Legal Frameworks for PoW → PoS

To understand how PoS will work legally, we must understand today’s legal frameworks for PoW.

CleanApp
CleanApp
Feb 26 · 17 min read

In basic terms, the PoS approach to scaling asks blockchain validators to put skin in the game; if validators form cartels or do other things that harm the network, they get burned.

PoS is not limited to Ethereum; even within Ethereum, there are several competing PoS proposals (see here or here).

Thesis A: To understand how PoS will work legally, we must understand the current legal frameworks behind PoW.

Thesis B: The legal structure of proof-of-stake (PoS) blockchains is qualitatively different and far more complex than the legal frameworks for proof-of-work (PoW) consensus — which are themselves indeterminate and increasingly complex.

Thesis C: Rigorous legal stress tests offer layers of additional security to global proof-of-stake blockchains.

1. Background

By way of brief background, today’s Ethereum employs a so-called Proof-of-Work (PoW) consensus-building process.

PoW Mining

In a PoW blockchain validation scheme, volunteers are incentivized to run specialized blockchain “mining” software on their computers. The blockchain node software then creates a fixed record of all transactions occurring on the blockchain, and works to update the blockchain for as long as the software is run.

PoW Node Operators

To verify that a block of transactions is authentic, and to confirm the addition of this block to the ever-growing global transactional chain, the volunteer PoW “node operators” have their computers solve complex hashing problems. The first crew of operators that successfully validates a block receives what is known as a block reward, which currently stands at 3 ETH. (This block reward is due to decay to 2 ETH following an imminent Q1 2019 protocol update — the long-awaited “Constantinople” hard fork.)

Today’s Ethereum Ecosystem

There are many other subtle nuances of the Ethereum 1.0/1.X design, including so-called “Uncle” rewards, “gas” fees for validating transactions depending on the extent of one’s usage of the blockchain, and different connections to specialized transactional protocols (e.g., 0x, Polkadot, etc.) — not to mention a long and growing catalog of “smart contracts,” dApps, and DAOs built or planned for Ethereum.

Ethereum is best thought of as a database, a network, an operating system, and a collection of interoperable programming languages.

Whether we think of Ethereum as the world’s slowest supercomputer or a crypto network, blockchains like Ethereum are the foundation of a more secure and equitable Internet. This is why it is so important to put existing and upcoming chains on the strongest possible legal footing.

2. PoW → PoS

Despite the impressive set of characteristics above, Ethereum needs a radical redesign to become a rapidly scalable general-purpose global public blockchain. PoS is that radical redesign.

2.A. Scale is Everything

First, PoW is not scalable. The larger the transactional pools and blocks become, the more computing power is necessary to validate a given block. As the value of the blockchain is directly tied to network effects and a growing number of users executing a growing number of transactions, PoW faces a conceptual Catch-22:

  • On the other hand, if adoption rates are artificially controlled and effectively depressed to track existing operational bandwidth, then Ethereum runs a high risk of being outpaced by a competing blockchain that offers higher transaction volumes, faster transaction times, and lower overall fees.

2.B. Forks Over Knives

Second, PoW mechanisms are proving easy to capture. Even large putatively-decentralized blockchains like Ethereum and Ethereum Classic are always at risk of the dreaded 51% attack.

2.C. PoW is Unsustainable

Third, PoW hashing is extremely energy hungry, which means that PoW blockchains like Bitcoin and Ethereum consume an increasingly large share of a presently-finite planetary thermodynamic pie.

2.D. PoW Favors Incumbents

Fourth, the hope of blockchain validation on a spare desktop PC is quickly giving way to the reality of BigCrypto — powerful hardware and software collectives determined to write the future operating rules of the New Internet.

A Bitmain Antminer S9, purpose-built to mine Bitcoin (credit: Wikimedia Commons)

The bottom line here is that a maximalist PoW posture means permitting brute force to rule the day. In this blockchain reality, might makes right.

For coders committed to building a more-or-less equitable networked transactional space, might-makes-right is not a viable strategy. Hence, in part, the transition to PoS.

3. PoW Through Legal Prisms

The context above shows what motivates the shift from PoW → PoS, and some of the jargon involved. To understand the legal requirements for PoS, we can now narrow our focus to some of the core legal forms underpinning PoW.

3.A. Blockchain Alegality

One way of analyzing PoW is to place it completely outside of existing legal regimes (PoW [Bitcoin, Ethereum 1.0, et al.] = alegal), and to maintain the experimental, research-focused, and voluntarist nature of the enterprise.

3.B. Blockchains as Property

Another way of analyzing PoW is to analogize PoW to settled property law regimes. In this view of PoW, node operators can be viewed like landlords of computer farms who lease out their computing power in exchange for fees. Property law theory offers rich analogical fodder for this vision of crypto and both PoW & PoS blockchains.

3.C. New Chains, Legacy Blocks

Another mainstream way of analyzing PoW focuses on the legal nature of the crypto form in question — such as the well-known Howey test for determining whether a given crypto instrument is a “security” versus “utility” token.


