Crypto TREND – Fifth Edition

As we expected, after the publication of Crypto TREND, we received many questions from readers. In this edition, we will answer the most common ones.

What changes could change the game in the cryptocurrency sector?

One of the biggest changes that will affect the cryptocurrency world is an alternative block verification method called Proof of Stake (PoS). We will try to keep this explanation at a fairly high level, but it is important to have a conceptual understanding of what the difference is and why it is an important factor.

Remember that the underlying technology behind digital currencies is called blockchain, and most digital currencies today use a verification protocol called Proof of Work (PoW).

When using traditional payment methods, you need to trust a third party such as Visa, Interact or a bank or clearing house to pay for your transaction. These trusted entities are “centralized,” meaning they maintain their own private ledger that stores the transaction history and balance of each account. They will show you the transactions and you have to agree that it is correct or start a dispute. It is visible only to the parties to the transaction.

With Bitcoin and most other digital currencies, the ledgers are “decentralized,” meaning that everyone on the network gets a copy, so no one needs to trust a third party like a bank because everyone can directly verify the information. This verification process is called “distributed consensus”.

PoW requires “work” to be done to validate a new transaction to enter the blockchain. In the case of cryptocurrencies, this verification is done by “miners” who have to solve complex algorithmic problems. As algorithmic tasks become more complex, these “miners” need more expensive and more powerful computers to solve the tasks before everyone else. “Mining” computers are often specialized, usually using ASICs (Application Specific Integrated Circuits), which are more proficient and faster at solving these complex puzzles.

Here’s the process:

  • Transactions are combined into a “block”.
  • A miner verifies the legitimacy of transactions in each block by solving a hashing algorithm puzzle known as the “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 verified, transactions are stored on a public blockchain across the network.
  • As the number of transactions and miners increases, so does the complexity of solving hashing problems.

​​​​​​While PoW has helped launch blockchain and decentralized, trustless digital currencies, it has some real drawbacks, especially given the amount of electricity these miners consume trying to solve “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 try to solve the problems, consuming even more energy.

All of this energy consumption just for verifying transactions has motivated many in the digital currency field to look for an alternative method to verify blocks, and a leading candidate is a method called Proof of Stake (PoS).

PoS is still an algorithm and the goal is the same as proof of work, but the process to achieve the goal is completely different. PoS does not have miners, but instead has “validators”. PoS relies on trust and the realization that all the people verifying transactions have skin in the game.

Therefore, instead of using energy to answer PoW puzzles, a PoS validator is limited to validating a percentage of transactions that reflects his or her ownership stake. For example, a validator who owns 3% of the available ether can theoretically only validate 3% of the blocks.

In PoW, the chances of you solving the proof-of-work problem depend on how much computing power you have. As for PoS, it depends on how much cryptocurrency you have “at stake”. The higher your bet, the higher the chance to solve the block. Instead of winning cryptocurrency, the winning validator receives a transaction fee.

Validators inject their stake by “locking up” a portion of their pool tokens. If they try to do something malicious against 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 win the right to validate the block, they get their stake or deposit back.

If you understand the basic difference between PoW and PoS, that’s all you need to know. Only those who plan to be a Miner or a Validator should understand the ins and outs of these two validation methods. Most of the general public who want to own cryptocurrencies will simply buy them through an exchange and not be involved in the actual mining or verification of block transactions.

Most in the crypto sector believe that in order for digital currencies to survive in the long term, digital tokens must move to a PoS model. As of this 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 implemented in 2018, putting Ethereum ahead of all other major cryptocurrencies.

As we have seen before in this sector, major events like the successful implementation of Casper can cause Ethereum prices to rise significantly. We will keep you posted on the next editions of Crypto TREND.

Stay tuned for updates!