What are you trying to prove?

Tuesday 01 July 2014

Do you Work, or do you Stake? There’s a battle heating up in crypto over the best way to secure a blockchain. One is inefficient and unsustainable, the other is fast and versatile. Or, looking at it another way, one is fair and dependable, the other is dishonest and insecure. We take a look at the technology underpinning cryptocurrency, and what it means for users.

Proof of Work or Proof of StakeYou might have heard sceptics complaining that bitcoin is environmentally unfriendly and unsustainable on a practical level because of the immense energy costs and carbon footprint associated with mining. You might also have heard of altcoins that don’t require mining at all, and various arguments surrounding the implications of this. Ultimately, most of these arguments come down to the model that underpins their protocol: Proof of Work (PoW), or Proof of Stake (PoS). Is one really better than another – and what’s all the fuss about?

Take a look at the top 10 cryptocurrencies by market cap. Everything from #3 to #10 moves around a bit on the short-term timeframe, but at the moment the list goes:

  1. Bitcoin
  2. Litecoin
  3. NXT
  4. Darkcoin
  5. Ripple
  6. Peercoin
  7. Dogecoin
  8. Namecoin
  9. BlackCoin
  10. Vericoin

Of these, at least half use PoW to secure their networks. But NXT, Peercoin, BlackCoin and Vericoin use PoS. (Ripple uses a different approach entirely.) Is that important – and if so, why?

What is proof-of-work?
In the bitcoin network, whenever a new block is added to the blockchain, it must include the answer to a hash: a complex, one-way mathematical function. That hash must fit certain narrow conditions. As the Difficulty of the network increases, the conditions become even more narrow. The ‘work’ done proves the block is valid, as it is very difficult to fake. The computer that finds the required hash is the one that enables the block to be added to the blockchain, including recent transactions and this ingenious cryptographic padlock. For their work in securing the blockchain, the miner is rewarded – currently with 25 new bitcoins.

Satoshi Nakamoto writes in the original bitcoin white paper, ‘Once the CPU effort has been expended to make it satisfy the proof-of-work, the block cannot be changed without redoing the work. As later blocks are chained after it, the work to change the block would include redoing all the blocks after it.’

In other words, if you’re trying to fool the network you’ve not only got to fake one block, but all the blocks that come after it – and unless you own more computing power than everyone else put together, you’re rapidly going to fall behind, your deception will be rumbled and your fraudulent blocks will be discounted by the rest of the network.

What is ‘proof of stake’?
PoS doesn’t require independent miners (independent because they may or may not actually own any bitcoins) to secure the blockchain. Instead, everyone who owns a ‘stake’ in the cryptocurrency – that is, any coins at all – can essentially act as a miner. The greater your stake, the greater network power you have. An obvious implication is that this aligns the interests of cryptocurrency holders and those tasked with securing the network. It makes little sense to buy up 50 percent of a currency and then destroy it.

Vitalik Buterin, co-founder of Bitcoin Magazine and co-founder of Ethereum, writes of one implementation of PoS (specifically, Peercoin’s): ‘When creating a proof-of-stake block, a miner needs to construct a “coinstake” transaction, sending some money in their possession to themselves as well as a preset reward (like an interest rate, similar to Bitcoin’s 25 BTC block reward). A SHA256 hash is calculated based only on the transaction input, some additional fixed data, and the current time (as an integer representing the number of seconds since Jan 1, 1970). This hash is then checked against a proof of work requirement, much like Bitcoin, except the difficulty is inversely proportional to the “coin age” of the transaction input... Because the hash is based only on the time and static data, there is no way to make hashes quickly by doing more work.’

PoW vs PoS
These are two different ways of securing the blockchain. They each have advantages and disadvantages.

PoW clearly works – it has proven an extremely strong way of protecting the bitcoin network.

The danger of a 51 per cent attack is real, but avoidable – at least in theory. However, it consumes huge amounts of energy. It is also inflationary, at least in the case of bitcoin and to begin with: 25 new bitcoins are mined every 10 minutes. As the rewards for mining decrease over time, miners will be paid to secure the network only with transaction fees. This may or may not be enough to incentivise them to continue providing their services.

PoS is far more efficient from an energy and time point of view, since it doesn’t require specialised mining rigs.

It doesn’t have to be inflationary, either. There’s also scope for faster transactions – arguably much faster.

But the flipside of a static money supply is that the coins have to be created all at once. (An alternative is using PoS to ‘mine’ new coins – but that gives rise to the problem of the rich getting richer since income is proportional to existing stake.) Depending on how you look at it, this can be seen as unfairly rewarding a group of initial stakeholders at the expense of later buyers. Alternatively, it’s like an IPO and the initial distribution reflects the risk that the stakeholders took.

Intractable differences?
These differences are fundamental, and they may be unresolvable, because they are partly ideological.

Ultimately, though, ideological differences won’t determine the success or otherwise of a cryptocurrency. Why? Because cryptocurrency is, at the moment, the preserve of a few. Adoption is minimal in terms of percentages of the population as a whole. When it does become mainstream – as the indications are that it will – then most people will simply use it rather than agonise about the way it was created and how works. Jane and Joe Average won’t even know what powers their money transfers and decentralised applications, any more than they knows how a smartphone or computer works. It’s enough that it works.

That means the result is going to come down to network effect, marketing and tech: which system is used most widely, which is better advertised, and which offers the best features. There’s room for more than one crypto in the world, but so long as they work well enough, PoS vs PoW is a minority concern.

The killer blow, however, will be security. Crypto is all about security. If centralisation of miners leads to a 51 percent attack on a PoW coin (bitcoin included), or an exploitable flaw comes to light in the PoS approach, all the marketing and technical innovation in the world won’t stop that coin from becoming almost instantly worthless.

Brandon Hurst

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