28 May, 2019, 02:22 PM 10
Kenneth Hearn

Fund Manager

Equality is the central driving force behind the way in which contributors to the Blockchain ecosystem are treated. Therefore, the system consists of equally privileged contributors or agents. Being a contributor means sharing one’s resources with the network such as: GPU/CPU power, disk space, RAM or network bandwidth and many more. These resources require investment, reliability, and a level of responsibility. In order to incentivise contributors to provide trustworthy energy with the highest quality to the network there must be a reward.

In the blockchain, these contributors are referred to as miners or nodes.

There are thousands of miners and nodes spread out across the globe. This ensures continuity in the system and a major benefit behind the decentralised blockchain ecosystem. It is important that all these nodes meet certain criteria, and of course, that all of it is agreed upon through consensus. In the blockchain, a consensus is an agreement or set of rules that every node must meet to be eligible to validate transactions or blocks. Only if all the rules are met will a block of transactions be accepted and validated.

These sets of rules or criteria are built into consensus algorithms. They are built by and decided upon by consensus of the network through a series of decisions.

The two most popular types of consensus algorithms are:

1) Proof-of-Work

2) Proof-of-Stake

PROOF OF WORK (PoW)

PoW was the first consensus algorithm implemented. PoW is used in Bitcoin and Ethereum as well as in forks such as Bitcoin Cash. It is also used in many other prominent currencies. These PoW consensus blockchains are made up of miners, nodes and stakeholders.

Miners solve mathematical puzzles to receive rewards for finding new blocks and adding them to the chain. They also validate transactions to ensure accuracy and security. Miners make up the “Work” part of the Proof of Work algorithm – they consume energy, time and GPU/CPU capacity. The puzzle difficulty increases with the increase in number of miners to reduce inflation (every block should be created once in ten minutes). It is a lottery and the most powerful miners do not always win. Mining difficult increases every two weeks.

Nodes propagate the blockchain all over the world. In other words, they store the entire history of the blockchain – all transactions and blocks. Nodes are rewarded for willingly contributing their computing resources to store and validate transactions and in turn earn fees from the underlying cryptocurrency.

Stakeholders invest in, trade, transact or use the cryptocurrency to store value, speculate, exchange and/or utilise products and services offered by underlying projects.

The biggest threat/challenge facing PoW is that it consumes a tremendous amount of energy due to the resources required to sustain the blockchain miners deciphering these puzzles. This means the environmental and economic costs are high based on the current energy grid. Ethereum is planning to move away from the PoW consensus to the Proof of Stake algorithm for these exact reasons.

PROOF OF STAKE (PoS)

PoS is also a system for validating transactions but is executed by miners that stake a certain number of coins to receive fees for their contribution to the network. The chosen miner to validate each block is determined by an algorithm based on the amount of coins staked relative to total circulation, how long they have been owned, and other factors depending on how the consensus algorithm has been structured. Generally, there are a set number of coins in circulation which does not change once a block of transactions is mined therefore all miners earn from all the transactions validated in each block.

Miners are chosen randomly from a pool of coin holders based on the percentage of coins staked (or locked up in wallets) relative to the total amount of coins in circulation. For example, if the number of coins staked by a node is 10% of the total coins in circulation, that node can potentially mine up to 10% of transactions for new blocks.

Benefits of Staking Coins

Staking coins offers number of benefits to ALL coin holders:

1) Effectively, anyone can become a miner as it removes the need for purchasing high-end computer hardware.

2) Coin holders can generate or mine a guaranteed fixed percentage of transactions on the network and therefore return as long as the coin price remains constant.

3) The value of the assets staked do not depreciate over time like the computer hardware does in the PoW method. The value is only impacted my coin price fluctuations.

4) Proof of Stake is environmentally friendly as it is far more energy efficient compared to PoW.

5) The threat of 51% attacks on the network are significantly reduced when using PoS.

The major benefit of PoS is its ability to generate predictable returns for stakeholders similar to those of dividends or interest on traditional assets.

Note: In order to stake coins, often certain minimum holdings of coins are required.

Risks of Staking Coins

Staking coins means that the assets are kept in a bound wallet and therefore locked up for a set period. Therefore, no action can be taken if the price of the currency begins to drop. The amount earned from staking may not cover the depreciation of the currency over the set time period. However, over the long term these losses may be recouped.

Staked assets are never at risk. Most of the staking service providers only require proof that coins belong to you and ensure that they are locked up for the agreed period. Therefore, there are no increased security risks involved with staking.

COIN STAKING RETURNS & INCOME

Here is a short list of coins that provide staking opportunities and the relative potential returns per annum:

Source: GIN Platform Staking Solutions, SwissOne.Capital

References:

1) Atomic Wallet

2) NovaMining

3) Krohn Media

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