The Proof-of-Stake algorithm and why it was created
To begin with, by and large you do not need to know the exact details of how cryptocurrencies work (this is for the very lazy) in order to use them. According to Coinmarketrate.com now there are platforms and wallets that can make the use of Bitcoin or other cryptocurrencies convenient for you, and in the future they will be improved to such an extent that you, as a user, will need to know almost nothing about the technical details. But this is in the future, and on the other hand, why not? Why not broaden your horizons? At the very least, it’s always helpful to know what you’re going to be dealing with.
Proof-of-Stake (POS) is an alternative algorithm for approving individual blocks of transactions in a decentralized blockchain registry. The Proof-of-Stake concept states that a person can verify transactions based on the number of coins they own.
So, in simple terms, you can mine cryptocurrency without expensive equipment, just owning a certain number of coins of this cryptocurrency. Let’s take the example of the SpaceBot wallet, a mobile application for staking (we will discuss it later). However, in this case, this is not called mining, but validation (verification). This means that for storing cryptocurrencies using the Proof-of-Stake algorithm in this wallet, you get a certain amount, depending on how much cryptocurrency you own.
Hence, betting is a term for obtaining some cryptocurrency equivalent of dividends on a stock, which in the case of cryptocurrency is nothing more than transaction costs for approving transactions that validators receive.
Back to Bitcoin
But this simplified explanation is not enough. That is why it is necessary to start from the very beginning, that is, with Bitcoin.
Bitcoin is the first cryptocurrency. It was created by an anonymous creator named Satoshi Nakamoto, and other cryptocurrencies are more or less based on it, and often react to some of its shortcomings, but we’ll come back to that.
Satoshi used a concept called Proof-of-Work to create the BTC. He didn’t invent it, it existed before. But Satoshi was able to find a use for it, for which he was subsequently nominated for the Nobel Prize, but we digress from the topic. In his Whitepaper, he defined a new electronic monetary system – Bitcoin.
Besides the fact that his money was conceived as electronic cash, they had at least one more difference from traditional cash, namely: they were decentralized. In Bitcoin, there was no central authority, state, bank that would guarantee the accuracy of data, confirm transactions, etc.
Cryptocurrency Mining and Proof-of-Work (POW)
This raises a number of fundamental questions. How to guarantee the reliability of the network, and who will verify transactions? What will prevent hackers from creating even more coins, and how to make sure that all nodes (computers in the network) reach a consensus about a particular database, the state of the wallet and the individual movement of funds?
This is where the Proof-of-Work mining algorithm comes into play – be careful and don’t confuse it with Proof-of-Stake. This ensures that there is no need for individual participants in a decentralized database to trust each other, nor is there a need for any central authority. Instead, all miners do the work, that is, they do not mean human labor, but computing power.
A complex puzzle is being solved, and the miner whose device gets the solution first can mine the block and approve the transaction. Then it will receive a reward (currently 6.5 BTC) + a transaction fee. The rest of the network checks his solution, and if everything is fine, he continues mining the next block. This process is called mining. Although cryptocurrency mining and the use of Proof-of-Work (POW) for Bitcoin are, in principle, absolutely brilliant in their simplicity, there are also negative sides.
The genius lies in the elegance of this solution. The only way to write anything to the blockchain is a new transaction, which must be approved by the miners and mined in the transaction block. However, the record cannot be changed in any way retroactively, only repeatedly by a new transaction.
At the same time, such a transaction cannot be recorded in the blockchain (a decentralized cryptocurrency database) by anyone other than a miner who solves a complex puzzle and produces a block. No one can send funds from any address anywhere, not even a miner, only the owner of the private key who sends the transaction for approval.
Initially, if you were lucky enough to become interested in Bitcoin shortly after its appearance, you could easily mine a significant amount of BTC on your personal computer. As interest in Bitcoin grew, so did its price, which attracted more and more miners. Over time, mining has turned into a ready-made industry.
- Centralization of mining
Specialized equipment for direct mining appeared, with huge power, which displaced small miners, the so-called ASIC miners. In addition, they began to form pools, that is, special groups in which more and more mining capacity is concentrated. Together they have a better chance of mining a block and then splitting the reward depending on the performance of the pool members. However, this leads to greater centralization, and with it, to the potential danger of combining several pools to dominate the network.
