As we expected, after publishing Crypto TREND, we received many questions from readers. In this publication, we will answer the most common one.
What changes are coming that could be game changers in the cryptocurrency sector?
One of the biggest changes that will affect the cryptocurrency world is an alternative block validation method called Proof of Stake (PoS). We’ll try to keep this explanation fairly high-level, but it’s important to have a conceptual understanding of what the difference is and why it’s an important factor.
Remember that the underlying technology with digital currencies is called blockchain, and most existing digital currencies use a validation protocol called Proof of Work (PoW).
With traditional payment methods, you must rely on a third party such as Visa, Interact, or a bank or check clearing house to complete your transaction. These trusted institutions are “centralized,” meaning they maintain their own private ledger that stores the history of the transaction and the balance of each account. They will show you the transactions and you have to agree that it is correct or start an argument. Only the parties to the transaction see it.
With Bitcoin and most other digital currencies, the ledgers are “decentralized,” meaning everyone on the network gets a copy, so no one has to rely on a third party, such as a bank, because anyone can verify the information directly. This verification process is called “distributed consensus”.
PoW requires “work” to be done to validate a new transaction to be included in the blockchain. With cryptocurrencies, this verification is done 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 ahead of everyone else. Mining computers are often specialized, usually using ASIC chips (Application Specific Integrated Circuits) that are more adept and faster at solving these difficult puzzles.
Here is the process:
- Transactions are collected in a “block”.
- Miners confirm that transactions within each block are legitimate by solving a hashing algorithm puzzle known as a “proof of work problem.”
- The first miner to solve a block’s “proof of work problem” is rewarded with a small amount of cryptocurrency.
- Once confirmed, transactions are stored on a public blockchain across the network.
- As the number of transactions and miners increases, so does the difficulty of solving hashing problems.
Although PoW helps to get blockchain and decentralized, trustless digital currencies off the ground, it has some drawbacks, especially since these miners try to solve “proof of work problems” as quickly as possible with the amount of electricity they consume. According to Digiconomist’s Bitcoin Energy Consumption Index, Bitcoin miners use more energy than 159 countries, including Ireland. As the price of each bitcoin increases, more and more miners spend more energy trying to solve problems.
All of this energy consumption has prompted many in the digital currency space to look for an alternative method of verifying blocks just to confirm transactions, and a leading candidate is a method called “Proof of Court” (PoS).
PoS is still an algorithm and the goal is the same as in proof of work, but the process of achieving the goal is completely different. With PoS there are no miners, instead we have “validators”. PoS is based on trust and the knowledge that all people validating transactions have skin in the game.
This way, instead of using energy to answer PoW puzzles, a PoS validator is limited to validating a percentage of transactions that reflect his ownership stake. For example, a validator that owns 3% of the available Ether can only theoretically validate 3% of the blocks.
Your chances of solving the proof of work problem in PoW depends on how much computing power you have. With PoS, it depends on how much crypto you have. The higher the stake you have, the better your chances of solving the block. Instead of winning crypto coins, the winning approver receives a transaction fee.
Appraisers enter their shares by “locking in” a portion of the stock’s tokens. If they try to do something harmful to the network, such as creating an “invalid block”, their stake or security deposit will be confiscated. If they do their job and don’t break the network, but don’t earn the right to approve the block, they’ll get their stake or deposit back.
Here’s what you need to know if you understand the basic difference between PoW and PoS. Only those who plan to become miners or validators should understand all the intricacies of these two verification methods. Most of the general public who want to own cryptocurrencies will simply buy them through an exchange and not participate in the actual mining or validation of block transactions.
Most of the crypto sector believes that for digital currencies to survive long-term, 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 a PoS algorithm called “Casper” for the past few years. It is expected that we will see the introduction of Casper in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we’ve seen before in this sector, big events like Casper’s successful implementation can drive Ethereum prices up significantly. We will keep you updated in future issues of Crypto TREND.
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