As we expected, since the publication of Crypto TREND we have received many questions from readers. In this edition we will answer the most common.
What kind of changes will occur that could change the game in the cryptocurrency industry?
One of the biggest changes to hit the cryptocurrency world is an alternative block validation method called Proof of Stake (PoS). We’ll try to keep this explanation at a fairly high level, but it’s important to have a conceptual understanding of what the difference is and why it’s an important factor.
Remember that the underlying technology with digital currencies is called blockchain and most digital currencies today use a validation protocol called Proof of Work (PoW).
With traditional payment methods, you must rely on a third party such as Visa, Interact or a bank or check clearing house to settle your transaction. These trusted entities are “centralized”, meaning they maintain their own private ledger that stores the transaction history and balance of each account. They will show you the transactions and you have to accept that it is correct or start a dispute. Only the parties to the transaction ever see it.
With Bitcoin and most other digital currencies, the ledgers are “decentralized”, meaning everyone on the network gets a copy, so no one has to trust a third party, like a bank, because anyone can verify information directly. This verification process is called “distributed consensus”.
PoW requires “work” to be done to validate a new transaction for entry into the blockchain. With cryptocurrencies, this validation is done by “miners,” who must solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and more powerful computers to solve the problems ahead of everyone else. “Mining” computers tend to be specialized, typically using ASIC (Application Specific Integrated Circuits) chips, which are more skilled and faster at solving these difficult puzzles.
Here’s the process:
- Transactions are grouped into a “block”.
- Miners verify that the transactions within each block are legitimate by solving the hashing algorithm puzzle, known as the “proof-of-work problem.”
- The first miner to solve the block’s “proof of work problem” is rewarded with a small amount of cryptocurrency.
- Once verified, transactions are stored on the network-wide public blockchain.
- As the number of transactions and miners increases, so does the difficulty of solving hashing problems.
While PoW helped bring blockchain and digital currencies decentralized and trustless, it has some real shortcomings, especially with the amount of electricity these miners consume trying to solve “proof-of-work problems” as quickly as possible possible According to Digiconomist’s Bitcoin Energy Consumption Index, Bitcoin miners are using more energy than 159 countries, including Ireland. As the price of each Bitcoin increases, more and more miners try to solve the problems, consuming even more energy.
All this energy consumption just to validate transactions has motivated many in the digital currency space to look for an alternative method to validate blocks, and the leading candidate is a method called “Proof of Stake” (PoS).
PoS is still an algorithm, and the purpose is the same as proof of work, but the process to achieve the goal is quite different. With PoS, there are no miners, instead we have “validators”. PoS is based on trust and the knowledge that everyone who is validating transactions has skin in the game.
This way, instead of using energy to answer PoW puzzles, a PoS validator is limited to validating a percentage of transactions that reflects their ownership stake. For example, a validator who owns 3% of the available Ether can theoretically only validate 3% of the blocks.
In PoW, the chances of solving the proof of work problem depends on how much computing power you have. With PoS, it depends on how much cryptocurrency you have in “play”. The bigger the bet you have, the more likely you are to solve the block. Instead of earning crypto coins, the winning validator receives transaction fees.
Validators enter their stake by “closing” a portion of their fund tokens. If they try to do something malicious against the network, such as creating an “invalid lock”, they will lose their stake or security deposit. If they do their job and don’t break the network, but don’t earn the right to validate the blog, they’ll get their stake or deposit back.
If you understand the basic difference between PoW and PoS, that’s all you need to know. Only those who plan to be miners or validators need to understand all the pros and cons of these two validation methods. Most of the general public who want to own cryptocurrencies will simply buy them through an exchange and not participate in the actual mining or validation of block transactions.
Most of the crypto sector believes that for digital currencies to survive in the long term, digital tokens must switch to a PoS model. At the time of writing, Ethereum is the second largest digital currency behind Bitcoin and its development team has been working on its PoS algorithm called “Casper” for the past few years. We expect to see Casper implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we’ve seen before in this industry, major events like a successful Casper implementation could send Ethereum prices much higher. We will keep you informed in future issues of Crypto TREND.