The State of Staking
By: Liam J. Kelly
Tags: Cryptocurrency, Blockchain, Proof Of Stake, Ethereum

Photo by Charlie Solorzano on Unsplash

Proof of stake (PoS) models have come a long way since their inception in 2012. What was once simply an energy-efficient alternative to Bitcoin’s proof of work (PoW) model, has now shown that it offers novel governance mechanisms too. Like many innovations in the crypto space, however, there are still a number of kinks that need to be ironed out.

In the following article, we’ll dig into how each of these consensus algorithms differs, examine the ways in which these models can prop up new archetypes for decentralized firms, and, finally, inspect the ways in which each mechanism falls short.

Consensus Algorithms 101

You’re already probably aware of the major differences between PoW and PoS consensus algorithms, but a quick review won’t hurt. Indeed, a rock-solid understanding of these two models is critical for understanding what comes next. Let’s start briefly with Bitcoin’s PoW.

Following several years of research from notable cryptographers, mathematicians, and computer scientists, a PoW-like consensus mechanism was released in 1997. More than a decade before the launch of Bitcoin, Adam Back proposed Hashcash in an attempt to limit email spam. In essence, a Hashcash stamp could be generated by the sender of an email only after expending a specific amount of computing power. Receivers could verify this by using a similar amount of computing power.

The thinking went that any business model built on the ability to send an infinite number of emails for free would quickly be hampered. The computing power needed would be too costly. From this experiment, it became clear that one could turn the cost of computing into a measurable economic unit. Satoshi Nakamoto took this premise one step further by minting computing power into a coin.

In the early days, anyone could help secure the Bitcoin network and mint cryptocurrencies on their laptops. Unfortunately, as time went on users began developing more powerful mining rigs so as to solve the PoW algorithm faster than competitors. This has led to the rise of large mining manufacturers like Bitmain, Hut 8, Bitfury, and many others. These companies spend huge amounts of energy and money in order to profitably mine Bitcoin.

This poses two issues. In the first, the amount of energy needed to sustain this model is incredibly high. According to reports from July 2019, the Bitcoin network consumes more energy than all of Switzerland. Secondly, commentators have pointed out that as the mining capabilities have moved from personal computers to massive industrial facilities, the world’s miners are becoming more and more centralized.

Both are indeed real problems that can be improved, but there are some quick rebuttals. Regarding energy usage, Google is responsible for roughly 1.3 percent of the entire planet’s electricity consumption. Maximalists have also argued that competition for cheap, reliable energy will inevitably lead miners to explore alternative sources like wind, solar, and hydro.

The cost of securing a network with all of this energy is also a huge advantage; it would be incredibly expensive for any size firm to acquire enough power to overtake and manipulate the network. To gather enough power to do this would indeed take some serious coordination from many members in the mining community. Bitcoin’s current hashrate, which can be thought of as the network’s processing power, hovers around 100 million terahashes per second according to Blockchain.com. This is a major bonus if one believes Bitcoin will inevitably become the world’s currency.

Despite these retorts, others in the crypto space have been hard at work devising an alternative consensus mechanism. The launch of PoS via Peercoin (PPCoin) in 2012 was the first iteration of a substitute. Although it wasn’t a thoroughbred PoS cryptocurrency, it eventually phased out the PoW feature once the initial mining of the coins was complete.

Holders of early minted PPCoins could then hold these tokens and earn the crypto equivalent of interest via the PoS model. It works like this: Instead of nodes competing via highly-specific mining rigs, token holders are selected to validate blocks based on the number of tokens they hold. In PPCoin’s model, if a user held one percent of the total currency they would generate one percent of the blocks in the network.

Thus, instead of investing in expensive hardware and overhead costs, network participants need merely invest in the token itself. This has the added benefit of reducing energy consumption and improving scalability. It is for this reason that Ethereum has been hard at work at shifting from PoW to PoS in their Ethereum Casper upgrade.

