As we expected, after the publication of Crypto TREND we received many questions from readers. In this issue we will answer the most common.
What changes are ahead 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 block validation called Proof of Stake (PoS). We will try to keep this explanation quite high, but it is important to have a conceptual understanding of what the difference is and why it is an important factor.
Remember that the core technology with 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 Visa, Interact, or a bank or clearing house, to arrange your transaction. These trusted entities are “centralized”, which means that they maintain their own private ledger, which keeps a history of transactions and the balance of each account. They will show you the transactions and you have to agree that it is right or start an argument. Only the parties to the deal see it.
With bitcoin and most other digital currencies, registers are “decentralized,” meaning that everyone on the network receives a copy, so no one should trust a third party, such as a bank, because anyone can directly verify the information. This verification process is called “distributed consensus”.
PoW requires “work” to be performed to confirm a new blockchain transaction. In the case of cryptocurrencies, this check is performed by “miners” who have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and more powerful computers to solve problems than anyone else. Extraction computers are often specialized, usually using ASIC chips (application-specific integrated circuits) that are smarter and faster at solving these difficult puzzles.
Here is the process:
- Transactions are grouped together in a “block”.
- Miners check whether the transactions in each block are legitimate by solving the puzzle of the hashing algorithm known as the “proof of operation problem”.
- The first miner to solve the “proof of work problem” of the bloc was rewarded with a small amount of cryptocurrency.
- Once confirmed, transactions are stored in the public blockchain throughout the network.
- As the number of transactions and miners increases, so does the difficulty in solving hashing problems.
Although PoW has helped bring out blockchain and decentralized, unreliable digital currencies, it has some real drawbacks, especially with the amount of electricity these miners consume in trying to resolve the “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 are trying to solve problems by consuming even more energy.
All this energy consumption just to validate transactions motivates many in the digital currency space to look for an alternative method to validate the blocks, and the leading candidate is the method called “Proof of Pledge” (PoS).
PoS is still an algorithm and the goal is the same as proving work, but the process of reaching the goal is quite different. There are no miners in PoS, but instead we have “validators”. PoS relies on the trust and knowledge that all people who validate transactions have skin in the game.
Thus, instead of using energy to respond to PoW puzzles, the PoS validator is limited to validating a percentage of transactions that reflects his or her share of ownership. For example, a validator that holds 3% of the available ether can theoretically validate only 3% of the blocks.
At PoW, the chances of solving a proof of performance problem depend on how much computing power you have. With PoS, it depends on how much cryptocurrency you have on “bet”. The higher your bet, the better your chances of solving the block. Instead of winning crypto coins, the winning validator receives transaction fees.
Validators enter their pledge by “locking” part of the tokens of their funds. If they try to do something malicious against the network, such as creating an “invalid block”, their pledge or deposit will be confiscated. If they do their job and do not break the network, but do not win the right to validate the block, they will get their bet or deposit back.
If you understand the main difference between PoW and PoS, this is all you need to know. Only those who plan to be miners or validators need to understand all the intricacies of these two validation methods. Most of the general public who wants to own cryptocurrencies will simply buy them through the stock exchange, and not participate in the actual digging or validation of block transactions.
Most in the crypto sector believe that in order for digital currencies to survive in the long run, digital tokens must move to a PoS model. At the time of writing, 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. We are expected to see Casper introduced in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we saw earlier in this sector, major events such as the successful deployment of Casper could lead to much higher Ethereum prices. We will keep you informed in future editions of Crypto TREND.
Stay on the line!