The Downside of Many Cryptocurrency Networks

One of the most commonly criticized aspects of the Bitcoin network is the tremendous computing power, and thus electricity requirements, needed to validate or “mine” its blockchain transactions. This is also known as the “CPU cost function”. The complexity of the mathematical “puzzles” that must be solved by miners is tremendous, so these miners have unleashed startlingly huge arrays of powerful computing hardware platforms called “mining rigs”, which integrate ASIC chips — chips designed solely for bitcoin mining operations — and specifically-designed motherboards and power supplies. Despite the original intention to make mining egalitarian, the days where anyone could use their home computer or laptop to pursue bitcoin “rewards” is long past.

The difficulty behind bitcoin mining is intentional and is due to the nature of the “proof-of-work” (PoW) protocol required to validate each transaction to create new blocks in the chain. Every miner must run extremely complicated mathematical computations in search of a specific number. The attempted solutions to these calculations are generated at random, so the correct number may arrive in minutes or it may take hours before it is located by any individual miner. However, each miner is in competition with all the other miners on the bitcoin network (currently around 10,000) to find the number first. If someone else finds the number, all the other miners who are still searching are out of luck, no matter how much time they’ve spent trying to solve that specific puzzle. They must then move on to try and validate a different transaction.

Clearly, this approach depends on raw computational power and little else, other than possibly some blind luck. It should also be obvious that most of this computing power is being wasted on useless computations that take place prior to the computation that finds the correct solution. It’s gotten to the point where most blocks are now created through the use of specialized “mining pools” which make use of many miners operating together in collaboration. Each successful block added to the chain then reaps a bitcoin reward for all the members of the pool based on their relative contribution to the overall computing power of the pool. In addition, the complexity of the puzzle is designed to automatically increase as the computational power of the network increases. It should be obvious, then, that this complexity level, and the power needed to support it, has steadily increased over time and will continue to do so, as miners add more computing power to their operations to maintain a positive economic balance.

Bitcoin is not the only cryptocurrency to use the PoW algorithm to validate its transactions. Other good examples include Etherium, Litecoin, Monero, Dash, Bytecoin, Zcash, and many others. The larger the specific cryptocurrency network, the more energy is required to mine it.

An Innovative Alternative

Given that the situation is only going to get worse as more and more miners join the networks, one would think that an alternative method that is just as effective at validating transactions, but a lot less energy-intensive, could be developed. That is one justification behind the “proof-of-stake” (PoS) protocol.

Proof of stake is very different from proof of work and holds out some hope that the cryptocurrency space will be sustainable over time. In fact, it is considered to be several thousand times more cost-effective than PoW. Unlike PoW, which relies on raw computational power, PoS relies on various selection methods based on a combination of the number of units of cryptocurrency owned along with other factors. So rather than creating blocks through the mining process described earlier, the ability to create blocks in PoS networks is assigned semi-randomly based to some extent on unit ownership. Blocks are said to be “forged” or “minted”, and those who validate transactions in PoS systems are called “forgers”.

In PoW networks, new coins are awarded to successful miners as a reward for their “work” and thus new coins are created continuously until a pre-specified cap is reached. In PoS networks, with only a few exceptions, the number of coins is set at a fixed number when that cryptocurrency is first created and will not increase. Instead of rewarding miners with new coins, forgers actually receive a transaction fees for each cryptocurrency transaction that they validate. In addition, forgers may also receive interest on their stakes.

Since there is no way in a PoS-based cryptocurrency to distribute the initial supply of coins, most either launch their coins with an Initial Coin Offering (ICO) or begin utilizing a PoW approach and then move to a PoS system.

In order to validate a PoS transaction, the forger has to actually put their own coins “at stake” which is like in a virtual “escrow account”. If a forger validates a transaction that is fraudulent, that forger will lose their stake, as well as be banned from participating in any further validation efforts. To be eligible to forge, you are putting your own coins at stake, which provides a very strong incentive to only validate transactions that are correct.

The PoS Selection Process

The selection of which forger will validate the next transaction is not based solely on the size of the forger’s stake. If that were the case, the wealthiest users would have an overwhelming advantage in their ability to forge. Consequently, the formula for determining the next forger is more complex than just the number of their coins. In fact, there are at least two different ways by which the actual selection can be made.

Randomized Block Selection

One way that forging rights can be assigned is called “randomized block selection”, which is currently used by Nxt and BlackCoin. This process finds the user with the lowest hash value combined with the size of their stake.

Coin Age Based Selection

Each coin a forger puts up as steak has an age. This method of choosing a forger bases its selection on the cumulative age of the coins at stake, as well as the number of coins in the stake. The older the coins the better; the larger the stake the better. However, once that user is successful at forging a block, the age of all the coins in their stake is set to zero. Since a coin has to be held for at least 30 days to be eligible to compete for a block, that user must wait at least 30 more days before any of those particular coins can be used in a new stake. Each day that a user fails to be assigned a block, their coins age by one day, so that their chance of being selected increases daily. Users never have to wait more than 90 days to be assigned a block, which leads to forgers being assigned blocks on a somewhat regular basis. Peercoin is an example of a PoS network that uses coin age based selection.

More Differences Between PoW and PoS

The energy costs of PoW mining are almost always paid in fiat money which introduces a continuing downward pressure on the price of the currency. This is not the case with stake-based forging.

It’s also important to recognize that PoW miners, themselves, are not required to own any of the cryptocurrency they are mining. Thus, they are incentivized primarily to maximize their own profits. It’s possible this may have some negative impact on network security. In PoS systems, however, those protecting the security and validity of the coins on their network are the actual owners of those coins, and so are incentivized to protect the integrity of their network in addition to making a profit.

Because PoS systems do not require the computing horsepower necessary to compete in PoW systems, they can be considered more affordable, inclusive, and welcoming to those trying to succeed in the crypto space. Having more users also increases the decentralization and distribution of the blockchain, making it more secure and democratic.

Summary

Proof-of-work was the protocol utilized by the first cryptocurrency, bitcoin. Today, the top currencies are successfully making use of one or the other systems. Both have their strengths and weaknesses, and for this reason, several other methods for validating blockchain transactions are being developed and tested.

Written by:

Parul Gujral, CEO-Snowball