As we expected, since the publication of Crypto TREND we have received many questions from readers. In this edition we will answer the most common.
What are the changes 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 checking blocks called Proof of Stake (PoS). We will try to maintain 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 an important factor.
Remember that the basic technology of digital currencies is called blockchain, and most modern digital currencies use a validation protocol called Proof of Work (PoW).
With traditional payment methods you need to trust third parties such as Visa, Interact, a bank or a cash center to pay for your transaction. These trusted structures are “centralized,” meaning they keep their own private ledger that stores the transaction history and balance of each account. They will show you the transaction and you have to agree to the correctness or start a dispute. It is seen only by the parties to the transaction.
With bitcoins and most other digital currencies books are “decentralized,” meaning everyone on the network gets a copy, so no one should trust third parties, such as a bank, because anyone can directly verify the information. This verification process is called “distributed consensus”.
PoW requires “work” to verify a new transaction to log in to the blockchain. In cryptocurrencies, the test 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 that are ahead of all others. Computers for mining often specialize, typically using ASIC chips (integrated circuits), which are more knowledgeable and fast in solving these complex puzzles.
Here is the process:
- Transactions are combined into a “block”.
- The miners argue that the transactions in each block are legal by solving a hashing algorithm puzzle known as the “proof of work problem”.
- The first miner who solved the problem of “proof of operation” 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 increases and so does the complexity of solving hashing problems.
Although PoW has helped lift blockchain and decentralized, distrustful digital currencies, it has some real drawbacks, especially in how much energy these miners consume, trying to solve “evidence of work problems” as quickly as possible. According to the Digiconomist Bitcoin Energy Consumption Index, bitcoin miners use more energy than 159 countries, including Ireland. As the value of each bitcoin increases, more and more miners are trying to solve the problem by consuming even more energy.
All of this power consumption-only transaction verification has forced many people in the digital currency space to look for an alternative way to verify blocks, and the main candidate is a method called “Proof of Bid” (PoS).
PoS is still an algorithm, and its purpose is the same as in job validation, but the process of achieving the goal is quite different. There are no PoS miners, but instead we have “validators”. PoS is based on trust and knowledge that all people who check transactions have skin in the game.
Thus, instead of using energy to respond to PoW puzzles, the PoS validator is limited to checking the percentage of transactions that reflects its share of ownership. For example, a validator that owns 3% of the available airtime could theoretically check only 3% of the blocks.
In PoW, the chances of solving a work confirmation problem depend on how much computing power you have. With PoS it depends on how much cryptocurrency you have on the “bet”. The higher your bet, the better your chances of deciding a block. Instead of winning crypto-coins, the winning validator receives a commission for the transaction.
Validators enter their bet by “closing” part of their fund tokens. If they try to do anything harmful against the network, such as creating an “invalid block,” their bet or deposit will be forfeited. If they do their job and do not break the network but do not win the right to confirm the block, they will get their share or deposit back.
If you understand the basic difference between PoW and PoS, this is all you need to know. Only those who plan to be miners or validators should understand all the intricacies of these two verification methods. Most of the general public who wants to own cryptocurrencies will simply buy them through an exchange and will not engage in actual mining or verification of block transactions.
Most in the crypto sector believe that in order for digital currencies to survive long, digital tokens must move to the PoS model. At the time of writing, Ethereum is the second largest digital currency after bitcoin, and their development team has been working on its PoS algorithm called Casper for the past few years. We are expected to see how Casper will be implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have seen in this sector, major developments such as the successful implementation of Casper can significantly raise Ethereum prices. We will keep you informed in future issues of Crypto TREND.