Evolution and the Future Proof of Stake: Ecology and Profitability

Evolution and future of Proof of Stake: impact on the environment and profitability

The development and implementation of Proof of Stake is undoubtedly a significant stage in the evolution of the crypto market. Ingenious in its simplicity, the solution transformed the vector of blockchain development, changed the rules of interaction in decentralized ecosystems, leveled the problem of negative environmental impact of the technology and became the cornerstone for creating democratic, scalable and efficient blockchains of the new generation.

Proof-of-Stake (PoS) is the most popular consensus algorithm in blockchain today. It does not require large expenditures to maintain network performance, and investments in PoS projects are many times cheaper than investments in mining equipment. The profitability of Proof-of-Stake is enhanced by the generation of passive income in the form of staking rewards and the high availability of DeFi tools. The environmental benefits of PoS are also clear. The Ethereum network, for example, eventually changed its consensus algorithm to achieve record blockchain energy efficiency, recording a 99.9 percent reduction in energy consumption.

“What is a consensus algorithm?

The decentralized nature of the blockchain requires consensus among network participants to validate transactions and generate new blocks. The set of rules that govern this mechanism is called a “consensus algorithm”.”

History and reasons for the creation of Proof of Stake

Bitcoin had been in circulation for almost three years when, in 2011, a user named QuantumMechanic described his idea for an alternative way to validate transactions on the crypto enthusiast forum Bitcointalk. His concept implied the exclusion of miners from the work chain, which was then an integral part of the blockchain’s functioning, and proposed a different principle of reward distribution. It consisted in the fact that the weight of a decentralized network participant’s vote could depend not on the amount of computation he brings to the blockchain, but on the number of crypto coins he possesses.

The Proof of Work (PoW) consensus algorithm on which bitcoin operated and continues to operate is based on the following principle: miners compete in solving computationally intensive tasks to find a hash. If successful, the miner gets the opportunity to add a new block and be rewarded for his work.

Within the first few years of bitcoin’s launch, it became clear that PoW has a number of significant drawbacks:

The principle of reward distribution leads to equipment racing and centralization of mining capacity.

The problems of low transaction speed need to be addressed.

High power consumption puts pressure on the environment and harms the ecology.

Proof-of-work required constant growth in mining power, investment and electricity costs. Computing equipment was subject to higher and higher standards and prices, which reduced the affordability of mining. And this is where the democratic concept of PoS entered the arena, suggesting that all participants in the network get the right to vote, and the strength of the vote will be proportional to their share of the total number of coins.

“What is cryptocurrency staking?

Staking is a mechanism by which the owner of cryptocurrency receives passive income by keeping digital assets in the wallet and not using them for a certain period of time. In this way, he allows the systеm to block his funds for a while, thus contributing to the stable functioning and security of the network. The blockchain pays him a reward for this in native coins”.”

QuantumMechanic’s idea found an immediate response, and in August 2012, the new consensus mechanism was implemented in the PPCoin cryptocurrency. A hybrid consensus systеm was implemented on the blockchain (new coins were created through mining, and transactions were processed through the PoS). This model was also implemented in other early projects such as Gridcoin and Blackcoin. The first 100% PoS cryptocurrency without the use of mining was NXT, launched in 2013. The Proof-of-Stake algorithm turned out to be so efficient and flexible that in the following years most decentralized platforms began to implement it in various modifications.

Working principle of Proof-of-Stake

So, according to the original concept of Proof-of-Stake, the rights to manage the blockchain are distributed among the participants of the network according to the share of coins they own. At the initial stage of the algorithm’s development, everyone had the ability to create a new block if they had an irreducible balance of coins in their wallet. For example, in the case of the “canonical” PoS coin NXT: each participant’s wallet is a node with a copy of the blockchain, and each user is entitled to a reward for forming a new block if there are at least 1002 NXT. The more coins stored in the wallet, the higher the probability of receiving a reward.

This highest level of decentralization is not the best for speed — the Nxt blockchain processes 4 transactions per second. To improve performance, more modern PoS networks have begun to use the principle of delegation, in which the right to control votes is transferred from many wallets to a few computing nodes. Initially, this mechanism had a separate name DPoS (Delegated Proof-of-Stake) and was implemented on BitShares, EOS, Tezos, Cardano, etc., and over time it became an industry standard and is used by default in most PoS implementations.