PPCoin was just the first step in PoS models. Further experimentation has revealed various different schemes based on early ideas. Decred, for instance, is sticking with their hybrid PoW/PoS model, EOS uses something called a delegated proof of stake (DPoS) model, and IOTA uses another mechanism called Tangle. Each has its own advantages and each is slightly more flexible than a pure-play PoW network.

On top of that, exchanges and other businesses are popping up that allow users to pick up these PoS tokens and earn via simply holding on to them. The space is booming with possibilities, but let’s pick a few examples that directly affect how decentralized organizations are governed.

Decentralized Governance

Traditionally governance in Bitcoin has boiled down to highly-contentious hard forks and toxic tribalism. The split between Bitcoin (BTC) and Bitcoin Cash (BCH) is one example of this. Members of both parties could not reach an agreement and thus forked code from Bitcoin, made a few adjustments to meet their needs, and then relaunched their token. This is certainly one way to solve problems, but if you’re familiar with the fallout from this event, it certainly isn’t the smoothest. And as networks become more complex and serve needs beyond the purely monetary, arriving at an equitable social consensus is critical. Consider Decred as an alternative.

Decred is powered by PoW nodes but governed by PoS nodes. This means that PoW miners operate much in the same way as Bitcoin miners, but they cannot confirm a block until the PoS nodes also approve. This helps to prevent contentious forks; miners cannot cause chain splits and build atop of unapproved blocks.

The PoS nodes have the additional ability to vote on any protocol changes. To participate in a vote, PoS nodes must lock up a portion of their Decred tokens (DCR) in exchange for a ticket. Ticket holders can vote on consensus rule changes, block validation, or the more variable Politeia forum where users discuss how the treasury should be spent or amending the Decred constitution, for instance.

According to Decred, participation is incentivized in the following:

“To compensate ticket holders for validating blocks and securing the network, 30% of the block reward (PoS reward) is sent to ticket holders for voting on blocks; the remaining block reward is split between PoW miners (60%) and the Treasury (10%) to fund ongoing development.”

Tezos, another governance-oriented blockchain project, takes the PoS formula a bit further. It still allows random stakeholders to publish blocks and earn rewards. In order to participate, these stakeholders must put up a safety deposit of Tezos tokens (XTZ) which incentivizes honest behavior. If the block publisher attempts any malicious behavior, they forfeit their stake. All of this is relatively straightforward, of course.

Tezos, however, does have the added ability to delegate staking abilities to other members of the ecosystem. Arthur Breitman, a co-founder at Tezos, wrote:

“Since not everyone holding tokens is interested in being a baker, tokens can be ‘delegated’ to another party. The delegate does not own or control the tokens in any way. In particular, it cannot spend them. However, if and when one of these tokens is randomly selected to bake a block, that right will belong to the delegate.”

This is, with a few differences, what is known as DPoS (some disagree with this term, but for further reading please check out this article).

Ultimately, what begins to emerge is the melding of free-market economics and corporate organization. Unlike the hierarchical delegation of tasks between employees, crypto networks offer every token holder a say in how a network moves forward. Their say is simply determined by how much they have invested in the network, thus their behavior is immediately aligned with the success of the organization.

The rise of decentralized autonomous organizations (DAOs) takes this a step further and wraps the networks in yet another layer of smart contracts to incite more complex activity. From there, a bright future of decision making emerges. Instead of a small startup making top-down choices on how to move forward, crypto networks incentivize massive, global communities to participate in its own trajectory.

The principle of staking and having skin in the game also extends to public elections. Instead of voting for the party with the best collection of policies, voters could vote on the policies themselves. Proof of stake networks thus allow for a more granular electoral process and, much like Bitcoin did to finance, return power to the people.

Stepping back from the technical features, blockchain technology and cryptoeconomics describe new ways to hard code certain social behaviors. In a seminal piece on PoS design philosophy, Ethereum co-founder, Vitalik Buterin, puts it thusly: