Satoshi Nakamoto’s implementation of hashcash cryptography and verification that backs Bitcoin and many forks has been revolutionary and helped create a massive decentralized and trustless currency ecosystem. This system is called proof-of-work (PoW), and many are relatively familiar with the basics of this process and its underlying mechanisms will only be briefly touched upon. The basic process of mining involves a series of mathematical computations or “guesses” that attempt to determine the answer or “nonce”, to a difficult math question. If the guess is correct, the miner receives a reward from the block plus the fees paid by transactions. These numbers are extremely difficult to guess and have no predictable pattern.
Miners compete to guess the next block and each correct guess is validated and transmitted to other miners in the network. Each miner’s guessing rate is determined by the amount of computational power of their mining rigs. In the early days, Bitcoins could be mined using central processing units (CPUs), then graphics cards (GPUs), and currently application-specific integrated circuit (ASICs) which are processors built specifically to solve hash based problems. As more Bitcoins are mined, the difficulty of each mathematical problem increases which requires both more guesses and guessing at a higher rate. It is still possible to mine with CPUs or GPUs, although the chances of receiving any reward is slim to non-existent. Those participating in mining must pay the cost of power to run the mining units, which can be offset by the rewards gained from mining. This creates a barrier to entry as finding both cheap power and affording the relatively expensive hardware is increasingly costly. This scarcity of hash power and electricity creates the scarce resource which creates economic competitiveness and security in proof-of-work. Miners must compete to submit valid blocks or else lose out on potential block rewards. More participants and miners increases the security of a chain, decreasing the chance of receiving the reward from the next block.
Over time however, the question of scaling mining-based security to a global scale has become an important question. In economies of scale, those who are able to produce or mine at more effective rates will tend to be able to do so in larger quantities and at a cheaper rate over time. As we have seen, large segments of the mining industry have been collected into pools that are primarily responsible for the majority of the mining rewards and security of the chain. Increasing this mining competition to a global scale in theory would include nation based mining pools who are competing against other nations. As of the time of this writing, Bitcoin Cash is engaging in a hash war with two factions named ABC and SV. This type of split could eventually be played out in a scenario of say the United States versus China. As block difficulty increases, more mining power will be needed to maintain profitability.
Proof-of-work helped to give birth to Nakamoto’s major breakthrough, however the nature of proof-of-work means that the crypto-currency is dependent on energy consumption, thus introducing significant cost overhead in the operation of such networks, which is borne by the users via a combination of inflation and transaction fees. As the mint rate slows in Bitcoin network, eventually it could put pressure on raising transaction fees to sustain a preferred level of security. One naturally asks whether we must maintain energy consumption in order to have a decentralized crypto-currency? Thus it is an important milestone both theoretically and technologically, to demonstrate that the security of peer-to-peer crypto-currencies does not have to depend on energy consumption.
-Sunny King/Scott Nadal — PPCoin (Peercoin) Whitepaper (2012, August 19)
The economic impact of this has been a talking point of many Bitcoin and cryptocurrency critics who feel it is not pro-environment and damaging in the long run. In 2018, the power by Bitcoin was greater than both Switzerland and the Czech Republic (Smith, 2018). Due to economic competition, miners seek the cheapest rates of electricity and have turned to such sources as hydroelectric or solar. It still remains a topic of hot debate as the trade-off between security and lasting environmental impact will remain an issue for the foreseeable future.
Sunny King and Scott Nadal created Peercoin in 2012 and first introduced a mechanism called proof-of-stake. In proof-of-work, energy backing mining is the scarce resource. In proof-of-stake (PoS), time is the scarce resource as block validation is based on time-stamped transactions. The time of each transaction is recorded and matures once it reaches a coin age of 30 days. After the 30 day mark, coin age will continue to increase as will the probability of it minting and verifying a new block. Any participant or holder of Peercoin can take part in this process of minting–or the creation of new coins–and receive roughly a 1% increase in their holdings to keep up with inflation. After 90 days, coin age reaches a maximum of minting probability to prevent squatting for chain control. Participants are strongly incentivized to take part in minting both for the security of the chain but also to protect their investment from inflation.
