‘Proof-of-Stake’ in Blockchain Technology
The blockchain technology was initially developed with the ‘proof-of-work’ system back in 2008. However, due to its ever-increasing mining difficulty and high energy consumption for miners, S. King and S. Nadal came up with a completely different approach in 2011, called ‘proof-of-stake’ algorithm.
In the following chapters, an explanation of the ‘proof-of-stake’ consensus and its advantages and disadvantages over the traditional ‘proof-of-work’ will be outlined. Moreover, the future aspects of this new approach, as well as the ways of making passive income out of it, will be given.
This article aims to educate its readers about the future digital financial world, therefore, sit comfortably in your chair and dedicate your undivided attention.
What is ‘Proof-of-Stake’?
The increasingly popular ‘proof-of-stake’ system handles the approval of transactions in a different way, while also managing the distributed network in the blockchain technology. It is an alternative algorithm, which objective is the same as the ‘proof-of-work’, but the way it achieves that is obviously different.
In the blockchain platforms utilizing ‘proof-of-stake’ consensus, the probability of creating a new block and receiving the reward is proportional to the number of tokens in the miner’s cryptocurrency holding account. In other words, the more cryptocurrency of a specific platform you own, the higher the chances of receiving the transaction fees as a reward. Essentially, it stands as an interest on your account balance.
Why does it matter for the future of the blockchain technology?
In the past few years, the blockchain technology and the ‘proof-of-work’ algorithm have been heavily criticized for the ever-increasing negative impact on the environment they create with each day.
The major issue with the blockchain and crypto-mining, just like real-world currencies, is extreme energy consumption. According to an independent source, Bitcoin network, for instance, consumes 71 terawatts per hour, which translated into simpler words means - it uses the same energy needed to power 6.6 million U.S. households. In July 2018, Bitcoin’s electricity consumption, as the largest blockchain platform, stands at the ludicrous 0.32% of the world’s consumption – equivalent to the country of Chile.
Moreover, the trend figures are predicted to reach new heights in the following years, since the ‘mining’ process becomes considerably more complex. Therefore, more demanding and advanced mining setups, which consume more energy, will be required to operate, while keeping a satisfactory profit margin.
Additionally, the incentive, in the form of cryptocurrency acquired through ‘mining’, is halved every fourth year. This system design has a purpose of preventing the devaluation of the cryptocurrency in the long run. Consequently, the diminishing compensation might drive away many users, meaning the blockchain network will become an easy target for cyber attacks.
Due to the unfavorable predictions of the ‘proof-of-work’ consensus, another alternative known as the ‘proof-of-stake’ algorithm is designed with tighter network security and sustainability in mind. Although, most of the new blockchain networks adopt this relatively new method, it is highly unlikely that the huge cryptocurrencies will approve it any time soon. In such a case, every huge corporation, which spent millions of dollars in expensive and super-efficient mining rigs, will have wasted their investment.
‘Proof-of-Stake’ versus ‘Proof-of-Work’
In this chapter, a comparison between the two algorithms, and the advantages and disadvantages over one another will be outlined.
To start off, ‘proof-of-work’ is the consensus that blockchain mining pioneered in 2008, while the ‘proof-of-stake algorithm was invented a few years after in order to bring solution to many drawbacks of the traditional design.
Design of block verification
The major difference between the two consensuses is the verification and validation process of a transaction within a block. In a system where ‘proof-of-work’ applies, each miner tries to solve a mathematical puzzle through a brute-force process. The one, who successfully find a solution and outrace the harsh competition, is rewarded a predetermined number of cryptocurrency tokens by the network. On the other hand, in the ‘proof-of-stake’ system, where there is no cryptographic puzzle to be solved, the creator of the new block is determined based on their current number of tokens present in their digital wallet. In other words, the more tokens one holds, the higher the chances to be elected for the next block creator. The different terms of creating new blocks in the two distinctive algorithms are ‘mining’ and ‘forging’, respectively.
The advantage of the newer consensus over the traditional one is the elimination of ever-increasing energy consumption and the continuous upgrade of mining rigs, which ‘proof-of-work’ is notorious for.
‘Proof-of-work’ algorithm is designed in such a way that the successful generation of a new block happens every 10 minutes. However, as the time passes, large organized mining rigs find it easier to solve the mathematical puzzles in less than the 10-minute mark, generating more frequent revenues. Nevertheless, the blockchain network automatically adjusts the difficulty level of mining every 14 days, bringing the time, required to chain a new block to the network, back to one-sixth of an hour. Due to this, it is predicted that it will be impossible for small individual miners to continuously upgrade their hardware, while keeping a reasonable profit after paying the electricity expenses. Thus, a centralization of large mining farms will start monopolizing the scene, which is against the blockchain’s principle of decentralization.
The advantage of the ‘proof-of-stake’ consensus is that no computational power is required, instead a capital to invest in tokens. Of course, determining the forger by the number of coins staked alone would lead to a substantial advantage for the wealthier users, thus various systems are being developed to counter this issue. The two most prominent are ‘randomized block selection’ and ‘coin-age based selection’.
