The Great Crypto Schism

Some contrarian news, folks. For a few weeks now I've been trying to establish a clear worldview on the wider Crypto landscape. Y'see, I'm fairly settled on the epic store-of-value proposition that is Bitcoin. I've dived into the gory details, gained some practical skills, and completely overindulged in the 24/7 debates (i.e. shitfights) sparked in Twitterland. And just like a BTC-Big Mac in El Salvador, it all feels rather warm, gooey.....and potentially fatal. So to address this intellectual comfort, I must stress-test my understanding of Bitcoin. I must fuel my curiosity by casting a wider net.

Fortunately, the digital asset space offers an array of comparison and thought-provocation. We are blessed to witness, in real time, the emergence of competing economic structures and incentive systems. Some may shift our perspective (like Bitcoin), whilst others will crash and burn (I'm looking at you, dog money). So where better to start than with an epic battle; Proof-of-Work (POW) vs Proof-of-Stake (POS). Admittedly, by looking at Bitcoin in isolation, my prior research had only skimmed the mechanics of blockchain consensus. But on further reading, this is so much more than a dry, technical debate. This is the story of the Great Crypto Schism.

‍

Pending, to Confirmed

Let us start with the dynamic that exists in the Bitcoin ecosystem. As each transaction is broadcast across the network, it is validated by nodes and held in a 'pending' state. Miners collate these transactions into blocks, which are then 'confirmed' and added to the distributed ledger. You can watch this process in realtime via the Mempool. Green blocks are being batched with 'pending' transactions. Blue blocks are 'confirmed' and included on the blockchain. Proof-of-Work is the magic that happens at the dotted line. Bitcoin uses the POW mechanism to incentivise miners to complete these confirmations, achieve consensus and help secure the network. How so?

‍

‍

When nodes are validating, they are essentially listening for 'legal' transactions by reviewing them against a set of agreed criteria (no double-spending, 21 million coin cap, correct signatures etc.). They play a critical role in Bitcoin's ecosystem, by enforcing consistent rules across a decentralised network and each keeping a historic record of the ledger. In short, nodes promote network legitimacy. Whilst that offers a great backdrop for mining activity, it also poses a quandary for miners (or mining pools), who work independently of each other. How can the network agree a common history when everyone is blindly creating their own blocks from the same source? A transaction could be validated by a node, only to end up in 2 (or more) blocks. No bueno.

‍

Sweating, for Blocks

Enter Proof-of-Work, the keystone of Bitcoin's incentive structure. POW is a competitive guessing game, where miners also consume energy (by employing specialist ASIC hardware) to solve a cryptographic puzzle in the fastest time. This is the final ingredient for a proposed block, and more energy = better odds. The result (and block) is then broadcast for final verification by the rest of the network, and the winner granted the right to add their block to the blockchain. Rinse and repeat, ad infinitum. To compensate successful miners for their efforts, they are richly rewarded with transaction fees and the mining subsidy (currently at 6.25 bitcoins). The outcome is engineered consensus; a single reality, forged by mathematical honesty.

The cost of the game also acts as a filtering mechanism. Only those who attribute a high value to the POW prize (i.e. bitcoins) will acquire mining hardware, expend electricity, and accept the loss of failed attempts. And to keep bringing participants to the table (and also maintain a 10 minute rate of block / coin creation), Bitcoin employs a neat little trick called the difficulty adjustment. When mining (or in fancy terms, hashrate) activity drops, the puzzle becomes easier to solve. When activity rises, you guessed it. The puzzle becomes harder. This delicious weaving of competition, integrity, supply and demand is what keeps Bitcoin ticking and discourages malicious intent.

‍

Status, for Blocks

Now let's take a look at Proof-of-Stake, which is used by other networks such as Solana and Polkadot. Ethereum, currently the second largest 'crypto' is also scheduled to convert to POS (from POW), sometime in 2022. Nodes are still required for checking transactions and recording network history. But instead of competing miners, the POS mechanism algorithmically selects a 'validator' to add the latest batch of transactions to the blockchain. Similar to POW, validators are compensated for block creation (when selected), but they also receive rewards for confirming the efforts of other validators (known as attestation).

To join this cosy club, network participants must pledge (or stake) tokens as collateral, for forfeiture (slashing) in the event of inactivity or permitting invalid blocks. The amount for becoming a 'full' validator varies for each network. Ethereum will require at least 32 Ether (their native token) for example. And by increasing your investment (in stake size and duration), or by joining a staking pool, you increase the chance of selection. In effect, POS integrity depends on validator behaviour (i.e. their self-interest), rather than miner commitment to competition and risk. It offers a lightweight model for consensus, but also leaves a network susceptible to petty politics, as the wealthiest validators wrestle for control and influence.

‍

Proof-of-Perspective

So which approach wins the day? It is a question that leads many round in circles. Is POW a waste of resource? Can it scale? Does POS result in less security? Can it endure? To compare and contrast is a fool's errand. Instead, the market you are serving determines how you achieve consensus. For Bitcoin, this is obvious; a permissionless store-of-value, with truth at its core, demands POW. It's real-world energy use and steady pace is a small price to pay for protecting honesty. The real rivals in this context are gold, real estate and sovereign currency.

On the other hand, POS is offering a solution for blockchain 'efficiency', commercial structuring and distributed utility. You give up ironclad integrity in exchange for functionality. And rather than a face-off with Bitcoin (the undisputed POW champion), that squares you up against the likes of AWS, SAAS platforms and equities. The Ethereum conversion feels like a recognition of this fact. So whilst POS may end up a settled home for data ownership and processing smart contracts (NFTs, DeFi, DAOs etc), the ultimate settlement of their value should always return to dependable, accomplished Proof-of-Work.

Just one more thing. The Great Crypto Schism also highlights two perspectives on power. With Proof-of-Work, it is nodes (rather than miners) who have the final say on network direction, as vividly demonstrated by Bitcoin's Blocksize War. In sharp contrast, Proof-of-Stake seems destined for centralisation, as a small subset of participants (i.e. savvy, well invested validators) gradually manoeuvre their way towards network dominance. So to end with a dramatic flourish, which ecosystem would you prefer to store your time with? One that rewards genuine, real-world effort (POW / Bitcoin), or one trending towards fragile inequality (POS / Ethereum et al)? I certainly know my answer.

‍

Support; if you found value in this work, and would like to send some sats in appreciation, then please go ahead here. And many thanks for your generosity too!