The family has largely shifted into non-technical topics this time.
Emily: I think we should talk more about the difference between Proof of Work and Proof of Stake.
Lily: I agree. I’ve read a report about some a billionaire named Bill Miller claiming that if Ethereum does accomplish its upgrade to Proof of Stake, it will give Bitcoin a huge advantage.
Emily: Why’s that?
Lily: Apparently Bitcoin has no plan to walk away from its tradition of Proof of Work to Proof of Stake, so this billionaire believes Proof of Stake is in favor of miners with rich resources. Switching from Proof of Work to Proof of Stake will make the inequality problem much worse.
Joy: Yeah, I’ve heard about that. The billionaire says Proof of Stake is “the most unequal thing you can imagine, because the rich people make all the decisions.” On the other hand, he believes Bitcoin’s Proof of Work is democratic. One reason he says that is because, as the report reveals, he himself owns a lot of Bitcoin, not Ethereum.
Emily: Okay, this is a good time to talk about the difference between Proof of Work and Proof of Stake. Looks like the two top cryptocurrencies, Bitcoin and Ethereum, are moving toward different directions, making it even more relevant and interesting for us to get a good handle on the two approaches.
Joy: That’s true. The good news is that we already talked about Proof of Work, like the level of difficulty, the fierce competition among all miners, the guessed number of nonce, the decreasing or halving of Bitcoin reward, the single winning miner. Now we only need to add Proof of Stake to that.
Emily: It’s good to know we are halfway done. But how is Proof of Stake different?
Joy: Let’s introduce some acronyms first. PoS is short for Proof of Stake, and PoW is for Proof of Work. One easy way to think of PoS is that it adds an extra “qualifying” layer to PoW, meaning before you become a PoS miner, who are called “validators,” you must prove you have sufficient ownership stake of cryptocurrency, such as owning at least 32 Ethereum coins. This is how PoS gets its name from.
Greg: Staking is pledging, promising or depositing. Say you own 32 units of Ethereum or ETH, you can pledge them to make yourself a validator. All you need to do is to deposit those coins, or to lock them up, not to use them for anything else.
Lily: That sounds like collateral.
Emily: What’s collateral?
Lily: It’s any asset a bank accepts before it lends you money. Say our family wanted to buy a new house, banks will use our current house as a collateral before they give us new mortgage. In case we were unable to pay back the mortgage, banks have the right to sell our current house to cover the loan.
Joy: The deposited coins are collateral because if the validator messes up things, acts dishonestly or lazily in verification, she’ll lose at least a part of their stake. The other way to lose or decrease stake is to fail to participate when she’s called upon. One thing that makes deposited coins different from collateral is that its purpose is not for bank loans but for the right to validate transactions and to get reward from doing that.
Emily: How do you define dishonest behaviors?
Joy: I assume there are different ways to define dishonesty, but I’ll quote an article from Ethereum that says one either proposed multiple blocks in a single slot (equivocating) or submitted contradictory voting for verification.
Emily: If a validator acts honesty she would not be in danger of losing her deposited coins, right?
Joy: No, she retains the full ownership of the coin unless she’s penalized for malicious behavior. Furthermore, she can change her mind and un-stake the coins.
Kimberly: Back to the criticism of the billionaire about PoS promotes inequality, are all validators equal in power?
Joy: Good question. The answer is no, those with more coins in stake have more power. Part of it is that if you only have a few coins to stake, you will have a lower chance to be selected as the validator. As the Motley Fool article points out, if your stake is only 0.0001% of the total stake, you only have 0.0001% of chance to be selected. I guess that’s why that billionaire with heavy investments in Bitcoin was saying that PoS is unfair and biased in favor of rich people.
Greg: Let’s have a look at the big picture first. I’ve seen a fairly recent report from the Forbes that says about 64% of the total market capitalization of all cryptocurrencies use PoW. Bitcoin is the biggest one of course. Since we only have two major consensus mechanisms, either PoW or PoS, it’s probably safe to say that about 36% use PoS.
Emily: What’s market capitalization?
Greg: “Market cap” is short for market capitalization and is very intuitive and simple; it refers to a company’s total market value in dollar. You multiply a company’s total number of shares in the market by its price per share. Say Google has a total of 1 million shares in the stock market and each share is priced at $100, then Google has $100 million in market cap.
Emily: So 64% of market cap is not saying 64% of cryptocurrency companies use PoW, right?
Greg: That’s right. A few large crypto companies can easily make up 80% of the market, while many smaller ones can barely add up to 20%. I bet after Ethereum completes its upgrade to PoS, its position will be much stronger. That’s why so many people are talking about it now.
Lily: Once we have validators, how exactly does PoS work?
Joy: First thing first, while PoW is fairly standard, when it comes to PoS, there are many protocols, and they tend to work differently from each other, sometimes significantly. Bear in mind there are well over 10,000 cryptocurrencies.
