As we expected, we’ve received a lot of questions from readers since Crypto TREND was released. In this edition we will answer the most common ones.
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What changes are there that could be game changers in the cryptocurrency sector?
One of the biggest changes that will affect the world of cryptocurrency is the alternative method of block validation called Proof of Stake (PoS). We will try to keep this explanation at a fairly high level, but it is important to understand what the difference is and why it is a significant factor.
Remember that the underlying technology with digital currencies is called a 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 check clearing to settle your transaction. These trusted entities are “centralized,” that is, they keep the main 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 a dispute. Only the parties to the transaction ever see it.
With Bitcoin and most other digital currencies, major books are “decentralized,” meaning everyone on the network gets a copy, so no one should have to 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 validate a new transaction to enter the block chain. Through cryptocurrencies, this validation is done by “miners” because they have to solve complex algorithmic problems. As algorithmic problems become more complex, these “miners” need more expensive and powerful computers to solve problems before others. “Mining” computers tend to be specialized, typically using ASIC chips (Application-Specific Integrated Circuits) because they are more skilled and faster at solving these difficult puzzles.
Here is the process:
- Transactions are grouped into a “block”.
- The miners check that the transactions made within each block are legitimate by solving the puzzle of the hashing algorithm known as “proof of the work problem”.
- The first miner to solve the “proof of work” of the block rewards a small amount of cryptocurrency.
- Once verified, transactions are stored in a public blockchain throughout the network.
- As the number of transactions and miners increases, so do the difficulties of solving hashing problems.
Although PoW has helped blockchain and decentralized and trusted digital currencies, it has real shortcomings, especially with the amount of electricity consumed by miners trying to fix “evidence of labor 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, consuming even more energy.
All of this energy consumption to validate transactions has led them to look for an alternative method of validating blocks in the digital currency space and the main candidate is the “Proof of Stake” (PoS) method.
The PoS algorithm is still there, and the goal is the same as in the work evidence, but the process for achieving the goal is different. With PoS there are no miners, but instead we have “validators”. PoS is based on trust and knowing that everyone who is validating transactions has their skin on the game.
In this way, instead of using energy to respond to PoW puzzles, a PoS validator is limited to validating the percentage of transactions that reflect its ownership share. For example, a validator with 3% of available Ether can theoretically only validate 3% of the blocks.
In PoW, it will depend on the amount of power to calculate the chance of proving a work problem. With PoS, the “game” depends on how much cryptocurrency you have. The higher the stake, the better your chances of fixing the block. Instead of winning cryptocurrencies, the winning validator receives transaction fees.
Validators include a locked part of their fund token in their game. If they try to do something harmful against the network, such as creating an “invalid block”, their participation or security deposit will be lost. If they fulfill their job and do not violate the network, but do not earn the right to validate the block, they will return the stake or deposit.
If you understand the basic difference between PoW and PoS, that’s all you need to know. Only those who intend to be a miner or a validator should understand all the outputs of these two validation methods. Most of the public who want to hold cryptocurrencies will buy them through an exchange, and will not participate in the actual mining or validation of block transactions.
Most in the crypto sector believe that for digital currencies to survive in the long run, digital tokens need to be changed to a PoS model. At the time of writing, Ethereum is the second digital currency behind Bitcoin and their development team has been working on a PoS algorithm called “Casper” in recent years. We expect to see Casper implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.
As we have seen before in this sector, the important events to implement Casper’s success can be much higher prices for Ethereum. We will update you in the next issues of Crypto TREND.