Ethereum plans to do this by shifting from a Proof-of-work model to Proof-of-stake. In today’s column, we take a look at how Ethereum’s new upgrade could change the crypto mining industry forever.
Cryptocurrencies use enormous amounts of electricity to secure their networks. This is done via something called crypto mining. Mining cryptocurrency is not just a way of adding or creating new coins. Crypto mining also involves validating cryptocurrency transactions on a blockchain network and adding them to a distributed ledger.
For instance, when you send money to your friend or your family, your bank updates the digital ledger by debiting one account and crediting the other. Blockchain essentially is a distributed digital ledger which records every transaction. Every crypto coin you buy or every NFT you mint has to be recorded on the digital ledger. Crypto miners verify and update each record on the blockchain.
However, Crypto distributed ledger only allows verified miners to verify and update these transactions on the digital ledger. And for verifying these transactions, miners are rewarded with crypto coins for contributing their computing resources to the network.
But how does blockchain ensure that only verified crypto miners can mine and validate these transactions? This is possible through Proof-of-work (PoW) consensus protocol. PoW also secures the network from any external attacks.
Mining consumes a lot of computing power and resources because of the proof of work algorithm. The idea was first introduced in 1993, as an effective way to combat email spams. However, until 2009 the idea remained largely ineffective.
Satoshi Nakamoto, a pseudonymous Bitcoin creatorrealized that this mechanism could be used as a way to secure the Bitcoin Blockchain.
The proof of work algorithm works by having all nodes (devices) to solve a cryptographic puzzle. This puzzle is solved by miners and the first one to find a solution gets the reward. This has led to a lot of competition and situations where people are building larger mining farms.
According to Digiconomist, Ethereum consumes about 112 terawatt-hours of electricity per year, which is comparable to that of the Netherlands and more than what the Philippines or Pakistan use. A single transaction on Ethereum is equivalent to the power consumption of an average US household for over nine days.
A single Ethereum transaction also equals the energy consumption of more than 1,50,000 Visa card transactions.
In the case of Bitcoin, it’s even higher — 137 terawatt-hours of electricity per year.
The more computational power you have, the easier it becomes to mine a coin. This computational power is also referred to as hash rate. To increase their chances to win further, miners can come together in what’s called mining pools, they combine their hashing power and distribute the rewards evenly across everyone in the pool, ultimately causing miners to use massive amounts of electricity.
This has also made crypto mining centralized. Imagine several big players coming together, combining their hash rate and eventually teaming up to increase their chances of mining a new block and thus collecting a reward.
Small crypto miners are left at the mercy of such big players. To address these issues, a new consensus algorithm was needed that is better than Proof-of-work.
In 2011, a user of a Bitcoin talk forum Quantum Mechanic proposed a new idea of ending competition between crypto miners. This was called Proof-of-stake (PoS).
Rather than competing against each other for a block, PoS uses a process in which one node is chosen randomly to validate the next block.
The terminology is slightly different here. PoS calls it miners ‘validators’. Unlike PoW, where users have to mine a new block, PoS users have to ‘mint’ or ‘forge’ new blocks.
To become a validator at PoS, users are required to deposit a certain amount of cryptocurrency as a stake—like a security deposit. The bigger the amount of stake, the more chances users have to mint a new block. For instance, if a user deposits $100 into the network as a stake, and another user deposits $500, the second user now has a five times higher chance of being chosen to forge the next block.
PoS vs PoW: Which is better?
Crypto miners have the potential to update and verify transactions, and there is a possibility that a transaction that never happened or a fraudulent transaction can be verified as well. This is where the stake comes in. Validators will lose a part of their stake if they approve any fraudulent transactions.
But what happens if the majority of the stake is bought in a network by a single entity, and worst, what if the entity starts approving fake transactions. This is called a 51 per cent scenario. If a single miner or group of miners can obtain 51 per cent of the hashing power, they can effectively control the blockchain. It was first discussed as a weak point of the proof of work algorithm.
On the other hand, Proof-of-stake makes this attack impractical, because users are asked to stake higher than what they receive from the block rewards. So, even if miners acquire 51 per cent of the hashing power, they would lose way more than they would earn for verifying every fake transaction.
It should be noted if a user stops being a validator, the stake plus all the transaction fees is released after a certain period of time, not straight away because the network still needs to be able to punish, should they discover that some of the blocks were actually fraudulent. So the 51 per cent attack is actually less likely to happen with Proof-of-stake.
At the energy front, PoS only allows a few crypto miners or ‘validators’ to mine cryptocurrency. This means less computational power is required. So, high-tech mining equipment is not needed, reducing the mining energy significantly.
PoS favors rich people who will get chosen more frequently, will collect more transaction fees, become even richer, and thus increase their chances of being chosen as a validator even further.
Another potential problem is when the network chooses the next validator, but the validator doesn’t turn up to do the job. In short, Proof-of-stake brings additional risks when compared to Proof-of-work.
A lot of research is yet to be done understand risks associated with PoS and then to mitigate them. For now, it seems more cryptocurrencies are likely to follow PoS in the future.