If you just look at the headlines, cryptocurrencies are in a downturn.
Bitcoin’s price has fallen roughly in half since its peak. More speculative projects like Dogecoin have fallen even further. While this may be daunting for day traders and fast-money types, there are exciting developments in cryptocurrency for longer-term investors.
For one thing, the trend towards more publicly traded funds and trusts in this sector continues. There is also a key debate in a technical area: does the future of cryptocurrencies lie in proof-of-stake protocols?
The problem of proof-of-work versus proof-of-stake boils down to this question: How can the integrity of a cryptocurrency be ensured. Most legacy cryptocurrencies like Bitcoin are based on a proof-of-work mechanism. If you see a picture of thousands of computers in a mining facility, it is proof of work. The computers solve complex algorithmic puzzles. In return, the miners receive tokens of the underlying cryptocurrency as a reward.
What is a proof of stake?
In contrast, the proof-of-stake relies on validators to maintain the cryptocurrency. In a proof-of-stake model, owners use their tokens as security. In return, they receive authority over the token in relation to their stake. Generally, these token stakers acquire additional ownership of the token over time through network fees, re-minted tokens, or other such reward mechanisms.
In the beginning, proof-of-work was attractive because people only needed an ordinary computer to mine coins. Nowadays, however, special expensive equipment is required to mine leading proof-of-work tokens. Much of the mining is now done by large, well-funded pools, which has taken the general public out of the equation.
In the proof-of-stake versus proof-of-work battle, the former could be more democratic. Anyone with a token can participate as a validator or staker and use the decentralized finance (DeFi) ecosystem. In general, analysts have focused on the environmental impact of proof-of-work protocols. Bitcoin, in particular, has developed a large environmental footprint as it has gained wider adoption. The proof-of-stake drastically reduces these environmental costs by eliminating the advanced cryptographic puzzles.
Proof-of-work advocates are protesting that the proof-of-stake is deviating from the original vision of the cryptocurrency. Bitcoin was different from other financial assets because the database or blockchain record was inherently valuable. The mining process, while inefficient in terms of energy, has created a clear and tamper-proof record of all financial transactions. The proof-of-stake has some weak points, at least in its basic forms.
For example, the problem of nowhere at stake revolves around the fact that if there is no cost to fork or add bad information to the consensus, it encourages malicious behavior. The proof of work energy costs inherently limit manipulation; The proof-of-stake, on the other hand, needs to use more sophisticated methods to address these security issues.
The proof-of-stake versus proof-of-work debate has largely remained in the technical realm. Proof-of-stake has a notable forerunner in Cardano, but the biggest projects have stuck with proof-of-work. However, Ethereum’s plans to migrate from proof-of-work to proof-of-stake are putting this issue in the spotlight. Ethereum’s move started in earnest in 2020 when Ethereum launched its proof-of-stake beacon chain. Development continues, with Phase 1 scheduled to start later in 2021 and the full merger for the Proof-of-Stake for Ethereum will take place over the course of next year.
Switching to proof-of-stake is complicated
Given the benefits of proof-of-stakes, why did it take Ethereum so long to make the switch? “The main obstacle to a faster introduction of Proof-of-Stake was certainly the difficulty of migrating the largest smart contract network Ethereum from Proof-of-Work to Proof-of-Stake,” says Justin Giudici, Product Manager at Telos Foundation . “The challenge of changing the consensus mechanism on Ethereum has been compared to ‘repairing an airplane while it is flying’ because the migration challenge is substantial with thousands of existing smart contracts in the Ethereum chain and billions of dollars in assets.
Here are some numbers to put the challenge in perspective. “The development of Ethereum has far exceeded its ability to change and thus scalability. It’s easy to see why, given the DeFi phenomenon, which saw an industry jump from zero to $ 76 billion in the last year, non-fungible tokens exploded in 2021, bringing in $ 2.5 billion a. Building on the Ethereum network has reached an explosive pace, while moving from proof-of-work to proof-of-stake is a long, arduous process, “said David Waslen, CEO of Rublix Development, a blockchain company – and smart contract software.
It’s easy to migrate from one technology to another in a vacuum. However, since Ethereum’s decentralized financial system is already widespread, it is important to maintain continuous network stability. “There may be unexpected critical errors or unpredictable circumstances before the merge takes place. This is a good reason not to rush the transition, ”says Mattias Nystrom, community manager for the Golem network.
“Ethereum’s timeline can be seen as a product of its strength: decentralization. It is a complex project with many stakeholders and, moreover, censorship-resistant and social approval-free. That means anyone can join the project and contribute to making changes in the network. So you need consensus between the developers who write the code and the wider community to keep things moving, ”says Nystrom.
Proof-of-stake and transaction costs
Another factor is the recent drop in cryptocurrency prices and the resulting amount of mining power for proof-of-work logs. Transaction fees for Bitcoin, Ethereum, and other leading proof-of-work projects support the mining network. As crypto has fallen, transaction fees have fallen. But even if the average transaction fee drops from, say, $ 25 to $ 5, it can still be a huge cut in smaller decentralized financial transactions.
With emerging economies like El Salvador adopting cryptocurrencies, fees need to be drastically reduced. El Salvador’s gross domestic product per capita is only about $ 11 per day. So if cryptocurrency is going to be the standard money in this economy, it is important that user fees do not constitute a large part of a worker’s average daily wage.
Additionally, high transaction fees, often found in proof-of-work logs, stifle progress in adopting cryptocurrencies.
“Innovation has a huge impact when you fall behind on slower, more expensive consensus technology. Historically, the transition from proof-of-work to proof-of-stake and other high-speed consensus models is comparable to the transition from dial-up Internet to broadband, “says Giudici.” Quite simply, the number and types of use cases, the degree the adoption and impact of the technology increases by orders of magnitude as entrepreneurs bring products to market that were even unimaginable with slower, more limited technologies. “
Ethereum is expected to adopt a proof-of-stake over the course of the next year. But don’t be surprised if the proof-of-stake still takes a while, like when switching from dial-up to broadband. “Even if the switch from proof-of-work to proof-of-stake begins in 2021, the end result is still a long way off. [Ethereum founder] Vitalik Buterin even pointed out an extended “cleanup process” after the planned hard forks and the eventual merging of the chain, before problems of the Ethereum platform such as lack of scalability, costs and overload can be aggressively tackled, “says Waslen.
Broader influence of proof-of-stake on users
Proof-of-stake has another much-discussed effect: the graphics card market. As Ethereum and other leading crypto projects introduce proof-of-stake systems, this should reduce the demand for graphics cards for cryptographic mining. This could finally break the scarcity in the region. This is great news for gamers.
Jahon Jamali, co-founder of Sarson Funds, agrees that the introduction of proof-of-stakes could increase the demand for graphics cards. However, the best proof-of-stake user benefit comes elsewhere. “The big positive effect is that consumers can participate in the consensus mechanism. It is more scalable and they can participate in the staking rewards. They will benefit greatly from being able to participate in a wider ecosystem,” says Jamali.
And it’s no guarantee that graphics card applications will decline in a proof-of-stake world. Giudici suggests that much of this crypto mining infrastructure could range from supporting proof-of-work systems to other crypto-powered applications like distributed research in areas like cancer, Alzheimer’s, and climate change. With a staking model, users could be rewarded with tokens for sharing their computing resources while promoting a greater good beyond simply maintaining the Bitcoin or Ethereum networks.