Since blockchain-based systems are decentralized, they do their decision-making by using consensus mechanisms. As per Wikipedia, “Consensus decision-making is a group decision-making process in which group members develop, and agree to support a decision in the best interest of the whole.” The mechanism by which the consensus is achieved is called consensus mechanism.
There are various types of consensus mechanisms out there, but the ones most commonly used are proof-of-work (PoW), aka “mining” and proof-of-stake (PoS). PoW’s ecosystem has a group of people called miners who use ASICs or GPUs to solve cryptographically-hard puzzles. PoS, on the other hand, has a staking model which takes care of consensus. If you want to know more about how PoW and PoS works, then check out this article.
In this article, we are going to be focussing on one of the biggest problems of mining, which makes it highly inefficient to achieve true decentralization. Later on, we are also going to see how staking mitigates this very problem
Mining and centralization
At the very heart of blockchain-based systems lies the concept of decentralization. PoW, as it turns out, is not as decentralization-friendly as we previously thought. The following is the current hashrate distribution chart of Bitcoin:
Bitcoin currently has four mining pools which own more than 50% of the network hashrate. It gets even worse when you look at Monero’s hashrate distribution:
Monero has three mining pools which hold more than 60% of the network hashrate!
The main problem with this is that these dominant pools have an unfair advantage in the ecosystem:
- Theoretically speaking, they can join forces and conduct a 51% attack on the ecosystem. If they do so, they can do whatever they want on the blockchain.
- Since they own a significant percentage of the network hashrate, the probability of them successfully mining the blocks is significantly higher and, as a result, they will be receiving most of the mining rewards.
There is one more factor which gives large mining pools an extremely unfair advantage. To understand that, let’s look into a concept called “Economies of Scale.”
What is “Economies of Scale?”
There are two kinds of productions out there:
- Short-run production: At least one of the input resources is fixed
- Long-run production: None of the input resources are fixed. This is where economies of scale come in.
Let’s go a little deeper into the second point.
Assume that you are doubling the number of input resources in a long-run production. When you do that, there are three possible outcomes:
- The output more than doubles, so you are getting increasing returns to scale.
- The output doubles, so that’s a fixed return to scale.
- The output doesn’t double, so you are getting decreasing returns to scale.
The following is a graphical depiction of economies of scale where the average cost of input resources is compared with the output value:
So, what is going on here?
- When you want to increase your output from Q to Q2, your cost of production decreases from C to C1.
- When you increase your output beyond Q2, the cost of production increases.
The implications of this are pretty staggering. The graph shows that until a particular limit, large corporations can actually increase their output value by decreasing the average cost of their input resources!
How does this apply to mining pools?
Larger and more powerful mining pools can leverage the economies of scale by, dollar-for-dollar, generating more hash-rate than other pools even if they spend the same amount of money.
Advantages that powerful mining pools have in a POW system
- They can use their superior hashrate to mine more blocks and gain more rewards.
- They can use the rewards to buy even more powerful ASICs and GPUs to give them an even greater advantage.
- They can use economies of scale to generate more hashrate for the same amount of money as their competitors.
So, as you can see, powerful mining pools have a clear advantage in this ecosystem, which makes it a lot more centralized that you’d want to believe.
How POS mitigates this problem
POS mitigates this problem by making the mining process completely virtual. You are not using your computational power to mine resources anymore, you are merely staking your money. While in a POW system, large pools can generate more hashrate from a dollar, in a staking system, one dollar is still one dollar. Economies of scale don’t apply here.
This is one of the biggest reason why a lot of the newer blockchains, including FLETA, have chosen a staking model. A truly decentralized network will be essential to their success and staking mechanisms can achieve that far more efficiently than traditional crypto mining. FLETA uses a faster and more secure variation of the POS algorithm called Proof-of-Formulation(POF).
In traditional POS, the entire network takes part in the consensus algorithm. In POF, two sets of actors are chosen from the network:
- Formulators: These are in charge of block generators. Based on their rankings, the Formulators will each get an opportunity to generate a block.
- Observers: These nodes do real-time confirmation of the generated blocks and prevent double spending. Five observer nodes are assigned to each Formulator group. At least three of out the five observers need to sign off on a generated block for it to be confirmed.
You can read this article to gain a deeper understanding of POF. POF has so far achieved a throughput of 15,000 transactions per second (tested and verified) which is a lot faster than Ethereum (15–20 transactions per second) and EOS (max of 3,996 transactions per second).