As we expected, since the publication of Crypto TREND, we have received many questions from readers. In this issue, we will answer the most common ones.
What changes are coming that could change the game in the cryptocurrency sector?
One of the biggest changes that will affect the cryptocurrency world is an alternative block validation method called Proof of Stake (PoS). We’ll try to keep this explanation fairly high-level, but it’s important to have a conceptual understanding of what the difference is and why it’s a significant factor.
Remember that the underlying technology with digital currencies is called blockchain and that most current digital currencies use a verification protocol called Proof of Work (PoW).
With traditional payment methods, you must trust 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 must agree that they are correct or open a dispute. Only the parties to the transaction see it.
With Bitcoin and most other digital currencies, the ledgers are “decentralized,” meaning that everyone on the network gets a copy, so no one has to trust a third party, such as a bank, because everyone can verify the information directly. This verification process is called “distributed consensus”.
PoW requires “work” to be done to confirm a new transaction for entry into the blockchain. With cryptocurrencies, this validation is done by “miners”, who have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need ever more expensive and powerful computers to solve the problems before everyone else. “Mining” computers are often specialized, usually using ASIC (Application Specific Integrated Circuits) chips, which are more adept and faster at solving these difficult puzzles.
Here’s the process:
- Transactions are grouped together in a ‘block’.
- Miners verify that the transactions within each block are legitimate by solving a hashing algorithm puzzle known as the “proof-of-work problem.”
- The first miner to solve a block’s “proof of work problem” is rewarded with a small amount of cryptocurrency.
- After verification, transactions are stored in a network-wide public blockchain.
- As the number of transactions and miners increases, so does the difficulty of solving the hashing problem.
While PoW helped launch blockchain and decentralized, trustless digital currencies, it has some real drawbacks, especially with the amount of electricity these miners waste trying to solve “proof-of-work problems” as quickly as possible. According to Digiconomist’s Bitcoin Energy Consumption Index, Bitcoin miners use more energy than 159 countries, including Ireland. As the price of each Bitcoin rises, 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 of block validation, with a leading candidate being a method called “Proof of Stake” (PoS).
PoS is still an algorithm, and the purpose is the same as in proof of work, but the process to the goal is quite different. With PoS, there are no miners, but instead we have “validators”. PoS relies on trust and the knowledge that all people validating transactions are in on the game.
In this way, instead of using energy to solve PoW puzzles, the PoS validator is limited to verifying a percentage of transactions that reflects his or her ownership stake. For example, a validator that owns 3% of available Ether can theoretically only validate 3% of blocks.
In PoW, the chances of solving the proof-of-work problem depend on how much computing power you have. With PoS, it depends on how much cryptocurrency you have on “stake”. The higher the stake, the higher the chances of solving the block. Instead of winning crypto coins, the winning validator receives transaction fees.
Validators enter their stake by ‘locking’ a portion of their token pool. If they try to do something malicious against the network, like creating an ‘invalid block’, their stake or security deposit will be forfeited. If they do their job and don’t breach the network, but don’t win the right to confirm the block, they will 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 the ins and outs of these two validation methods. Most of the general public who want to own cryptocurrencies will simply buy them through an exchange and will not participate in the actual mining or confirmation of block transactions.
Most in the crypto sector believe that digital tokens must move to a PoS model in order for digital currencies to survive in the long term. At the time of writing this post, Ethereum is the second largest digital currency behind Bitcoin and their development team has been working on their PoS algorithm called “Casper” for the past few years. We are expected to implement Casper in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have already seen in this sector, major events such as the successful implementation of Casper could boost Ethereum prices. We will keep you posted in future issues of Crypto TREND magazine.
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