As we expected, since the publication of Crypto TREND we have received a lot of questions from readers. In this edition we will answer the most common one.
What different changes are coming that could be game changers in the cryptocurrency sector?
One of the most common changes affecting the cryptocurrency world is an alternative block validation method called Proof of Stake (PoS). We try to keep this explanation at a relatively high level, but it’s important to have a conceptual understanding of what diversity is and what it causes.
Keep in mind that the underlying technology with digital currencies is called blockchain and most today’s digital currencies use a validation protocol called Proof of Work (PoW).
With traditional payment methods, you must trust a third party, such as Visa, Interact, or bank, or a check clearing house to pay for your transaction. These trusted entities are “centralized”, meaning they keep their own private ledger where the transaction history and balance of each account are stored. They will show you the transactions, and you will have to agree that they are correct, or launch a conflict. Only the parties to the transaction saw it.
With Bitcoin and most other digital currencies, ledgers are “decentralized”, meaning that everyone on the network gets a copy, so no one has to rely on a third party, such as a bank, because anyone directly can verify the information. This process of validation is called “distributed consensus.”
PoW needs to do the “work” to validate a new transaction for blockchain entry. In cryptocurrencies, that authentication is done by “miners”, who have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and more powerful computers to solve the problems that come first of all. “Mining” computers are always specialist, often using ASIC chips (Application Specific Integrated Circuits), which are more skilled and faster at solving difficult puzzles.
Here is the process:
- Transactions are combined in a ‘block’.
- The miners verify that the transactions inside each block are legitimate by solving the hashing algorithm puzzle, known as “proof of the work problem”.
- The first miner to solve the block’s “proof of work” problem was rewarded with a small amount of cryptocurrency.
- Once verified, transactions are stored in a public blockchain across the network.
- As transactions and miners increase, the difficulty of solving hashing problems also increases.
Even if PoW has helped get blockchain and decentralized, unreliable digital currencies off the ground, it has some real drawbacks, especially with the amount of electricity consumed by miners trying to solve the “ proof of work problems ”as quickly as possible. According to Digiconomist’s Bitcoin Energy Cons Consumption Index, Bitcoin miners use more energy than 159 countries, including Ireland. As the price of each Bitcoin rises, many miners try to solve the problems, wasting even more energy.
All the power consumption just to prove transactions has prompted most of the digital currency space to look for alternative methods of validating 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 to prove the work, but the process to reach the purpose is different. In PoS, there are no miners, but instead we have “verifiers.” PoS relies on trust and knows that all the people who authenticate transactions have the skin of the game.
In this way, instead of using energy to solve PoW puzzles, the one who determines PoS is limited to verifying a percentage of transactions that reflect his or her stake in ownership. For example, a verified owner of 3% available in Ether could theoretically validate only 3% blocks.
In PoW, the chances that you will solve a proven problem at work depend on how much computing power you have. With PoS, it depends on how much your cryptocurrency is at “stake”. The higher your stake, the higher the chances that you will solve the block. Instead of winning crypto coins, the winning validator receives a transaction fee.
Validators enter their stake by ‘closing’ a portion of their fund tokens. Should they try to do something bad against the network, such as creating an ‘invalid block’, their stake or security deposit will disappear. If they do their job and don’t break the network, but don’t win the right to validate the block, they get their bet or deposit.
If you know the basic difference between PoW and PoS, that’s all you need to know. Those planning to become miners or validators should know all the ins and outs of these two methods of validation. The vast majority of the public who seek to own cryptocurrencies will only sell them through an exchange, and will not engage in actual mining or validation of blockchain transactions.
Most in the crypto sector believe that in order for digital currencies to survive in the long run, digital tokens need to be transferred to a PoS model. 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 expect to see Casper implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have seen before in this sector, major events such as a successful implementation of Casper could send Ethereum prices even higher. We will keep you updated on future issues of Crypto TREND.
Keep an eye out!