The ‘coin-age based selection’ system determines the next forger, who will be awarded with the transaction fees, based on the time he kept his stake at his digital online wallet. This calculation is made up by the coins at stake multiplied by the number of days the cryptocurrency tokens have been held. One requirement for the tokens to be valid as ‘being at stake’ is that they have been held for a minimum of 30 days. Following this manner, the older the coins, the higher the chance of being selected as the next forger to be rewarded for completing a new block. However, once a user has forged a new block, the tokens’ age is reset and the next chance to be elected as the new forger becomes possible in 30 days. A security measurement preventing users dominating the network is implemented into this system to make the blockchain more secure, which sets the coins longevity of no longer than 90 days. Furthermore, the longer a user fails to be assigned as a forger, the higher their chance of success grows. Therefore, this selection system is designed in such a way that promotes a growing and decentralized network.
The second mechanism that prevents the wallets with bigger stakes to always reap the rewards in a ‘proof-of-stake’ system is called ‘randomized block selection’. This implementation selects the new forger based on the combination of the lowest hash value and the size of the stake. In this case, ‘hash’ is simply a process of the computers that transforms some input data to output one, which basically looks as a string of random letters and numbers.
Security of the two algorithms
There is a term called ‘51% attack’ concerning the possibility of a single user taking over a blockchain network by purchasing more than half the coins in circulation in a ‘proof-of-stake’ system or owning more than half the computational power of a ‘proof-of-work’ consensus. Having the majority of either the computational power or coins of a blockchain network, would let the dominant user ‘double-spend’ tokens. In other words, the fraudster would be able to spend a certain amount of cryptocurrency coins twice.
When it comes down to security of the cryptocurrency networks against this type of attack, it is safe to say that huge networks as Bitcoin (‘proof-of-work’) and other ones utilizing ‘proof-of-stake’ are virtually impossible to be victims of ‘double-spending’ attack as the investment to execute one, would be of astronomical numbers, thus the attack profitability would be next to nothing. However, the smaller coins are extremely vulnerable to such malicious actions due to their low hash rate (for ‘proof-of-work’) or the low combined value of all the tokens in circulation (for ‘proof-of-state’). In fact, numerous cryptocurrencies were victims of 51% attacks in the past few months, some even multiple times.
As already discussed above, the design of ‘proof-of-work’ algorithm requires an ever-increasing computational power to ‘mine’ blocks, because the difficulty to successfully chain a new block is continuously increased. Moreover, this consensus let only one user to be rewarded a predetermined number of the network tokens, meaning that the other users energy consumption, who also competed for the compensation, is meaningless and wasted. This system has been heavily criticized for its unsustainable approach for the last couple of years, simply because the electricity consumption will only be increasing and because it already has reached tremendous levels. Therefore, its counterpart design is totally different, which does not require any computer power, but just an investment into purchasing tokens. In this line of thinking, ‘proof-of-stake’ is sustainable-oriented.
Variations of ‘proof-of-stake’ algorithm
There are several variations of ‘proof-of-stake’ algorithm in existence, which will be discussed in this paragraph.
The obvious difference in this system is that the community of the blockchain network vote for ‘witnesses’. Only a hundred will be elected as ‘witnesses’, which will receive rewards for their service, while the first 20 will get a regular salary. Every user on the network has a voting strength, which is determined by the stake of coins he/she holds. However, the voting process is always ongoing, therefore, in the case of a ‘witness’ acting bad or doing wrongful actions, he can be opted out by the community. In that way, it is in the interest of the community to be actively participating.
This algorithm rewards the users based on the number of tokens they hold and how actively they use them in circulation.
This is a hybrid version between ‘proof-of-stake’ and ‘proof-of-work’ algorithms, comprising only the best of the two. The difference is that the blocks being mined do not include transactions, but just header information and mining reward address instead. It is better secured against ‘51% attack’, because it would require both most of the computing power and the majority of the coins in circulation to execute the malicious action.
How to make money with ‘proof-of-stake’?
Perhaps you are willing to take on this endeavor of cryptocurrency, which has been getting enormous popularity in the past few years, but you are unable to spend a large sum of money on purchasing the extremely demanding and resourceful mining rigs. Worry no more, because there are alternatives, which can bring you profits without investing a fortune.
The first out of the two steps to start making money with ‘proof-of-stake’ is to find a reliable and maintained blockchain network that utilizes this type of authenticating transactions. A list of popular coins with ‘proof-of-stake’ algorithm will be described in the next paragraph.
The second step involves investing money into purchasing some number of tokens of the network of your choice. The bigger the investment, the bigger your profits. To better grasp the idea, imagine you put a certain amount of cash in your bank account, which increases over the course of years in the form of interest rewarded by the bank for using your money. This is the exact same idea of ‘proof-of-stake’.
The most popular ‘proof-of-stake’ coins on the market
We have created a list of the four most popular coins for you to start with.
It is one of the first to adopt the ‘proof-of-stake’ algorithm back in 2014. In fact, it is still up and running with great feedback from its community – a great source of passive income earner. To start earning, you must invest into buying coins and set up a local copy of the Core Wallet. One requirement is keep your computer on and connected to generate revenue for you. The approximate return on investment is 5% annually.
Often referred as ‘the China’s Ethereum’, lets you generate its local currency, even while not having your computer on, which makes it one of the easiest passive income earners. The approximate return on investment is 4% to 6% annually.
Lisk utilizes the delegated ‘proof-of-stake’ algorithm, which means that the stakes have additional responsibility – to vote for ‘witnesses’ every now and then. It can be a bit more complicated for beginners, but the returns are approximately 10% annually.
This project puts the security of its network before anything else. It has extra security in place that’s why it makes it to the top 5 of this list. The astonishing 70% annual returns, while staking on its platform, makes it even more enticing to start right there.