The current share of individual mining pools in the Bitcoin network. Source: coin.dance
- 51% attack and double spending
This would mean not only a return to centralization, but also a loss of trust in the Bitcoin network. In addition, it is possible (hypothetically) the so-called 51% attack. This is possible with the help of the PoW algorithm precisely when one subject has the majority of computing power.
You can also buy computing power, but because of the strong network, it will be very expensive, and if you spend twice as much, the costs will be huge. You can imagine double spending as a situation where an attacker sends a transaction, but then uses 51% of the mining power to discard the blockchain containing that transaction and instead creates a new chain where the transaction does not exist. This, in other words, allows him to spend the same coin twice.
Fortunately, thanks to the development of mining, Bitcoin now has such a strong network that this cannot happen. We are talking about the complexity of mining, which automatically changes depending on the total capacity of the network (the sum of the capacities of all miners of this cryptocurrency), and now it is so high that the cost of buying enough mining capacity to carry out an attack of 51% for at least an hour would be unrealistically huge. Thus, the attacker will most likely find himself at the short end of the chain, and the blocks he has obtained will be rejected and discarded by the network.
A short termination occurs when several miners believe that they have mined a given block. Transaction blocks are always combined one block at a time into a blockchain, or a chain of blocks. For Bitcoin, the average block time is 10 minutes, which means that about every 10 minutes a new block is mined containing individual transactions verified by the miner.
However, if two miners simultaneously mine a block, a situation may arise where the two ends grow in parallel. This can happen, and is not a serious problem. Essentially, eventually one end gets overloaded, the network accepts it, and it becomes the longest, and the other end is discarded, including the corresponding blocks.
This, by the way, is one of the reasons why it is always useful to wait for several confirmations during a transaction. Therefore, if you prefer to buy cryptocurrency, for example, from a person in a cafe, and not on the stock exchange, then before paying it is better to have a snack, chat about the latest news and wait for not 1, but 5 or more confirmations to make sure that everything went right.
But back to the problems of PoW. Critics of Bitcoin sometimes point to energy consumption. This is a legitimate argument, since mining is really very energy intensive. As the graphs below show, the energy consumption of Bitcoin miners, although it has decreased to the level of November 2020, remains very high.
Bitcoin mining – electricity consumption. Source: Bits Media
Problems with the algorithm used for Bitcoin have caused some members of the community to think about whether it is possible to make it even better. Back in 2011, a message appeared on the Bitcointalk forum in which QuantumMechanic shared the idea of using Proof-of-Stake, or PoS for short, instead of PoW.
He said that instead of the probability of mining a block based on the percentage of mining power, it can be replaced by the number of coins you own – the more, the higher the chance of mining a block of transactions, or validation (verification).
He also suggested that some of the network participants would not necessarily use this opportunity directly, but could delegate their share to delegates, who would then pay them a percentage. This special kind of PoS algorithm is calledDelegated-Proof-of-Stake (DPoS) and is used, for example, in EOS or DecimalChain (DEL).
Advantages of PoS
Proof-of-Stake has one drawback, which can also be interpreted as an advantage. In order to purchase new coins, you need to own some of them. So this is an ideal concept. In fact, you are not mining, you are storing, and the cryptocurrency (its network) rewards you for it. This also eliminates the need to purchase expensive mining machines.
The energy consumption compared to PoW is not even worth mentioning. Therefore, PoS is more environmentally friendly and economical.
To carry out a 51% Attack, you will have to own most of the market value of this cryptocurrency, which is not only practically impossible, at least for large cryptocurrencies, but moreover, it is simply unreasonable. Even if you owned that much, you probably wouldn’t carry out the attack anyway, for fear of losing billions after the exchange rate reacts to the attack and collapses.
The Proof-of-Stake algorithm is currently the most used alternative to PoW. There are other algorithms, and PoS itself still exists in several forms, differing in certain aspects.
PoS is what is needed for hodlers, and has a number of advantages. However, PoW is still a widely used and time-tested method, although it has its drawbacks.
As we have repeatedly written, Ethereum, currently the second largest cryptocurrency by market capitalization, will (hopefully) make the transition to Proof-of-Stake next year. So, for the PoS future!