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Ethereum’s transition from Proof of Work to Proof of Stake is being very actively discussed today. This change could have a significant impact on the cryptocurrency market, which is closely linked to mining. Every investor should understand what positives and negatives this change brings with it.
It would not be an exaggeration to say that Proof-of-Work is the main idea behind bitcoin, which gave rise to the development of cryptocurrencies: it serves as the basis for a distributed ledger.
To begin with, it is necessary to understand what mining is. Mining is the complex computer calculations that must be done to create a new block and add it to the blockchain.
The importance of blockchain consensus
The most important advantage of blockchain is decentralization. It is a distributed database that the computers involved in it, called “nodes,” jointly maintain. All nodes are registers, meaning that they store the entire history of transactions on the blockchain. The network cannot be destroyed by unloading any central server.
Records of information, called “blocks,” are linked together through a protocol program, and no existing block can be deleted or changed. Adding a new block is the only way to update the blockchain; any node can do so without any central command.
If a node ignores predefined standards and creates a block, other nodes ignore it. However, if an incompatible node continues to create blocks without following the standards and other nodes start creating blocks on top of the incompatible blocks, then there will be a conflict in the community. A consensus mechanism is needed to prevent incompatible nodes creating so-called forks.
There may be malicious nodes that suppress other nodes in the network using a distributed denial of service (DDoS)
attack. Such nodes can initiate false positives. A consensus mechanism is also required to prevent this.
Proof of WorkProof-of-Work
(PoW) is used when a miner’s technical equipment solves complex mathematical problems. The miner receives a reward in the form of cryptocurrency for adding a verified block to the blockchain. Finding solutions is a complex process that requires a lot of computing power. Once a computer finds a solution, it sends a message to other computers in the community to verify. The solution is easy to verify because the other computers are given the answer.
The key feature of this mathematical problem is asymmetry: it must be moderately complex for the miner, but simple enough for the network as a whole. This is achieved with the help of cryptography. Each miner in the network tries to find the solution first, and it can in fact only be found by brute force, so it takes many attempts for a successful solution.
An example, perhaps a little fantastical, but illustrative. Imagine you are given a keyboard with several million numbered keys. You’re looking for the exact key you need to do the job right, but you don’t know its number, so you go through everything. There is a crowd around you looking for the right key, too.
Suddenly you find the right key, you tell everyone, “Guys, I found the key, its number is 22,875. Everyone around you starts checking the key number 22,875, and oh yes, that’s the key. The first one to find the key gets a prize. Then everyone is given another keyboard with a few million more keys on it. It starts all over again.
Unfortunately, while a mining company finds solutions in the real world, it also uses a lot of real world resources. Mining requires the constant purchase of equipment and huge amounts of electricity. People concerned about the planet and the environment are beginning to raise the issue of excessive use of electricity for mining.
It takes a lot of energy to run computers or clusters that are mining. The constant turnover of equipment, resulting from the fact that the process quickly wears out the components of the computers, creates a massive warehouse of obsolete parts. From an environmental perspective, this is bad for the planet.
Furthermore, the fact that mining requires serious computing hardware, costing more than the average person can afford, means that the mining society is made up mostly of rich and powerful people. This is very much at odds with the idea of decentralization, creating the risk of an individual who controls more than 51% of the computing power
taking over the entire mining ecosystem. Given the enormous cost of the hardware that will allow a net benefit, it is unlikely that the average person will go into this business.
Proof of Stake
The idea of Proof-of-Stake was first proposed on the bitcointalk forum back in 2011; a year later, the first cryptocurrencies using this method appeared – Peercoin, ShadowCash, Nxt, BlackCoin, NuShares/NuBits, Qora and Nav Coin.
Unlike Proof-of-Work, where the algorithm rewards miners who perform calculations to validate transactions and create new blocks, in Proof-of-Stake the creator of a new block is selected by the system in advance based on its state, that is, its share in the total amount of cryptocurrency.
The idea of proof-of-stake is to solve the problem of proof-of-work associated with high electricity consumption. Instead of participants’ computing power, it is the amount of cryptocurrency in their account that counts. So, instead of using a large amount of electricity to solve the PoW problem, a PoS participant has a limited percentage of transactions that can be verified. The limit corresponds to the amount of cryptocurrency in a participant’s account.
Proof of Stake (PoS) is used when a miner blocks a predetermined number of coins to verify a block of transactions. The cryptographic calculations in PoS are much simpler for computers. You only need to prove that you own a certain percentage of all coins available in a given currency. For example, if someone owns 2% of all ether (ETH), he will be able to mine 2% of all transactions through Ethereum.
Some believe that PoS would be a fairer system than PoW because technically anyone can become a miner. PoS offers a linear scale regarding the percentage of blocks a miner can validate based on that person’s share of the cryptocurrency. This means that the person who has ten times as many coins (e.g., one has $10,000 and another has $1,000) can only create 10 times as many blocks as the other.
Some believe that the move to PoS could foster greater global participation, as well as greater decentralization of capacity. By taking mining out of the hands of a few GPU farms, there would be an even distribution of mining work across the entire network, leading to a more democratized system.
Other consensus models
Other consensus algorithms are emerging on the market. For example, the “Proof of Space” proportionality factor, based on how much storage space a node has. There is also PoET (Proof of Elapsed Time) and a number of other algorithms, most of which are still unproven.
It is fair to say that technology continues to evolve exponentially, and it is impossible to predict what might happen or upset the balance in the mining world. However, Hydrominer is structured in such a way that we can innovate when new ideas and technologies emerge. With multiple lines of business and services, you can quickly move between departments as needed to increase revenue.
