Crypto TREND - Fifth Edition
As we expected, since publishing Crypto TREND we have
received many questions from readers. In this edition we will answer the most
common one.
What kind of changes are coming that could be game
changers in the cryptocurrency sector?
One of the biggest changes that will impact the
cryptocurrency world is an alternative method of block validation called Proof
of Stake (PoS). We will try to keep this explanation 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 of the current digital currencies use
a validation protocol called Proof of Work (PoW).
With traditional methods of payment, you need to trust
a third party, such as Visa, Interact, or a bank, or a cheque clearing house to
settle your transaction. These trusted entities are "centralized",
meaning they keep their own private ledger which stores the transaction's
history and balance of each account. They will show the transactions to you,
and you must agree that it is correct, or launch 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, such as a bank, because anyone can
directly verify the information. This verification process is called
"distributed consensus."
PoW requires that "work" be done in order to
validate a new transaction for entry on the blockchain. With cryptocurrencies,
that validation is done by "miners", who must solve complex
algorithmic problems. As the algorithmic problems become more complex, these
"miners" need more expensive and more powerful computers to solve the
problems ahead of everyone else. "Mining" computers are often
specialized, typically using ASIC chips (Application Specific Integrated
Circuits), which are more adept and faster at solving these difficult puzzles.
Here is the process:
- Transactions are bundled together in a 'block'.
- The 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, the transactions are stored in the public blockchain across the entire network.
- As the number of transactions and miners increase, the difficulty of solving the hashing problems also increases.
Although PoW helped get blockchain and decentralized,
trustless digital currencies off the ground, it has some real shortcomings,
especially with the amount of electricity these miners are consuming trying to
solve the "proof of work problems" as fast as 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
rises, more and more miners try to solve the problems, consuming even more
energy.
All of that power consumption just to validate the
transactions has motivated many in the digital currency space to seek out
alternative method of validating the 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 in the proof of work, but the process to reach 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 the people who are validating
transactions have skin in the game.
This way, instead of utilizing energy to answer PoW
puzzles, a PoS validator is limited to validating a percentage of transactions
that is reflective of his or her ownership stake. For instance, a validator who
owns 3% of the Ether available can theoretically validate only 3% of the
blocks.
In PoW, the chances of you solving the proof of work
problem depends on how much computing power you have. With PoS, it depends on
how much cryptocurrency you have at "stake". The higher the stake you
have, the higher the chances that you solve the block. Instead of winning
crypto coins, the winning validator receives transaction fees.
Validators enter their stake by 'locking up' a portion
of their fund tokens. Should 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 do not violate 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 is all you need to know. Only those who plan to be miners or
validators need to understand all the ins and outs of these two validation
methods. Most of the general public who wish to possess cryptocurrencies will
simply buy them through an exchange, and not participate in the actual mining
or validating of block transactions.
Most in the crypto sector believe that in order for
digital currencies to survive long-term, digital tokens must switch over 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" over the last few years. It is
expected that we will see Casper implemented in 2018, putting Ethereum ahead of
all the other large cryptocurrencies.
As we have seen previously in this sector, major
events such as a successful implementation of Casper could send Ethereum's
prices much higher. We'll be keeping you updated in future issues of Crypto
TREND.
Stay tuned!
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