Where does the money come from? Dollars are printed by the US Mint. For cryptocurrencies, the answer is more complicated. Until now, both of the most widely used digital tokens, Bitcoin and Ethereum, have only been issued to pay for tasks performed by so-called miners in so-called proof-of-work systems. It is an approach that has received increasing criticism for the large amounts of energy consumed and the pollution produced. Ethereum is switching to a different system, called proof of stake, in a process known as the merge. Supporters say the approach could cut Ethereum’s power usage by 99%.
What is Crypto ‘Proof of Work’ and ‘Proof of Stake’?: QuickTake
1. What are the “proof of” systems for?
Cryptocurrencies would not work without blockchain, a new technology that performs the old-fashioned function of maintaining a ledger of time-ordered transactions. What differs from pen and paper records is that the ledger is shared on computers all over the world. Blockchain must take on another task that is not necessary in the world of physical money – making sure that no one is able to use a cryptocurrency token more than once by manipulating the digital ledger. Blockchains operate without a central guardian, such as a bank, in charge of the ledger: Both proof-of-work and proof-of-stake systems rely on group actions to create, validate and secure a blockchain’s sequential record.
In the Bitcoin and Ethereum main networks today, transactions are grouped into “blocks” that are published to a public “chain”, but only after “proof of work” ordering is done. With Bitcoin’s software, that happens when the system compresses the data in the block into a puzzle that can only be solved through potentially millions of trial-and-error calculations. This work is done by miners who compete to be the first to come up with a solution and are rewarded with free cryptocurrency if other miners agree that it works.
3. What is evidence of the work’s disadvantages?
When Bitcoin was worth pennies, mining was also cheap. But as the currency’s value rose, an arms race of sorts began, as miners added resources in the quest to win new coins. Bitcoin’s software responds to increased competition by increasing the computational difficulty. The resulting skyrocketing power consumption led to calls from environmentalists to avoid Bitcoin. The European Union considered banning the practice before deciding that cryptoasset providers should be required to disclose the energy consumption and environmental impact of the assets they choose to list. The proof-of-work system has also led to the increasing dominance of huge, centralized mining farms, a development that has created a new vulnerability for a system designed to be decentralized. In theory, a blockchain could be rewritten by a party that controlled a majority of the mining power.
4. What is proof of stake?
The idea behind the proof of stake system adopted by Ethereum is that the blockchain can be secured more easily if you give a group of people a set of carrot-and-stick incentives to cooperate. People who put up, or stake, 32 Ether (1 Ether traded at around $1,900 in mid-August) will be able to become “validators”, while those with less Ether can become community validators. Validators are elected to order transactions into a new block on the Ethereum blockchain. If a block is accepted by a committee whose members are called attestors, validators are awarded Ether. But someone who tried to game the system could lose the coins that were bet. Ethereum’s proof of stake system is already being tested on a blockchain, called the Beacon Chain, which is separate from the proof of work system; so far, $25 billion in Ether has been staked there. The two blockchains are expected to merge in September.
5. What are the system’s advantages?
It is believed that switching to proof of stake will reduce Ethereum’s energy use, estimated at 45,000 gigawatt-hours per year, or slightly more than New Zealand’s, by 99.9%. In terms of its carbon footprint, it will essentially be like any other Internet operation whose energy use involves nothing more than running a network of computers, rather than a venture that resembles a collection of giant digital factories.
6. What are the vulnerabilities?
Proof of Stake is less battle-tested than Proof of Work, whose security has been scrutinized for more than a decade. So new vulnerabilities can be found. The advocates believe the risk is worth what can be achieved in terms of environmental benefits, as well as by bringing a wider group of users into the process.
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