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10.10.2018

Masternodes: How do they work?

With the search for that elusive passive income among investors and the financially savvy increasing in popularity, masternodes offer crypto investors yet another opportunity to earn an income from their holdings while supporting the infrastructure of the coins they love.

What is a Masternode?

A masternode is a server supporting a decentralized network. Similar to Bitcoin’s full nodes, masternodes maintain a copy of the blockchain they are supporting in real-time and must be constantly up and running to carry out their unique functions. For instance, Dash is one of the most popular masternode coins, and its masternodes perform critical functions for maintaining the Dash blockchain such as running a dash wallet, locking transactions with Dash’s InstantSend, coordinate the mixing of coins, and voting on budget funding. In general, masternodes perform critical core functions related to privacy, instant transactions, governance, and voting.

Still interested in earning that passive income? Masternodes require a substantial investment to run but operators can benefit substantially for their work. As with all consensus mechanisms, incentivization is key. Masternode operators are incentivized through portions of block rewards earned in whichever cryptocurrency they are supporting. Unlike mining, operating a masternode does not require continued investment in expensive mining equipment or huge electricity costs.

While every masternode supporting coin is different and approaches payouts in different ways, all masternodes share the same characteristics in that they allow holders to earn passive returns on their crypto assets. Of course, this is easier said than done, as their is usually a substantial barrier to entry such as a minimum asset threshold that must be met for a holder to set up their own masternode.

What does it take to run a masternode?

If you want to earn a passive income as a masternode operator, the first step to success is accumulating a large amount of the coin you wish to facilitate. For example, to run a Dash masternode an operator must possess a minimum of 1000 Dash tokens. With Dash currently trading an around $180 USD per token, 1000 Dash requires an investment of $18,000 USD, which is no small sum! In any case, if you do have the assets, then you should definitely consider running a masternode as a means for guaranteeing a return on your investment. Typically, masternode operators earn anywhere from five to twenty percent of a given block reward, depending on which cryptocurrency is being supported.

You might be wondering why the minimum threshold for operating a dash masternode is so high. The answer again lies with incentivization. Developers want to make sure the values of masternode operators are aligned with dash itself. Thus to discourage masternode operators from trying to potentially disrupt the blockchain, operators must also be asset owners. As asset owners, masternode operators will behave much more responsibly as they now have a vested interest in making sure the blockchain runs smoothly.

Masternodes are similar in concept to the proof of stake consensus mechanism but perform higher order functions than staking. In fact, masternodes are not exclusive to proof of stake systems as there are several proof of work systems that utilize masternodes as well. But for the smaller portfolio unable to meet the threshold for operating a masternode, staking through proof of stake remains the best way to earn a passive income.

How to run your own masternode

The most common way to set up your own masternode is known as a cold wallet setup. Follow the steps below to begin your own cold wallet masternode setup.

  1. Decide on which coin you are going to support and buy the necessary amount of coins. Consider buying slightly more than the minimum in case of exchange fees or other hidden fees.
  2. Download and install the desktop wallet client to your computer and synchronize your system to the blockchain.
  3. Send your new coins to your wallet. Setup a masternode address in your wallet and send your coins to it. This step allows you to gather the private key and transaction information necessary for setting up your masternode.
  4. To set up the node, you need to decide whether to use a personal server at your home or to use the most common method of renting a virtual private server (VPS) a provider’s data centre. Vultr is a popular VPS that costs about $10 a month per masternode.
  5. Once your server it up and running,  synchronize all your software to the blockchain by starting the masternode ‘daemon’ at the server. Make sure to configure the masternode wallet to your own desktop wallet.
  6. Masternode setup is complete! Begin collecting your block rewards.

How much money can a masternode earn?

How much money a masternode earns depends entirely on the coin you choose to support, the rewards given, and the future performance of the underlying asset. Those looking to set up their own masternode should do their own due diligence in order to find the best masternode coins. Given the substantial amount of assets a masternode operator must stake to even run a masternode, you must be willing to lock up your assets for the long term. Every coin is different, and not every coin will be valuable in the future so pick your asset carefully.

The best way to analyze a masternode supporting coin is through its utility. While it sounds obvious, for a masternode to be valuable, the system its supporting must have an actual use case. Masternodes should be a feature rather than the defining characteristic. To avoid scam coins, consider looking for coins with well established use cases that have only recently decided to introduce masternodes into their infrastructure. Remember, as famous equity investor Warren Buffett once said: “price is what you pay, value is what you get”.

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