higher rewards and get to vote on network changes.Learn more
NEM3,000,000 NEMNEM supernodes are the highest tier consensus nodes. Suitably collateralized nodes that meet certain standards (low ping, high bandwidth etc) in constant testing will automatically earn supernode nodes.Learn more
VeChain25,000,000 VETThere are 101 manually selected VeChain masternodes who select block producers. They are hand-picked from those who contribute to the VeChain ecosystem in some way beyond just running a node.Learn more

Risks and benefits

The benefits of operating a masternode include the following:

  • They offer a unique window into the inner workings of a blockchain.
  • They give you a lot of oversight into a blockchain’s actions.
  • They offer you a certain level of responsibility and authority on a network.
  • You will receive payment.

However, the risks include the following:

  • Volatility. If the cryptocurrency loses its value, the cost of collateralizing a masternode might accentuate your losses.
  • Thin markets. There might currently be no market for the cryptocurrency you’re getting paid in, and there might never be one. It could be tough to cash out your masternode rewards and the collateral without depressing prices, especially if you want to do it fast. There are over 100 masternode cryptocurrencies, but the majority don’t have enough of a market to reliably sell your earnings.
  • Inflation. If you and all the other masternodes are constantly selling your earnings, that might cause a lot of downwards price pressure. If a masternode’s rewards seem too great relative to the collateral requirement, it might be because the rewards are unsustainably high or because there’s no market for that crypto.
  • Centralization. If you need crypto collateral to run a masternode, and the most efficient way of earning that crypto is by running a masternode, you might have a highly centralized and unsustainable economic problem.
  • Loss of collateral. User error can result in the loss of your collateral in many different ways. You might forget the password to the hardware wallet it’s stored on, a third-party masternode hosting provider might scam their way out of your funds, a buggy update might leave your funds vulnerable or your collateral could be lost in any number of ways.
  • Responsibilities. There may be responsibilities associated with running a masternode that you are unprepared for. For example, you may suffer a loss of earnings if you don’t keep your masternode up to date.

The bottom line

It’s possible to make money with masternode cryptocurrencies, but you’ll still have to contend with the usual volatility of cryptocurrency and some additional risks beyond that.

It’s important to make sure you’ve done your research and to have a complete understanding of a cryptocurrency’s requirements before committing to a masternode.

Frequently asked questions

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Disclaimer: Cryptocurrencies are speculative, complex and involve significant risks – they are highly volatile and sensitive to secondary activity. Performance is unpredictable and past performance is no guarantee of future performance. Consider your own circumstances, and obtain your own advice, before relying on this information. You should also verify the nature of any product or service (including its legal status and relevant regulatory requirements) and consult the relevant Regulators' websites before making any decision. Finder, or the author, may have holdings in the cryptocurrencies discussed.

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