What are Proof of Stake Coins: Ultimate Guide - Blockgeeks
In this guide, what are Proof of Stake Coins we will introduce you to some promising POS coins. Before we go any further, let’s give you an overview of Proof of stake and why it is preferable over POW.
While proof-of-work (POW) coins have paved the way for cryptocurrencies, all indicators point towards market domination by POS/ proof of stake coins. The truly amazing thing about POS is that it is more scalable than POW, while not being nearly as wasteful. However, POS also gives different economic benefits/dividends to its users, such as providing the option of running a masternode or staking their coins in a stake-able wallet.
What are consensus mechanisms?
By its very definition, a decentralized ecosystem lacks a centralized body controlling its activities. While this keeps them safe from the corruption and perils of a centralized system, it does open up one very valid question.
How does anything get done in a decentralized system?
In a centralized system, the central body is in charge of making decisions, which is a luxury that a decentralized network doesn’t have. To mitigate this, decentralized ecosystems make the use of “consensus protocols.” Consensus is a dynamic way of reaching an agreement in a group. While voting just settles for a majority rule without any thought for the feelings and well-being of the minority, a consensus makes sure that an agreement is reached which could benefit the entire group as a whole.
From a more idealistic point-of-view, Consensus can be used by a group of people scattered around the world to create a more equal and fair society.
A method by which consensus decision-making is achieved is called “consensus mechanism.”
As per Wikipedia, the main objectives of a consensus mechanism are:
- Agreement Seeking: A consensus mechanism should bring about as much agreement from the group as possible.
- Collaborative: All the participants should aim to work together to achieve a result that puts the best interest of the group first.
- Cooperative: All the participants shouldn’t put their own interests first and work as a team more than individuals.
- Egalitarian: A group trying to achieve consensus should be as egalitarian as possible. What this basically means that each and every vote has equal weight. One person’s vote can’t be more important than another’s.
- Inclusive: As many people as possible should be involved in the consensus process. It shouldn’t be like regular voting where people believe that their vote won’t have any weight in the long run.
- Participatory: The consensus mechanism should be such that everyone should actively participate in the overall process.
The method by which a system achieves consensus is called consensus protocols or consensus mechanisms. While creating Bitcoin, Satoshi Nakamoto completely changed consensus protocols by ushering in the concept of Nakamoto consensus. The requirements for such a protocol are as follows:
- It should be able to deal with a wide area network.
- The consensus mechanism should provide proper validation of transactions by at least 2/3rd of the network.
- Should protect against double-spending.
The unique thing about Nakamoto consensus is the concept of “difficulty.” The difficulty could be some sort of work, resource, or asset, which the member of the network must invest to create a new block. The “difficulty” helps in:
- Block verification.
- Controlling the number of coins/tokens floating around in the ecosystem.
- Bringing security into the system.
We will be looking into the two most popular and widely used forms of Nakamoto consensus:
- Proof of Work (POW)
- Proof of Stake (POS)
We won’t go into the details of POW, but let’s give you a brief idea. In a POW consensus system, we have miners in the network who use their computational resources to solve cryptographically hard puzzles. If someone solves the puzzle correctly, then their block gets added to the blockchain. In return, they get a block reward for their efforts.
Unfortunately, POW has two major issues:
- It is not a scalable system.
- It is extremely wasteful as it requires miners to waste real-life computational resources.
This is the reason why many projects are opting the proof-of-stake consensus system instead,
What is Proof of Stake?
Proof of stake will make the entire mining process virtual and replace miners with validators. This is how the process will work:
- The validators will have to lock up some of their coins as a stake.
- After that, they will start validating the blocks. Meaning, when they discover a block that they think can be added to the chain, they will validate it by placing a bet on it.
- If the block gets appended, then the validators will get a reward proportional to their bets.