Greg: That’s right. That Motley Fool article tells us that Cardanoprotocol selects only one validator, who then determines whether the block of transactions is valid or not. But check the Ethereum Wiki and its Proof of Stake FAQ page, it says not just one validator, but all current validators can participate in the process and their consensus takes control. On the other hand, another cryptocurrency exchange called Binance Coin uses the “Proof-of-Authority” consensus, which uses just 21 validators and each of these validators must be approved by Binance itself.
Joy: For some crypto coins the number of PoS validators is much smaller than PoW miners. This report from TheStreet.com published in last October says Cardano has 2,924 validators that are responsible for finding or verifying cryptocurrency transactions in blocks, while Ethereum has nearly 3,500. Once the transition to PoS is done, however, Ethereum will have 243,000 validators in the network.
Greg: Yeah, that article also separates PoW and PoS in terminology. For example, it tells us that mining and hashrate are specific for PoW, while stake pools and validatorsonly for PoS. Both systems have nodes. To respect their differences, we should follow those guidelines.
Joy: It’s not hard to follow. For example stake pools are obviously only for Proof of Stake, and mining is for PoW. I have a picture that provides intuitive sense: PoW has a miner holding a pickaxe, while PoS has a validator holding a key to a safe box.
Emily: A couple of questions: What is a “node” again and what is “hashrate?”
Joy: There is an article from Blockchain Council that explains a node well. A node is “any system or physical equipment that is connected to a network and capable of performing specific duties such as creating, receiving, or sending data across a communication channel.”
Lily: So a node is basically a computer connected to a network of other computers. I believe nodes and network must co-exist. You can’t have a network without nodes, and a node is useless unless connected to a network.
Greg: You would be right for all other nodes and networks. But for Bitcoin it’s different. Here a node can exist independently of other nodes in the same network, because a Bitcoin node contains a complete copy of all the blocks and transactions, just like any other nodes. This is due to decentralization, meaning maintaining duplicated copies all over the world for exactly the same blockchain, so we won’t have a single point of failure like in a centralized control system.
Lily: Oh yeah! Thank you for reminding me of that.
Emily: It’s funny that I’ve been thinking all along that nodes and miners as the same thing.
Greg: You are not alone. The truth is they are closely related but not the same. First, a node is not just any computer but one equipped with cryptocurrency software in it. Also, nodes and miners work together to get verification of transactions done. I have this picture from River financial website that does a good job illustrating how miners and nodes work.
Lily: In the end it is miners’ job to grow the blockchain because they are the ones verifying transactions.
Greg: Right. A node or a blockchain can’t grow itself. Remember a blockchain is just a decentralized and distributed digital ledger. If you read the article by River financial, you will see two types of nodes, one is full, and another light weighted but nowadays the latter are rarely seen.
Joy: Sometimes I can’t help thinking that Bitcoin really did it with a “security overkill.” It’s virtually impossible for Bitcoin to be hacked, although the cost is also extremely high, both in energy consumption and in human inputs. Basically, the Bitcoin algorithm makes it extremely hard to attack because miners work extremely hard.
Greg: I agree. Look at the hashrate now to get back to Emily’s question what is hashrate: It’s a measure of computing capacity for the network. An article from Robinhood.com explains it well: “A hashrate measures how many calculations can be performed per second and can be measured in billions, trillions, quadrillions, and quintillions. For example, a hashrate of 1TH/s means one trillion calculations can be performed every second.”
Emily: One trillion calculations in one second? That’s incredible.
Greg: Computers or nodes can do much better than one trillion calculations per second. An article from Robinhood.com says the Bitcoin hashrate has been as high as 179 exahashes per second (1 exahash = 1 quintillion). In case you don’t know, one quintillion is one million trillion or one trillion times one million, and yet miners are still working on it, apparently the reward is bigger than the cost.
Joy: Hashrate is not just about computing resources but also is used as an indicator of decentralization.
Lily: Really, how so?
Greg: Your mom said it right. Generally, the more miners participating in a network, the higher that network’s hashrate will be. Meanwhile, the fewer miners, the lower the hashrate. So let’s say the hashrate becomes lower this week, it means fewer miners are participating in mining. But with fewer miners, hackers or the bad guys will need less computing power to mess up the verification. The opposite holds for higher hashrate.
Lily: Wow, mining is a democratic game. This is not much different from an election: The more voters showing up, the better election results.
Kimberly: Enough for the details, what do you think of the two approaches, PoW and PoS?
Joy: The story is more complicated than simply claiming one is definitely better than others. Like I said earlier, both approaches end up being proof of resources more than anything else, they rely on different resources, though.
Emily: What do you mean?
Joy: Well, for PoS it’s about financial resources, meaning how many coins you have in stake matters the most. For PoW it’s about computing resources, meaning how powerful your hardware is matters the most.
Kimberly: I guess we haven’t talked much about computing resources until this point. I heard that in PoW, miners compete to have the fastest hardware in order to win the reward. One thing they all want is called ASIC or Application Specific Integrated Circuit. If you only have a laptop, you are doomed to lose the competition.
Greg: That’s right. The sad thing is that ASICs are designed only for Bitcoin mining, uncapable of doing anything else. This is a bad news to hackers because they would have to buy ASIC equipment, otherwise it’s impossible to become a winner.