What makes Peercoin different is its hybrid PoS/PoW chain validation. By using PoW, the economic competition that is vital for the survival of a chain is maintained and effective for distribution of new tokens. Without miners competing for profit, there are less participants which weaken participation. Pure PoS systems cannot survive due to their lack of economic incentive and competition. PoS system have ineffective distribution of coins leading to a concentration of supply in the hands of those who have first mover advantage. Including PoW, supply can be competitively distributed. By also including PoS, the chain remains not only extremely secure (six years running), but also energy efficient, proving proof of possible independence of energy centered validation methods. Those who wish to participate in minting the backbone of the validation system, can do so through any device that can run a simple wallet interface. Many Peercoin holders use devices such as Raspberry Pis which have an extremely low level of power consumption. This allows for a low barrier of entry to participate in securing the network for Peercoin holders. Many who hold Bitcoin or its forks are unable to participate in the securitization due to the barrier to entry with the cost of mining rigs. The inclusion of PoW is effective for distributing the supply through participant determined inflation. When asset price interest returns and mining interest increases, the chain remains secure when many other projects would have died or become vulnerable to attack. PoS also means that transaction speed remains regular maintaining Peercoin’s value as a medium of exchange. For many chains, a lack of mining interest results in delayed or inconsistent block confirmations.
Pure PoS coins forked from Peercoin and generally come with masternodes, and require a large percentage of coins to be owned and held in a hot wallet that verifies on-chain transactions. Masternodes require a number of coins to create artificial demand for the asset, reducing available market liquidity, making the whole economic system prone to so called “pump and dump” trading cycles. These systems work in a standard pyramid scheme of incentivizing a second participant to take a position in order to increase the value of the first participants’ holdings. These masternodes operate with low power requirements making them environmentally friendly, but are based entirely on the valuation of the coin, and have no economic competition built into the currency which has led to a large number failing. Once early holders begin to sell, returns diminish and selling pressure increases greatly, generally leading to the collapse of the project and asset price. The economic incentive to continued maintenance disappears after this point. Again, PoW has competition through mining rates and profitability. In PoS, a more powerful computer does not increase chances of minting as it is tied to the scarce resource of time. Without an opportunity for economies of scale to exist, pure PoS system will fail over time.
Inevitably, for a pure proof-of-work currency to exist on a global scale, a chain with maximum security must posses the majority of hash, making side chains insecure or non-existent. The power requirements for this system will become so costly that it is probable that governments and private lobbies will step in with a more sustainable model in mind. We have already seen this taking place in China where mining became illegal with the official reason being the rampant electricity costs (Rhodes, 2018). There was also a local ban on mining in upstate New York. For PoW systems to scale on a global level and continue their growth, a balance must be found. Peercoin’s dynamic mining protocol serves to keep not only the environment in mind but also the inflation rate of the supply. As hash rate increases, block reward decreases proportionally, disincentivizing mining as profitability decreases. In parallel, the chain is validated and protected through eligible coins with a high enough coin age which mint and validate blocks. This allows Peercoin to scale at a rate determined by participants.
As participation increases in cryptocurrencies, adapting to environmental regulations and economies of scale will become vital. Pure PoW chains will begin to die as they lose mining interest to larger projects such as Bitcoin. Without interest, these chains will become vulnerable to 51% attacks as we have seen with projects such as Bitcoin Diamond (Graham, 2018). Chains with less security cost less to attack as overwhelming the current mining participants becomes easier and easier. This is the outcome of a reduction in competitiveness among participants. Even at its lowest point of interest, Peercoin has remained secure due to PoS during its six years of being active. PoW and PoS validation is the optimal balance between security and economic incentivisation which is required for long term sustainability. Without these mechanisms, many projects will fail and disappear into the abyss. As the first coin to utilize PoS and PoW mechanisms, Peercoin is positioned to last and remain economically competitive for years to come.
Citations:
Graham, N. (2018, May 24). Bitcoin Gold Hit By 51 Percent And Double-Spend Attacks, Millions Stolen. Retrieved from https://www.ethnews.com/bitcoin-gold-network-loses-millions-from-a-51-percent-attack
King, S. Nadal, S. (2012, August 19). PPCoin: Peer-to-Peer Crypto-Currency with Proof-of-Stake. Retrived from https://peercoin.net/assets/paper/peercoin-paper.pdf
Rhodes, D. (2018, May 16). Why Are More Governments Stopping Bitcoin Mining Operations? Retrieved from https://coincentral.com/why-are-more-governments-stopping-bitcoin-mining-operations/
Smith, R. (2018, October 03). What is the Environmental Impact of Bitcoin Mining? Retrieved from https://coincentral.com/what-is-the-environmental-impact-of-bitcoin-mining/
