As expected, we’ve received a lot of questions from readers since Crypto TREND was released. In this edition we will answer the most common ones.
What changes will come in the cryptocurrency sector that could be a game changer?
One of the biggest changes that will affect the world of cryptocurrency is the alternative method of block validation called Proof of Stake (PoS). We will try to keep this explanation relatively high, but it is important to understand conceptually what the difference is and why it is a significant factor.
Remember that the technology behind digital currencies is called blockchain, and most current digital currencies use a validation protocol called Proof of Work (PoW).
With traditional payment methods, you need to trust a third party, such as a Visa, Interact or bank, or a check settlement to settle your transaction. These trusted entities are “centralized,” that is, they keep their own private book, which stores the history of the transaction and the balance of each account. They will show you the transactions, and you must accept that it is correct or put in a dispute. Only the parties to the transaction ever see it.
With most Bitcoin and other digital currencies, books are “decentralized,” meaning everyone on the network gets a copy so no one has to rely on a third party, such as a bank, because anyone can directly verify the information. This verification process is called “distributed consent.”
PoW requires “work” to validate a new blockchain access transaction. With cryptocurrencies, this validation is done by “miners” and they have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and powerful computers to solve problems before everyone else. “Mining” computers tend to be specialized, typically using ASIC (Application Specific Integrated Circuits) chips, which are more skilled and quicker in solving these difficult puzzles.
Here is the process:
- Transactions are grouped in a “block”.
- The miners check that the transactions in each block are legitimate by solving the hashing algorithm puzzle, known as the “work proof problem”.
- The first miner to solve the “problem of proof of work” is rewarded with a small amount of cryptocurrency.
- Once verified, transactions are stored in the public block throughout the network.
- As the number of transactions and miners increases, so does the difficulty of resolving hashing issues.
While PoW has helped bring out the blockchain and decentralized and reliable digital currency, it has some real shortcomings, especially with the amount of electricity these miners consume in an attempt to fix “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 their problems, consuming even more energy.
This power consumption has only motivated many of the digital currency space to validate transactions in search of alternative methods to validate blocks, and the main candidate is the “Proof of Stake” (PoS) method.
It’s still a PoS algorithm, and the goal is the same as the proof of work, but the process for achieving the goal is quite different. With PoS, there are no miners, but instead we have “validators”. PoS is based on trust and knowing that everyone who is validating transactions has their skin in the game.
Thus, instead of using energy to respond to PoW puzzles, a PoS validator is limited to validating a percentage of transactions that is a reflection of its ownership share. For example, a validator who owns 3% of the available Ether can theoretically only validate 3% of the 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 in the “game”. The higher the stake, the greater the chances of fixing the block. Instead of winning cryptocurrencies, the winning validator receives transaction fees.
Validators enter their participation by “blocking” a portion of the fund token. If they try to do something malicious against the network, such as creating an “invalid lock”, their share or security deposit will be lost. If they do their job and do not violate the network, but do not earn the right to validate the lock, they will return their share or deposit.
If you understand the basic difference between PoW and PoS, that’s all you need to know. Only those who intend to be miners or validators need to understand the purpose of these two validation methods. Most audiences who want to hold cryptocurrencies will buy them through an exchange, and will not be involved in the actual mining or validation of block transactions.
Most in the crypto sector believe that for digital currency to survive in the long run, digital tokens need to be converted to a PoS model. At the time of writing, Ethereum is the second largest digital currency behind Bitcoin, and its development team has been working on a PoS algorithm called “Casper” for the past few years. We expect to see Casper set in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we’ve seen in this industry before, big events like Casper’s successful deployments can lead to much higher Ethereum prices. We will keep you updated on future issues of Crypto TREND.