Proof of Work, Proof of Stake and the Consensus Debate

It seems that over the last six months the debate of whether proof of work (PoW) is the right long-term consensus protocol has been intensifying.

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Proof of Work, Proof of Stake and the Consensus Debate

It seems that over the last six months the debate of whether proof of work (PoW) is the right long-term consensus protocol has been intensifying. This is not an accident: For cryptocurrencies, there couldn't be a more fundamental debate than this one. The outcome will likely be one of the biggest factors shaping the crypto-ecosystem of the future. With proof of stake (PoS), a radically different consensus mechanism has been gaining increasing mindshare as a contender.

In the Beginning There Was Proof of Work

One of the sources cited in the original Bitcoin white paper is Adam Back's paper on Hashcash, which proposed the use of PoW mining to combat spam. PoW requires the production of information (a hash) that is hard to produce (through mining) but easy to verify. Satoshi Nakamoto's breakthrough was to use PoW and the blockchain to achieve distributed consensus, and it is this that made cryptocurrencies possible.

On the surface, it would seem that PoW has remained the unassailable winner among consensus systems. Bitcoin's share of the total cryptocurrency market cap is larger than ever, and non-PoW currencies only make up a minuscule percentage. With the fear of mining centralization receding recently, and onetime contender Litecoin losing traction, who would question that things should stay this way?

The Search for Newer Ways

Yet, some projects have decided to go down different routes and pursue PoS systems. NXT, one of the most successful altcoins, and BitShares are two examples, and even Ethereum is considering switching from a PoW to a PoS system at some point down the line. None of these systems has been tested or seen the same level of adoption as Bitcoin, but what is their chance to prevail eventually?

One recent event that has further inflamed the discussion is the publication of the sidechains proposal. The idea of sidechains is to allow the trustless innovation of altcoins while offering them the same monetary base, liquidity and mining power of the Bitcoin network.

For the proponents, this represents a crucial effort to rally the cryptocurrency ecosystem behind its most successful project and to build on the infrastructure and ecosystem already in place, instead of dispersing efforts in a hundred different directions.

For the critics, it represents a doomed effort to patch a broken system and stem Bitcoin's inevitable demise, an effort motivated by the vested economic interests of Bitcoin's earliest adopters, which (according to the critics) only supports the need to find alternatives to Bitcoin and its PoW.

The Cost of Security

While there are countless aspects to this debate, in my view, it all boils down to two things: security and economics. Will it be possible to achieve a high degree of security with PoW, particularly once there are millions of users, and once the potential payoff for a successful attacker is in the billions? What about the security level of PoS? What is the cost of achieving a high level of security in either case? How attractive will one system be, versus the other?

It's useful to pause here and ask what mechanism Bitcoin uses to achieve consensus. Bitcoin makes it very expensive to amass a majority of the hashing power. This does provide a level of security: A lone hacker will have no chances to gather the mining power necessary to disrupt the Bitcoin network. But there are also disadvantages.

The first is economic: Most of the value of newly mined Bitcoins flows out of the ecosystem into purchasing hardware and electricity. We pay for this with Bitcoin's inflation, and it is not farfetched to attribute much of the price decline this year to the inflation rate. It is true that the inflation rate will decrease over time, and if Bitcoin succeeds, the adoption rate will far outpace the inflation rate. But this only gives rise to another question: Will a decreasing mining reward provide sufficient security?

The second problem is that mining introduces risk factors that cannot be controlled because they are not parameters of Bitcoin itself. Just imagine that, due to some technology breakthrough, one manufacturer is able to produce ASICS at one tenth the cost of their competitors. Wouldn't this present a huge security risk for Bitcoin?

The Proof-of-Stake Approach

PoS aims to address these issues and improve on Bitcoin by using the coins themselves, instead of hashing power, as the scarce resource to achieve consensus. With PoW, an attacker has to either purchase lots of hashing power, or at least obtain control over it; for example, by bribing mining pool operators. With PoS, an attacker has to purchase a majority of the coins themselves. This may be much more secure.

It is possible to carry out a 51% attack with PoS as well, but such attacks should be orders of magnitude more expensive to carry out. It's easy to see why. Total investments in mining hardware are currently estimated at a few hundred million dollars—likely less than 10% of Bitcoin's total value. So in the worst case, purchasing 50% of the mining power might cost 5% of Bitcoin's market capitalization. With PoS, it's not just that acquiring 51% of the coins would cost 51% of the market cap (actually, it would cost ten times as much), but any attempt at doing so would drive up the price dramatically and make it prohibitive. Imagine what would happen to the Bitcoin price if someone tried to buy 7 million coins. We'd be waving goodbye to the moon pretty quickly.

There is also an economic advantage to PoS. Transaction fees and a possible block reward can be paid to the coin holders so that there is no monetary dilution. No money has to flow out of the system to buy external resources that provide security, and that could be great for the price of the currency.

A Conversation with Vitalik Buterin

Vitalik Buterin

I have no doubts that these questions will be accompanying us for years, as we grapple with the full ramifications of decentralized technologies. To think ahead and wonder where this journey will take us is a fascinating exercise. We're stoked that on our next episode, Ethereum founder Vitalik Buterin will join us to discuss these exact questions and how they have affected the design choices Ethereum has made. Through his brilliant writing and thinking, he has been at the very forefront of this debate.

Join us for the discussion (and ask questions in the live chat room) on Sunday at 6 p.m. UTC (7 p.m. CET, 10 a.m. PST, and 1 p.m. EST). RSVP here.

About Epicenter Bitcoin

Epicenter Bitcoin is a show about the technologies, projects & startups driving decentralization and the global cryptocurrency revolution. Every week hosts Brian Fabian Crain and Sebastien Couture talk to some of the most influential people in the cryptocurrency space about their projects, and get their perspectives on recent events.

You can take part in the live Google Hangout on YouTube or download the audio version after the fact on SoundCloudiTunes and other podcast apps.

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