Proof-Of-Work Vs. Proof-Of-Stake (Blockchain)

I am writing this post from Bar Harbor and Acadia National Park in Maine. If you’re looking to understand the blockchain, you’ll first need to know the difference between Proof-of-Work and Proof-of-Stake consensus rules.

Proof-Of-Work

Proof-of-Work (POW) was created by Satoshi Nakamoto as the consensus algorithm for the Bitcoin blockchain network. On the Bitcoin blockchain, miners authenticate transactions onto blocks on a “first-come, first-solve” basis. Essentially, larger miners with the fastest supercomputing servers “win” the Bitcoin reward by solving the transaction puzzle first.

Proof-of-Work (PoW) consensus rules allow decentralization and security at the same time, but at the cost of expensive server capacity and energy. As a result, the larger miners with faster supercomputing capacity tend to dominate the smaller miners… inadvertently reducing some of the decentralization value of the node networks. In a nutshell, PoW works for simple transactions like cryptocurrency but is too energy inefficient for more complex touring tasks needed to run apps.

Proof-Of-Stake

The genius of Satoshi’s blockchain innovation was to make it prohibitively cost-inefficient to hack the Bitcoin network. In other words, hackers would have to inefficiently pay for the supercomputing costs of mining 51%+ of the block verifications if they wished to change the consensus rules. A proposition that makes no financial sense. Read my blog last month to understand details of how the blockchain works.

Ethereum founder Vitalik Buterin, however, plays “devil’s advocate” and claims that the risk to the Bitcoin blockchain security would be malicious attacks by governments or attention-seeking hackers.

“What about attackers who have a really large, extra protocol incentive, or just want to watch the world burn? Could be a government. Or hackers that want to have some fun. The critique here says we’re assuming we have these participants motivated by economic incentives. What if there are people who just want to break the thing regardless?” Buterin said.

Buterin is moving Ethereum 2.0 from a Proof-of-Work to a Proof-of-Stake (PoS) consensus model that will gradually be implemented over the next five years. He claims increased security, performance and scalability for an Ethereum built on the PoS consensus model.

The Proof-of-Stake (PoS) replaces “miners” (who create new blocks) with “validators.” Staking is when validators voluntarily put their own ether (the currency used to pay validators on the Ethereum network) into an “escrow like deposit” lock up utilizing smart contracts. So instead of a PoW “first-come, first-solve” reward system… the PoS grants transaction validations based on how much ether the validators lock up.

Buterin plays “devil’s advocate” on his own PoS system by explaining the possibility of Evil Smiley Face Guys who purposefully adds new blocks with incorrect transactions. So the new Casper PoS system including a “challenge period” where anyone on the blockchain can challenge the validator’s validations. If the challenger finds an error, the challenger will receive a portion of the lock up deposit that was due back to the validator.

“The challenger can submit a transaction that points to [the block in question]. That calculation runs on the blockchain. The blockchain’s like, ‘wait the actual answer is 256 and this guy submitted 250 so this guy’s wrong.’ The original guy’s deposit is destroyed and part is given to the challenger,” Buterin said.

Weaknesses Of Proof-Of-Stake

Proof-of-Stake consensus systems can work as long as the platform is widely in use. On the Bitcoin network, new coins are issued in exchange for successful authenticating transactions onto the blockchain. Because only a finite number of Bitcoins will be issued, the limited supply encourages the value of Bitcoin to keep going up.

Because new ether coins do not have a limited supply, the value of ether has no underlying basis and fluctuates wildly based on market whims. If a better blockchain system came along causing everyone to jump on the bandwagon, the value of ether could theoretically collapse. Furthermore, because validators need to own ether to participate in validating transactions into blocks, a collapse in the value of ether will likely create a “panic” scenario where validators leave in flocks.

Perhaps, this is worse case thinking… but I’m just playing the devil’s advocate. Nevertheless, the likelihood of an ether collapse has a higher probability than a government or attention-seeking hacker attempting majority control over the Bitcoin Proof-of-Work system. In addition, a government or attention-seeking hacker could also manipulate the markets to create an ether collapse.

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