Nobody likes email spam. It’s annoying, often fraudulent and never welcome. Without it, Bitcoin may never have seen the light of day.
Ok, let me explain.
Electronic money has been around for a long time. David Chaum authored Ecash in 1983 and launched DigiCash in 1995. Chaum was not a Cypherpunk, but instead took a more corporate approach to digital cash, promoting it as a software solution and even opening offices in Amsterdam.
Three years later the Cypherpunks made their noisy entrance into the world of cryptocurrency. Wei Dai authored b-money and although it can be considered the philosophical forebear of Bitcoin, it failed to get past the prototype phase.
It wasn’t until a 1993 research paper by Cynthia Dwork and Moni Noar entitled “Pricing via Processing or Combatting Junk Mail” started gaining attention, that a new era of cryptocurrency became possible.
More specifically, Dwork and Noar proposed a solution by which a user is required to “compute a moderately hard, but not intractable, function” in order to send an email. The idea being that the computation brings energy costs which would prove prohibitive at scale, essentially making bulk spam emails uneconomical.
This idea was groundbreaking, and although it failed to tackle email spam, it wasn’t long before the Cypherpunks started incorporating it into their electronic cash systems as a way of achieving consensus. In 2004 Hal Finney launched Reusable Proof of Work (RPOW), the first cryptocurrency (prototype) to use Proof of Work successfully.
When, in 2009, Satoshi Nakamoto incorporated it into Bitcoin, Proof of Work (POW) became the de-facto standard in the cryptocurrency space, embarking on a victory lap that would last until 2014. That is the year that Proof of Work’s biggest problem started raising serious questions: centralization of mining power.
We’ll go into this in more detail later, but for now it suffices to say that a mining pool called GHASH.io controlled over 40% of the Bitcoin network’s hashing power. Such a drastic centralization of power posed a serious security threat and the community scrambled for a solution.
Just like Proof of Work, Proof of Stake aims to establish an incorruptible history of transactions on the blockchain. The way it achieves this is completely different, leading many commentators to believe that it barely works at all.
But what are the major differences and why would anyone think of switching to POS? Let’s find out.
Proof of Work (PoW) vs Proof of Stake (PoS)
|Proof of Work||Proof of Stake|
|High Profile Implementation||Bitcoin||NXT|
|Energy Intensive Mining?||Yes||No|
|Uses Block Rewards?||Yes||No|
|Block is Processed By||First miner to find the hash||Stakeholder chosen deterministically|
|Miner Receives||Block reward (e.g. 12.5 BTC) plus transaction fees||Transaction fees|
|Common Variations||Scrypted Proof of Work (e.g. Litecoin)||Delegated Proof of Stake (e.g. EOS)|
|Original Author||Cynthia Dwork and Moni Naor||Sunny King and Scott Nadal|
|Paper||Pricing via Processing or Combatting Junk Mail||PPCoin: Peer-to-Peer Crypto-Currency with Proof-of-Stake|
How does Proof of Work work?
Both Proof of Work (PoW) and Proof of Stake (PoS) provide a method of reaching consensus on the blockchain.
In cryptocurrencies using POW, a transaction would go through the following steps:
First Alice wants to send Bitcoin (for example) to Bob. In order to inform the network that Bob should now own Alice’s Bitcoin, the transaction has to be recorded on a publically accessible ledger. For this to happen, miners group together as many transactions as possible into blocks.
In Bitcoin’s case, the block size is roughly 1 Megabyte, which can typically contain around 1,700 transactions.
In order to prevent malicious actors from accessing a block and altering a transaction, each transaction and each block is hashed (encrypted) using the SHA256d hashing function. More specifically, the hash function transforms the transaction data (input) into an alphanumeric string with a fixed length (output).
Even tiny changes in the transaction data would change the output and would be easily detected. Interestingly, creating these hashes is trivial from a computational perspective, but Bitcoin requires that the hash has a certain form, meaning that a dynamically determined number of zeros must be placed at the beginning of the hash. The hash for block #557340 for example is:
Creating this alphanumeric string is a computationally intensive task. Miners who achieve this can broadcast their hash to the network as proof that they have validated the block of transactions (Proof of Work…). If they are the first to do so, they receive a reward of 12.5BTC and the block is then added to the blockchain.