Why does Proof of Work continue to evolve and exist?
While PoS is definitely better than its rival, we believe that PoW will not disappear for the next decade, its need while mining will increase.PoW provides many benefits to participants and the industry that PoS does not.
Supply Distribution. Proof of Work is much better suited than its opponent for distributing the sale of currencies. Although miners are paid for their work, the costs associated with verifying the solutions found require them to sell their stock of coins rather than storing them. This creates a more even distribution and liquidity in the market. The accumulation of assets is not profitable for the miner, as in the Proof of Stake algorithm, so the miner will get more profit for buying and selling rather than holding.
Consensus and SPV customers. In Proof of Work, when a blockchain splits into two chains due to social or technical issues, it is much easier to determine which one has the best mining support. Miners tend to follow the chain that has more work done. This creates a more resilient blockchain with less chance of double payment or verification.
Inflation Management. The Proof of Work algorithm is great for the development of inflated currencies, it can change the complexity of the equation at any time to adjust for the creation of new coins. In the Proof of Stake algorithm, there is no cooperation between technology and markets to regulate and maintain the deflationary supply.
Mining is determined by the balances in the wallets of coin holders. Blocks are produced according to a set schedule, the distribution of new coins is determined proportionally based on how many crypto-asset holders have unspent coins. Essentially, Proof of Stake leaves no room for the market mechanism to regulate inflation. In theory, the development of coins through the PoS algorithm is stable, regardless of their value and profitability, but this completely destroys any market rules that control development.
As a result, even with a general supply shortage, errors in supply will hurt the PoS-based monetary system, leaving no room for stability and making reliable economic growth difficult.
Quality of equipment. While working with the PoW protocol, the community of miners is constantly improving the equipment used and looking for less power-hungry solutions. Using the best equipment is often exponentially better than less expensive counterparts when working through the PoS algorithm.
Reducing the possibility of a global attack. PoW encourages forces in the ecosystem working to improve the community by encouraging investment in the system – miners who use more blockchain computing hardware earn more cryptocurrency. Above all, it encourages integrity, because ensuring transaction integrity also ensures that miners are rewarded.
In addition, as more capacity comes online and better processing equipment is introduced, it is in the interest of the miner to invest more in the industry in order to compete in the marketplace. While miners still receive a commission for every transaction they process, they still need to compete for a piece of the network to get a better chance at mining, such as bitcoins.
This makes it much more difficult to get a sufficient hash rate (51%) to perform an attack on the system – this action becomes too expensive for the hacker, gives very little reward, especially compared to mining. Today, experts estimate that such an attack would cost more than a billion dollars.
Security. The PoS algorithm creates higher security threats to the system that are not inherent in the PoW system. The PoS consensus is not fixed in the physical world (with hashing hardware in PoW). Most currencies that rely on PoS also use additional mechanisms to solve security problems, often a combination of both PoS and PoW.
Forking and double payment. Proof of Stake has a serious problem: if there is a fork in the block chain (accidental or intentional), the rational behavior of users of a given network is to split blocks on both branches. With the PoW algorithm, such behavior is irrational. By splitting resources into multiple branches, the miner reduces the probability of finding a block.
The optimal strategy in a PoW system should always be executed on a single branch, since the rational behavior in a PoS system is to cull blocks over all branches that the user is aware of. This problem makes it easy to perform double payments or other types of attacks that come with branching the blockchain.
The rich get more. Unlike PoW, where a miner gets paid for doing work, in the PoS world, the more assets you own, the more you earn. Also, under this algorithm, protocol code changes are not determined by the miner’s agreement, they are determined by wallet votes. The protocol weighs votes based on wallet holdings.
So whoever has the most money has the most influence on the vote. This means that a small group of wealthy miners can control the entire miner network by voting for changes that benefit them. Under such a system, a large organization or wealthy group of people, such as a central bank, can use cash to buy huge amounts of coins in the PoS algorithm, holding them until their wallets are eligible to vote.
By seizing power in the system, controlling interests in the PoS network could vote to remove the supply restriction. And because they have the highest supply of coins, they get the highest return in the whole system-they have control of the entire money supply. Such a vote would essentially create a central bank, allowing controllers to use and distribute newly issued coins as they see fit. In other words, they could conduct central bank monetary policy. Consequently, economic cycles, politics, and corruption would enter the system, turning a PoS-based economy into total chaos.
Participant apathy. In the delegated PoS, one of the main problems is voter apathy. Many people vote once, forget to change their vote or vote for proxies, and forget to keep track of the results. The presence of voter apathy is a sign that incentives are not set properly in the system.
When the power is in the hands of users who have a long-term commitment of capital to the project, they have more incentive to vote because they cannot sell for months or years. Under the current system of delegated evidence, most users prefer to passively accept decisions made by others and then vote by selling the token. When users have the ability to “vote without commitment,” the balance of power changes completely.
Asset accumulation. POS encourages asset accumulation, which is great for speculation, but not for currency development or liquidity. Since PoS rewards people for the amount of coins they have, it would be natural to hold coins rather than distribute them. This would mean that liquidity would decrease, and the miners who have the most tokens would be in control of the validation process. This goes against the whole basis of a decentralized system and removes the most important part of blockchain: the trust factor.
Conclusion
The reality is that while the Proof of Stake algorithm manages some of the problems that exist with the Proof of Work mechanism, it creates several new completely different problems. In the cryptocurrency world, the Proof of Work algorithm is the most common protocol.
In the bitcoin world, Proof of Work is the only protocol. In the PoS world, most crypto-assets use a combination of the two algorithms. Understanding the reasons behind all this explains why PoW is still the driving force behind the blockchain community.