Thus, the day-to-day work of maintaining the blockchain is delegated by network participants to validators (professional participants who manage nodes). The number of validators needed to ensure the smooth operation of the blockchain depends on its architecture and varies from network to network. For example, Polkadot plans to triple the number of validators to 1,000 by the end of 2024, while the number of active Ethereum validators today is close to 1 million. To launch a node, the validator needs equipment with constant access to the Internet and special software, for the activation of which it is necessary to block a certain number of native coins in staking. For example, for Ethereum at least 32 ETH, Avalanche — 2000 AVAX, Tezos — 6000 XTZ. The blocked assets serve as a guarantee of the validator’s intentions and as a reserve at the expense of which the network can compensate for erroneous transactions made by its node. The right to process transactions between validators is distributed by the systеm depending on the number of coins in the stake, the length of the blocking period and randomization.

Types of PoS

Here are some of them:

Proof-of-Authority (PoA) is a hybrid algorithm that takes into account the reputation of the validators. After going through a series of verification procedures, each validator must be approved by the developers. PoA ensures transparency of the relationship between network participants and the project. It is used in Binance Smart Chain, VeChain, TomoChain.

Leased Proof-of-Stake (LPoS). Used in the Waves blockchain, it allows users to rent their coins to validators for a fee. As a result, the validator increases his locked funds and the chances of finding new blocks.

Nominated Proof-of-Stake (NPoS). Developed by Polkadot and used in Kusama. It places a strong emphasis on the social capital of the validator, similar to PoA. Participants “nominate” validators by voting, providing their tokens as collateral, and sharing risk with them. The validator must prove his bona fides to the participants.

Pure Proof-of-Stake (PPoS) is an Algorand network algorithm in which any participant holding more than 1 ALGO can become a validator and be rewarded. Validators are randomly selected to ensure democratization of earning opportunities.

Effective Proof-of-Stake (EPoS), developed by Harmony, also aims to distribute rewards fairly. It is based on encouraging a large number of small validators as opposed to large validators, thus supporting greater decentralization of the blockchain.

Comparison of PoS and PoW

Bitcoin’s capitalization makes up about 50% of the global cryptocurrency market, which follows its trends. The PoW algorithm is also used by Dogecoin, Litecoin, Ethereum Classic and Monero. The communities of these networks are actively discussing the possibility of changing the algorithm to improve the scalability and sustainability of the blockchain. The increasing use of electricity is at odds with the global concept of climate security. Environmentalists criticize PoW blockchains and banning the algorithm is actively discussed. However, it cannot be overlooked that the real damage of mining with carbon footprint is objectively lower than many socially approved industries such as gold mining, banking and others. In any case, the environmental impact of PoS is virtually invisible compared to PoW.

Moreover, experts point to the significant contribution of PoS to green technologies. In addition to the inherently low energy consumption, there are many use cases for PoS in renewable energy projects, recycling, and carbon footprint offsetting.

As for centralization risks, they are present in both algorithms. And while PoS blockchains are trying to solve the problem of the power of the big vote, which can create an imbalance between PoS and the principles of decentralization, the crypto market is watching the monopolization of mining — the main computing power to support PoW in recent years can only be afforded by large corporations or state governments.

The future of consensus mechanisms

The undeniable advantages of PoS over other algorithms open up great prospects for the development of new and better PoS protocols. Project teams face the challenge of improving security, because although this algorithm is more technologically advanced and ideal for payment systems, PoW is considered more secure due to its unprecedented decentralization.

Changing the algorithm from PoW to PoS seems difficult to implement, as it is hard to imagine conditions under which miners would agree to do so. In addition, bitcoin has several separate development teams, and any changes will cause fierce disputes that will take years to resolve. Adjusting PoS in large blockchains is therefore a non-trivial task. The developers of Dogecoin and Zcash announced the possibility of moving to PoS in 2021, but it hasn’t happened yet. On the other hand, Ethereum successfully passed the algorithm adaptation process in 2022 and is now the largest PoS cryptocurrency by capitalization.

In any case, the inherently high scalability of PoS blockchains is not in doubt, while PoW network developers are forced to develop Layer 2 solutions to increase throughput. Among the challenges facing PoS, some analysts cite the risks of uncertain regulation, as PoS tokens may be treated as securities by the SEC.Either way, the entire market has been waiting for years for a solution to the issues of blockchain regulation in general and PoS tokens in particular.

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