The Proof Systems of Cryptos

The Proof Systems of Cryptos

Confused by all the “proof” talk? Let’s examine what these terms mean.

The global crypto market capitalization reached US$2.18 trillion in 2021. According to the Bloomberg Galaxy Crypto Index, the cryptocurrency market grew by 160% in 2021, which far surpasses ‌growth of conventional commodities. With such a booming market segment, it is only natural that people would want to find ways to make money from crypto.

For anyone even doing the absolute surface-level research, the most common terms you would find scrolling through article after article about crypto are proof of work, proof of stake, proof of burn and proof of transfer. These “proofs” are systems that decide how transactions are processed within various cryptocurrencies, with each having specific benefits for miners and investors. Here is a breakdown of all these terms to help you easily navigate through the crypto world.

Proof of work (PoW)

PoW is a crypto consensus mechanism used to confirm transactions and create new blocks on the blockchain. Under this mechanism, miners need to be the first ones to solve a set of complex mathematical problems and generate a 64-digit hexadecimal number called “hash”. Bitcoin uses the PoW system and consumes 91 terawatt-hours of electricity annually—more than seven times the total electricity used by Google. 

As cryptocurrency grows, more and more crypto miners enter the market and compete with each other to solve these problems. The increased competition for crypto blocks to mine leads to an increase in the complexity of the problems needed to be solved to mine crypto. This means that over time, PoW will become a really energy-intensive way of mining cryptocurrency. 

Besides being energy-intensive, one of the major challenges posed by PoW is called the tragedy of the commons. It is an economic principle wherein every individual has an incentive to consume a resource, but in doing so, it leads to the total depletion of the resource and harms others. For Bitcoin, in particular, it refers to a point in time in the future where there will be a shortage of miners because of falling mining rewards (mining rewards fall every four years or every 210,000 blocks). 

The tragedy of the commons will, in turn, lead to a situation where a handful of the miners control 51% of the computational power (also known as the 51% attack) on the network and may create fraudulent blocks of transactions for themselves.

Proof of stake (PoS)

To solve the problem existing in the PoW system, the PoS consensus mechanism has been developed. While the PoW mechanism is all about a rush to be the first to solve the mathematical problem, PoS puts a cap on mining power based on the number of coins a validator has staked. The stake within a PoS system is locked up during the staking period (a specific period of time for which you cannot pull out your crypto holding).

Validators are chosen randomly from within the pool of those who have staked their crypto holdings. However, the larger the share of coins staked, the higher one’s chances of becoming a validator. This limits mining capacity and also limits the number of validators, therefore, making the process less resource-intensive. This consensus mechanism came about in 2020. Some cryptocurrencies, like Cardano, Tezos and Atmos, use the PoS mechanism, with each having its own specific techniques within the larger PoS system. 

Relative to the PoW system, PoS is safe from a 51% attack. It is because to do such an attack, the validator would have to hold 51% of the crypto staked. Holding that amount of crypto will make it disadvantageous for them to attack the network. Nonetheless, validators with a large stake do hold a lot of influence on the consensus process (since they have higher mining capacity). 

Proof of burn (PoB)

PoB is another alternative to the high energy-consuming PoW system. The idea behind the PoB system is to provide miners with mining power based on the number of coins burned (burning means the removal of the coins from the blockchain, rendering them unusable). 

To burn coins, miners need to send them to unspendable addresses. This system prevents early adopters from getting an unfair advantage (of owning coins) by periodically burning coins. The system promotes regular activity of miners instead of one-time early investment. An example of a cryptocurrency that uses PoB is Slimcoin. 

PoB has not been verified to work on a large scale and needs further testing to ensure security. It is also not as fast as the PoW mechanism.

Proof of transfer (PoX)

An extension of the proof of burn mechanism is PoX. A PoX blockchain is anchored on a selected PoW-based cryptocurrency. The PoX mechanism is used by the cryptocurrency Stacks. 

Within this system, miners send Bitcoin to those who hold Stacks and, in turn, have a chance to get mining capacity. The chances of receiving mining capacity are proportional to the amount of Bitcoin they transfer to another user. The miner who wins the chance to earn mining capacity for Stacks mines their respective block and receives newly minted Stacks as a reward. 

All of this goes to show that crypto mining is gradually becoming more energy conscious by limiting the miner base by various means. This means that over time, we may be able to find ways of using cryptocurrencies without the massive environmental impact the proof of work system currently has. If you are interested in crypto mining, make sure to keep up with these changes to keep yourself ahead of the curve on everything crypto-related. 

Header image courtesy of Unsplash

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