Proof-of-Stake: the next crypto step.

By Jessica Sier 4 August 2018 4 min read

Outline:

  • Proof-of-Stake is a passive way of generating income using a cryptocurrency stash;
  • It is based on an ownership protocol;
  • To maintain the network, a person needs to prove they own a certain percentage of all coins issued in a given currency.

There are those crypto-investors who have hooked themselves up to the drip of rollicking markets...

...and there are those getting down to the business of exploring crypto-economics and are using their stash for things other than speculation.

In this post, we introduce "Proof of Stake:" a passive way of generating income using a cryptocurrency stash.

Case Study:

Joshua is a 31-year-old architect who invested in cryptocurrencies in 2016 and since then has built a nice healthy stash.

Joshua fully acknowledges that all assets in the altcoin market react to fluctuations in Bitcoin, given it is by far the largest and most liquid market.

But still, he’s tried to diversified his holdings to include a variety of crypto-assets.

Joshua classifies himself as a long term participant, though he definitely cashed out a few coins throughout the run in December, and feels pretty good about that.

But on top of everything, he is an advocate of “staking”, a practice that, in essentials, earns him something akin to interest on his cryptocurrency while it sits in his various wallets.

Why Proof-of-Stake is in the news:

The Ethereum protocol is gearing up to change its Proof-of-Work system to a Proof-of-Stake network, in a bid to lessen its reliance on expensive and damaging mining.

It’s also seeking to ensure itself against the possibility of a 51% attack.

The significance of this follows:

Proof-of-Work:

Proof-of-Work is where miners compete with each other to solve incredibly complex mathematical problems.

Miners use computational power to constantly make sure that every existing crypto-asset and its every recorded transaction are true and accurate.

These calculations are bundled together, stored in blocks and available for everyone to view.

Maintaining this growing and unwieldy public blockchain is an enormous task and the computers are rewarded for their efforts with new currency units.

As it stands, miners can’t cheat this system because the majority of participants must agree that, yes, this is a true and accurate history of the blockchain.

But cryptocurrency mining has become an expensive and exclusive endeavour.

Those with money to establish enormous mining farms, using hardware that produces higher computational power, are able to verify more blocks than others, which yield them more cryptocurrency rewards.

They also burn through electricity and hardware at ferocious pace.

Ultimately, Proof-of-Work networks have prompted miners to have much more power within the crypto-universe and this is contrary to the core idea of decentralisation.

51% Attack

Should one party have majority mining power - more than 50 per cent - they would be able interfere with transaction confirmations.

That party could halt payments between some or all users and they could also potentially double-spend coins.

Proof-of-Stake

Unlike Proof-of-Work, where computational power is used to validate transactions and create new blocks, Proof-of-Stake uses an ownership protocol.

New blocks are created by those who put up a stake of their coin stash.

To contribute, a person needs to prove they own a certain percentage of all coins issued in a given currency.

Proving these “stakes” creates new blocks, which is called “forging” rather than “mining”.

“Putting up a stake” - or creating a node - is like an individual’s holdings being held in an escrow account: if they validate a fraudulent transaction, they lose their holdings, as well as their rights to participate as a forger in the future.

In most PoS cases, digital currency units are created at the launch of the currency and their number is fixed.

So rather than receive new crypto units as rewards for their participation, forgers receive transaction fees.

As time goes on and your stake - or node - is used over and over again to validate the network, transactions fees will flow to you. Not dissimilar to interest.

(That said, there are a a few cases where new currency units can be created by inflating the coin supply, and forgers can be rewarded with new currency units created as rewards, rather than transaction fees.)

And rather than enormous miners having an advantage over the verification process with the sheer size of their computational power, PoS is proportional.

Essentially, if you owned 5 per cent of the entirety of a PoS coin, you’d be paid 5 per cent of all transaction fees across the protocol. Depending on the price and particulars of the coin, that could be very lucrative.

Which also means, it returns to scale. So for those of us with only small amounts of crypto: if you owned 0.005 per cent of all available coins, you’d be able to forge 0.005 per cent of all transactions.

How it works in real life

Joshua - a person we interviewed for this story - stakes using Coin1.

He has his Coin1 wallet on a Raspberry Pi - a small, cheap computer that doesn’t use much electricity - and doesn’t use the device for anything other than staking.

It is important to note that anytime your crypto-wallet is online it is potentially more vulnerable to attack and so Joshua has fully encrypted his wallet.

He has installed a firewall and has blocked Telnet and Secure Shell to reduce attack vectors.

In order to use his stash to verify the larger Coin1 protocol, he keeps his wallet “open” (meaning online) and has it synced with the broader protocol.

It took about half a day before his wallet was accepted and could begin “staking”.

As such, Joshua has been earning proportional transaction fees on this particular cryptocurrency for the last few months using Proof-of-Stake.

So while he's not riding the wild fluctuations of other crypto-markets, he says it beats the current interest rate. And money for nothing is always nice.

Spaceship does not have a position on the appropriateness of investing in cryptocurrency – all investments carry risk and the information presented is simply a snapshot of facts based on current understanding of the technology. Joshua’s story is an edited representation of recent events and should not be relied upon to determine an investment strategy or otherwise influence a decision to buy, hold or sell any cryptocurrency or any other financial product or service.

Words by
Jessica Sier Right Chevron

Jessica Sier is a financial journalist who currently heads up Spaceship's content. Prior to that she was a reporter at the AFR where she discovered breaking down financial bulls**t was a public good.

Proof-of-Stake: the next crypto step.