Joy: In other words, investing in ASIC equipment increases cost for everyone, including hackers, which is a good thing for the security of Bitcoin.
Lily: But all hardware can be purchased with money. In the end, it’s all about financial resource, don’t you think?
Joy: I see your point, but it’s more complicated than that as subtle differences exist. For example, PoS critics are saying allowing current big owners of cryptocurrency to confirm transactions makes little sense because owners are biased. It’s better to let professional miners in a peer-to-peer network do the job of transaction verification. They would disagree with you that everything is about money but would rather argue that money should stay out of the mining process.
Greg: Yeah, that’s a good point. Unfortunately, whether it’s financial or technical, resources tend to be concentrated quickly to the hands of a few people rather than evenly spread out among everyone. That Forbes advisor article I was talking about earlier correctly points out that in PoW the power can become concentrated to those with fancy hardware. There is no easy solution because that’s how market works.
Joy: Having a few miners winning reward all the time in PoW is just as bad as having a few owners of cryptocurrencies to verify transactions in PoS.
Lily: I would prefer finding a balance between efficiency and equality. Isn’t that true that we should seek tradeoff between efficiency and equality? Can we find a way so that we can have “democracy” in mining but also efficiency in getting transactions confirmed?
Kimberly: By “democracy” you mean to get more people involved in the mining process?
Lily: Yeah! Remember that billionaire criticizing PoS for letting a few rich people validate all the transactions? That doesn’t sound good, and we don’t want that to happen.
Joy: Things can be more complicated than just efficiency and equality. We also must pay attention to the environment. One major weakness of PoW is its huge energy consumption from hundreds of thousands miners all the world busy mining. PoS reduces the number of validators involved and therefore significantly reduces energy consumption from mining.
Greg: Although one may argue that energy consumption is one dimension of efficiency. So the challenge is still about finding the best tradeoff between efficiency and equality.
Joy: You are right on that. The good news is that there are ways to overcome financial or computing constraints and still allow sufficient number people to participate in the mining process for both PoW and PoS. For example, people without Ethers can join a “staking pool” to get qualified for validation. Similarly, people without advanced hardware like ASIC can join a “mining pool” for faster mining.
Greg: That’s true. Those pools may be called social solution to the better tradeoff. I’m also optimistic that someday we will find a more efficient way to mine so that even though a million people are mining at the same time, the energy cost is still controllable.
Joy: In a sense the technology is already born with quantum computers. We just need to make it better and more accessible. From what I’ve read, like this one by Coinshares.com, the energy use of quantum computers is far lower than digital computers, even with much faster computing speed.
Emily: What is quantum computing and why are digital computers using so much energy?
Joy: From what I can understand, and from an article I read from livescience.com, quantum computing is a new generation of technology that is 158 million times faster than a digital computer. I remember two numbers well: What it takes four minutes to finish by a quantum computer can take a digital supercomputer 10,000 years to accomplish.
Greg: To answer your second question: Most energy in mining is used on the cooling system, not exactly on computing. Once again, quantum machines are more efficient on energy. It’s reported that the Google Quantum computer was about a trillion times more energy efficient than a summit supercomputer, the fastest digital computer in the world today.
Joy: I heard that quantum computing poses extra risk for cryptocurrencies.
Greg: Yeah, it is called “quantum attack” these days. But I wonder how much we should “cry wolf” before determining if the danger is real. I mean we can take precaution without exaggerating the risk.
Joy: From what I’ve read, the current cryptography is vulnerable to quantum attack. I read a report on a website called “investmentmonitor.ai” that says some four million Bitcoin addresses could in theory be hacked by a quantum computer. And that’s not the only problem. Quantum attack can happen to Bitcoin transactions in transit.
Greg: I’ve also heard about that but still, we must keep in mind that PoW is vulnerable to 51% attack, not to a single hacker standing alone by himself. My sense is that in one or two decades quantum computing will enter the mainstream but that will be a good news because it is unlikely for a single quantum equipped “bad” guy to dominate the network.
Emily: What’s a 51% attack?
Joy: That’s when some bad guys were able to work together either by themselves or by convincing at least 51% of miners that a transaction is true, which is required consensus for a transaction to be verified in PoW.
Greg: Looking at the positive side, we’ve already seen some “post-quantum” cryptography algorithm being developed. Hopefully this helps speed up the race against time and against risk of quantum computing.
Lily: What’s your closing argument on PoW versus PoS?
Greg: I think both have pros and cons, strengths and weaknesses. In the end, it is likely that both will exist and serve different audiences. Some people care less about decentralization and more about fees, while others are all about getting the highest yields. For those who really care about safety of large amount transactions, PoW is likely to be the choice. On the other hand, if someone does not possess many coins, and cares about environmental impact, she would prefer PoS.
Joy: I agree. For the society in general, keeping both PoW and PoS is the best idea. We are still early in the game and with so many cryptocurrencies competing with each other, it’s hard and unwise to claim or even to aim a single winner. While PoW has been proven working well and Bitcoin has some first mover advantage, PoS still has some way to go but Ethereum is unlikely to sink.