What is a Masternode?

Part 1 - A new way to generate passive income
Part 2 - What is a Masternode?
Part 3 - Are you an ideal Masternode operator?
Part 4 - Finding the Perfect Masternode Coin
Part 5 - How to Buy Masternode Coins
Part 6 - Masternode Setup 101

If you want to understand why I’m so excited about Masternodes and the passive income they generate, read Part 1 of this series. 

In simplest terms, a Masternode is a participant of a decentralized blockchain network that performs the function of validating transaction on that network. In exchange, the masternode operator is rewarded with NEW money supply on a periodic basis (usually daily). On the face of it, this is very similar to cryptocurrency mining, but with one major difference - COST. 

As a cryptocurrency mining operator, you invest in the hardware (mining rigs), facility, and most importantly ongoing POWER costs to run the miners. This initial (and ongoing) investment is what you are trading to receive the passive income of mining rewards. In an ideal world, the rewards are much higher than your costs and you make a profit. In 2017 I was practically printing money all year long. Since the bear market of 2018 hit, the rewards barely cover operating costs and one might find himself driving an Uber to make ends meet. 

The investment and operating model for a Masternode are similar to mining, but the deployment of capital is different and ongoing operating costs are practically zero as compared to mining. Instead of purchasing computer hardware and renting a facility, you need to purchase a large amount of the actual cryptocurrency that you want to get rewarded in. This investment is the collateral needed to operate a Masternode. As long as the collateral is in your wallet (locked up), you will continue to receive the rewards. The only ongoing cost to operate a masternode is a Virtual Private Server (VPS). You set up a VPS on a cloud hosting provider such as Amazon Web Services (AWS), or my recommended option - Vultr. I will go into more detail as to the actual cost in Part 3 of this series. 

That’s It! All a Masternode operator has to do is buy enough cryptocurrency to fund the masternode, download a desktop wallet to store the funds, and deploy a VPS. There is no rent to pay, facility to keep cool or massive power costs. 

Another key concept to understand before investing in masternodes is that the rewards that masternode operators get are FIXED, but the number of masternodes that can participate in UNLIMITED. Said another way, the more masternodes that participate the less each masternode operator gets. This diminishing reward structure is balanced with the fluctuation of the price of the coin. The higher the price of the coin the more masternodes people will set up and the less each operator gets. As the price falls, masternode operators will leave the market and each operator that stays gets more rewards.

Masternode collateral amounts vary by cryptocurrency. The oldest and most popular masternode coin is Dash requiring 1000 DASH for each masternode and costing a whopping $460K in May 2018. But you can also buy masternodes for several bucks and everything in between. The return on investment (ROI) for the different nodes also varies. Currently, the Dash node will earn you 7% APR on your investment. While other nodes that are newer and riskier investments payout as high as 10,000% (not a typo). That number seems outrageous, and in part, it is, as those returns are TEMPORARY. I’ve been operating many of my nodes with 300-700% APR for months.

Forcing the collateral of the masternodes to be locked up and not spendable offers another key economic benefit to the HODLers and Masternode operators of the coins. It effectively limits circulating money supply and therefore creates scarcity. The scarcity helps drive prices higher for a currency that is in great demand. The balance to the scarcity is the continual flow of NEW money supply in the form of masternode rewards. Getting this balance correct is key to having a good money supply algorithm. Not all masternode coins are created equal and in Part 4 of this series, I'll do a deep dive on how to pick great ones.

Now that you know what a Masternode is and how they work, Part 3 will explain why you should get one (or not?).