As we expected, we received a lot of questions from readers since the publication of Crypto TREND. In this issue, we will answer the most common one.
What changes are coming that could change the game in the cryptocurrency sector?
One of the biggest changes that will affect the world of cryptocurrencies is an alternative method of block validation called Proof of Stake (PoS). We will try to keep this explanation at a fairly high level, but it is important to have a conceptual understanding of what the difference is and why it is a significant factor.
Remember that the underlying technology with digital currencies is called blockchain and most current digital currencies use a validation protocol called Proof of Work (PoW).
With traditional payment methods, you have to trust a third party, such as Visa, Interact, a bank or a clearing house to check your transaction. These trusted entities are “centralized,” meaning they keep their own private ledger that stores transaction history and the status of each account. They will show you the transactions, and you have to agree that it is correct or initiate a dispute. Only the parties to the transaction see it.
With bitcoin and most other digital currencies, books are “decentralized”, which means that everyone online gets a copy, so no one has to trust a third party, such as a bank, because anyone can directly verify the information. This verification process is called “distributed consensus”.
PoW requires that “work” be done to confirm a new transaction to enter the blockchain. In the case of cryptocurrencies, this validation is performed by “miners”, who have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and powerful computers to solve problems ahead of all others. “Mining” computers are often specialized, usually using ASIC chips (Application Specific Integrated Circuits), which are more skillful and faster in solving these difficult puzzles.
Here is the process:
- Transactions are linked in a ‘block’.
- The miners confirm that transactions within each block are legitimate by solving the hash algorithm puzzle, known as the “proof of labor problem”.
- The first miner to solve the “proof of work problem” of the block is rewarded with a small amount of cryptocurrency.
- After verification, transactions are stored in a public blockchain throughout the network.
- As the number of transactions and miners increases, so does the difficulty of solving hashing problems.
While PoW has helped blockchain and decentralized, unreliable digital currencies get launched, it has some real drawbacks, especially given the amount of electricity these miners consume trying to solve “evidence-at-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 are trying to solve problems, spending even more energy.
All that energy consumption just for transaction validation has motivated many in the digital currency space to look for an alternative method of block validation, and the leading candidate is a method called “Proof of Stake” (PoS).
PoS is still an algorithm, and the purpose is the same as with proof of work, but the process of reaching the goal is completely different. There are no miners in PoS, but instead we have “validators”. PoS relies on the trust and knowledge that all people who check transactions have their skin in the game.
In this way, instead of using energy to solve PoW puzzles, the PoS validator is limited to validating the percentage of transactions that reflect his or her ownership stake. For example, a validator that owns 3% of the available ether can theoretically only validate 3% of the blocks.
At PoW, the chances of solving a proof of work problem depend on how much computing power you have. With PoS, it depends on how many cryptocurrencies you have on the “role”. The higher the stake, the higher the chances that you will solve the block. Instead of winning crypto coins, the winning validator receives transaction fees.
Validators enter their stake by ‘locking’ part of their fund tokens. If they try to do something malicious against the network, such as creating an ‘invalid block’, their stake or security deposit will be lost. If they do their job and do not break the network, but do not win the right to validate 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 must understand all the details of these two methods of validation. Most of the public who wants to own cryptocurrencies will simply buy them through exchange, rather than participating in actual mining or block transaction validation.
Most in the crypto sector believe that digital tokens need to move to the PoS model in order for digital currencies to survive in the long run. At the time of writing, Ethereum is the second largest digital currency behind Bitcoin and their development team has been working on its PoS algorithm called “Casper” in recent years. We are expected to implement Casper in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have seen earlier in this sector, major events such as the successful implementation of Casper could lead to much higher Ethereum prices. We will keep you informed of future releases of Crypto TREND.