4. PoW as Contract?

By this point, we see that even relatively straightforward PoW schemes are complicated legal beasts.

But as blockchain analysts know well, a PoW scheme cannot be reduced to something like unilateral payouts from an employer to employees, like rewards from a queen bee to an army of miner drones. Blockchain mining rewards are far more complicated, legally.

The simplified framework above omits important PoW stakeholders. It is also flawed because it reduces a decentralized web of actors to a heuristic centralized body — “Ethereum” — which arguably lacks legal personality.

5. Jurisdictional Detour

Thus far, we have discussed PoW/PoS networks as clusters of contracts without necessarily tapping into the contract law of X or Y jurisdiction, even though jurisdiction questions are ultimately existential ones for blockchain devs. At first, this may seem like an analytical bug, but in this context, it’s actually a neat legal analytical feature.

Jurisdiction questions already structure how Ethereum developers think about the transition to PoS. We just need to make the legal issues even more explicit.

Please note, the jurisdiction question is not just about forums for resolution of disputes or the law that will govern those disputes. Acknowledging the operation of plural, overlapping, and conflicting jurisdictional authorities is a prerequisite to stronger substantive legal arguments and postures as well. It allows us to get comfortable with the fact that we cannot ever fully eliminate legal uncertainty and legal risk.

6. Blockchains as Clusters of K

Our broader jurisdiction maps produce seemingly contradictory answers to supposedly straightforward questions, and that’s precisely why the broader maps are so valuable.

Thus, returning to whether PoW schemes are contractual, we learn that the answer is both yes, and no — simultaneously.

It is fair to think of a PoW scheme as a cluster of contracts in general terms. And in fact, there are many jurisdictions where the Ethereum ↔ miner relationship, for instance, could be considered contractual. Just like there are many jurisdictions that have radically conflicting views on the legality of so-called “smart contracts.”

6. Ethereum Miner/Validator Contracts?

Let us dive deeper to see how blockchain developers can weaken centripetal contract bonds in order to strengthen the system as a whole.

Although a contract is a legal ghost, one can’t form a contract with a legal ghost. That’s too many ghosts.

You can only have a contract with a legal entity capable of entering into contractual relations. If the global public blockchain is not a legal entity, then it cannot enter into contracts. It’s as simple as that.

Here is the same map as the one drawn above, now with additional legal actors that fragment “Ethereum” into more granular constitutive parts.

6.A. Who’s Ethereum? Where’s Casper?

First, we must recall that the many enterprise integrations of/with “Ethereum” are not contractual entanglements between enterprise actors like, say, Amazon, and the “Ethereum blockchain.”

6.B. P2P Functionality → P2P Liability

Second, we can further weaken the potential contractual nature of the Ethereum ↔ miner relationship by recalling that miners obtain block rewards from other blockchain users, not from Ethereum-the-blockchain.

6.C. Less Liability → More Security

Third, contractarian approaches PoW blockchains omit the reality of miner cartel formation, or what is colloquially known as “pool mining.” In a nutshell, pool mining wrinkles the idealized blockchain vision of democratic, ubiquitous, and decentralized transactional space-time.

7. Core Design Objectives of PoW & PoS

Our brief overview of the transition from PoW → PoS focused on foundational legal issues in order to anticipate potential legal attack vectors. Before closing, we should recall some of the bigger design objectives common to Ethereum PoW & PoS.

  1. Anticipate, prevent, and minimize cartel-formation behavior;
  2. Prevent and ameliorate abuse of dominant crypto-market position (anti-monopolistic strain of blockchain governance theory);
  3. Maintain and expand the security gains of decentralization without jeopardizing scaling;
  4. Provide legitimate governance mechanisms that accomplish #1 to #4 in a sustainable and socially-meaningful manner.

Despite major conceptual, personnel, and market shifts, Ethereum PoS seeks the same heights as Ethereum PoW — to build a censorship- and capture-resistant data structure and socio-legal marketplace.

It is not clear how (or even if) Ethereum 2.0 will get there, but it is clear that global public blockchains will continue to grow and evolve. At least one global public project will fulfill the promise of a general-purpose globally-scalable mass-adopted blockchain: the potential utility gains are just too great to let status-quo-favoring lawyers destroy the emancipatory dream.

8. Crypto Legal Innovations

In our next installment, we will analyze one of the most significant differences between Ethereum 2.0 and Ethereum 1.0. This is, of course, bETH, the planned network token for the Ethereum 2.0 blockchain.

For now, we hope you agree that, PoW or PoS, crypto scaling is also a legal problem in need of innovative legal solutions.

If you agree, please share our work and sustain it. It is far easier to take action today than to support future armies of lawyers to fight battles that you could have prevented.

Crypto Law Review

A journal pushing the bounds of our legal imaginaries, on-chain, off-chain, and against the chain.

CleanApp

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CleanApp

Small NGO with a big patent urging BigTech & Crypto to enable trash/hazard reporting & open source data. "The Wi-Fi & Bluetooth of TrashTech" - cleanapp.io.

Crypto Law Review

A journal pushing the bounds of our legal imaginaries, on-chain, off-chain, and against the chain.