As we expected, after publishing Crypto TREND, we 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 an important 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 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 keep their own private ledger that stores the transaction history and balance of each account. They will show you the transactions and you have to agree that it is correct or start 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, like a bank, because anyone can directly verify the information. This verification process is called “distributed consensus”.
PoW requires “work” to be done to confirm a new transaction to enter the blockchain. In cryptocurrencies, this validation is done by “miners” who must solve complex algorithmic problems. As algorithmic problems become more complex, these “diggers” need more expensive and more powerful computers to solve the problems before everyone else. “Mining” computers are often specialized, typically using ASIC chips (application specific integrated circuits) that are more adept and faster at solving these difficult puzzles.
Here is the process:
- Transactions are grouped together in a “block”.
- Miners verify that the transactions in 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, transactions are stored on the network-wide public blockchain.
- As the number of transactions and miners increases, so does the difficulty of solving hashing problems.
While PoW helped launch blockchain and decentralized, trustless digital currencies, it has some real drawbacks, especially with the amount of electricity these miners consume 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 of this energy consumption just for validating transactions has motivated many in the digital currency space to look for an alternative method to validate blocks, and the leading candidate is a method called Proof of Stake (PoS).
PoS is still an algorithm and the goal is the same as proof of work, but the process to achieve the goal is completely different. With PoS, there are no miners, but instead we have “validators”. PoS relies on trust and the knowledge that all the people validating transactions have skin in the game.
Thus, instead of using energy to answer PoW puzzles, the PoS validator is limited to validating a percentage of transactions that reflects his or her ownership stake. 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 at “stake”. The higher your bet, the better the chances of solving the block. Instead of earning crypto coins, the winning validator receives transaction fees.
Validators enter their stake by “locking up” a portion of their stock tokens. If they try to do something malicious against the network, such as creating an “invalid block”, their stake or security deposit will be forfeited. If they do their job and don’t break the network, but don’t earn 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 need to understand all the ins and outs of these two validation methods. The majority of the general public who wish to own cryptocurrencies will simply buy them through an exchange and not be involved in the actual mining or validation of block transactions.
Most in the crypto sector believe that for digital currencies to survive in the long term, digital tokens must move to a PoS model. At the time of writing this post, Ethereum is the second largest digital currency after Bitcoin and their development team has been working on their PoS algorithm called “Casper” for the past few years. It is expected that we will see Casper implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have seen before in this sector, big events like the successful implementation of Casper can lead to much higher Ethereum prices. We will keep you updated in future editions of Crypto TREND.
Stay on the line!