Interestingly, the hash for Bitcoin’s genesis block is:
As you can tell, the number of zeros required to mine a block has increased substantially, signaling an equally substantial increase in mining difficulty. This is Proof of Work’s dynamic way of ensuring that a block of transactions is mined at predefined times, despite a volatile number of miners. In Bitcoin’s case for example, a block of transactions should be added to the blockchain every 10 minutes whether the network contains 5 miners or 5,000.
Until about a year ago, the value of the Bitcoin block reward was far higher than the cost of running energy intensive ASIC miners, especially in countries with subsidized energy like China and India. This caused the emergence of “Mining Farms”: businesses using large numbers of ASICs to mine blocks, earn the block reward and turn a profit.
ASIC miners and Mining Farms have turned an activity formerly pursued by enthusiasts and geeks, into an ultra-competitive, professional endeavour.
“One Bitcoin transaction uses the same amount of energy as 16 US households combined in an entire day.”
We’ve come full circle to the key problem underlying Proof of Work: it causes centralization. ASIC miners are expensive, typically costing between $500-1,500 a piece and are bought as part of a business endeavour.
Not only does this put an inordinate amount of power into the hands of profit driven businesses, who have no accountability outside of their bottom line, but it also makes Bitcoin’s security vulnerable to price volatility.
Additionally, specialized ASIC miners are extremely energy intensive, meaning that POW at a scale such as Bitcoin’s creates serious environmental damage. To give you an idea of the scale of the problem, Digiconomist estimates that one Bitcoin transaction uses the same amount of energy as 16 US households combined in an entire day.
How does Proof of Stake work?
Proof of Stake is often touted as the antidote to PoW’s ailments.
On paper, it is inherently CPU-mining friendly and bears a much smaller ecological footprint than its competitor. That said, it doesn’t favor decentralization and therefore arguably does not overcome PoW’s biggest problem.
But how does it work?
The high-level definition often sounds worrying. Network members in control of large sums of tokens are picked algorithmically to mine blocks.
“Huh? You have a lot of money, so you get to decide what transactions are added to the blockchain….”
Although this sounds like an oligarchy at first, it makes a lot more sense on closer inspection. The network members with the most to lose are in charge of ensuring the blockchain’s integrity.
Pure implementations of POS are few on the ground, but NXT is perhaps the most high profile coin using it today. Using NXT’s decentralized network a transaction would work like this:
Alice wants to send NXT to Bob. She initiates the transaction and broadcasts it to the network. Instead of launching a frenzied mining competition (like in POW) the POS consensus algorithm instead picks a network member to validate the block. Just like in POW the network member must ensure the coins are not being double-spent and then hash the transactions into a predefined form using the SHA256d hashing function. This hash includes the hash of the previous block, creating a blockchain.
Crucially, the likelyhood of being picked to mine the block is weighted in accordance with your staked tokens and your token age. Specifically, the more NXT you hold the more likely you are to be picked to mine the next block.
As we can see from the NXT Monitor, this creates a similar level of centralization to typical POW models, with the largest single stakeholder mining over 30% of total blocks. With this in mind POS – in its purest iteration – really only solves the ecological problem raised by POW.
It’s clear that Proof of Work, in its current form, poses one of the biggest challenges in the cryptocurrency space. The out-of-control energy consumption, along with the centralization of hashing power seriously hamper Bitcoin’s (and other’s) chances of establishing mainstream credibility.
PoS is a valiant first attempt at resolving some of its core issues, but falls short on most counts. The significantly reduced environmental impact makes it worth considering, but it only offers a different flavour of centralization. Instead of mining pools, the POS model is especially conducive to high-net-worth individuals and businesses.
More importantly, next time you get annoyed at a spam email, just remember that modern cryptocurrencies would not have been possible without them.