Apart from the consensus mechanism, there are some projects which allow for special staking functionalities. In these projects, the holders lock up a portion of their tokens in the network to receive special privileges such as voting and hosting masternodes. Another thing that you need to note is that each project has its own version of the Proof of stake S algorithm. In this guide, we are going to be looking into three projects who are using (or going to use) a variation of the Proof of Stake algorithm, namely – Ethereum, EOS, and Tezos. After that, we are going to be looking at how Dash leverages staking to run Masternodes.
Before we start, there is one thing that should be made clear Ethereum is currently not a Proof of stake coin, but it is a POW coin. Ethereum will eventually move on to Proof of stake in its final stage. Ethereum’s Proof of stake implementation is called the “Casper Protocol.” Casper was created to mainly mitigate the biggest flaw in the Proof of stake algorithm – the “Nothing at Stake” problem.
What is the Nothing at Stake problem?
Consider the following situation:
In the diagram above we have the main chain (blue) which has been mined till block #53. However, there is a parallel branch originating from block #50 (red). What will happen if some malicious miners get together and keep mining on the red chain until it overtakes the blue one? All the transactions that have taken place in block 51, 52, and 53 will be instantly null and voided.
In a Proof of Stake system, this risk can be mitigated.
Suppose malicious miner Alice wants to mine on the red chain. Even if she dedicates all of her hash power to it, she won’t get any other miner to join her on the new chain. Everyone else will still continue to mine on the blue chain because it is more profitable and risk-free to mine on the longer chain.
Now, remember, POW is extremely expensive resource-wise. It makes no sense for a miner to waste so many resources on a block that will be rejected by the network anyway. Hence chain splits are avoided in a proof of work system because it will be extremely expensive.
However, things look a little different when you bring in Proof of Stake. If you are a validator, then you can simply put your money in both the red chain and blue chain without any fear of repercussion at all. No matter what happens, you will always win and have nothing to lose, despite how malicious your actions maybe.
This is called the “Nothing at Stake” problem, and this is something that Ethereum had to address. They needed a protocol that could implement POS and mitigate the “Nothing at Stake” problem.
Enter Casper Protocol
Casper is a POS protocol that has an in-built punishment mechanism. This is how it will work:
- The validators stake a portion of their Ethers as a stake.
- After that, they will start validating the blocks. Meaning, when they discover a block that they think can be added to the chain, they will validate it by placing a bet on it.
- If the block gets appended, then the validators will get a reward proportionate to their bets.
- However, if a validator acts in a malicious manner and tries to do a “nothing at stake,” they will immediately be reprimanded, and all of their stakes are going to get slashed.
Anyone who acts in a malicious/Byzantine manner will get immediately punished by having their stake slashed off. This is where it differs from most other Proof of stake protocols. Malicious elements have something to lose so it is impossible for there to be nothing at stake.
This means that validators will have to be careful about their node uptime. Carelessness or laziness will lead to them losing their stake. This property reduces censorship of transactions and overall availability. Along with all that, the “slashing” property also lends Casper a distinct edge over standard proof of work protocols.
The current state of Casper
There are currently two versions of the Casper algorithm that are being developed side-by-side:
- Casper the Friendly Finality Gadget (FFG): Ethereum founder Vitalik Buterin is developing Casper FFG. FFG is a hybrid POW/Proof of stake consensus mechanism. The blocks are still going to be mined via POW and every 50th block is going to be a Proof of stake checkpoint.
- Casper Correct-by-Construction (CBC): Vlad Zamfir heads Casper CBC. CBC enables Ethereum to derive Casper dynamically.
EOS is aiming to become a decentralized operating system which can support industrial-scale dApps. Headed by Dan Larimer and Brendan Blumer, it is one of the most talked-about platforms in the crypto-space. Ethereum, as mentioned above, is currently using the POW protocol, which makes it very slow and unreliable. EOS plans to produce a platform that can potentially do millions of transactions per second. The way they are doing that is by using a unique form of the Proof of stake algorithm, called DPOS or delegated proof of stake.
How does DPOS work?
The standard proof-of-stake consensus algorithm follows the principle of a classic Nakamoto consensus. A majority of the entire network is taken for the consensus process. However, this can be a slow process as the network grows in size. In DPOS, delegates are elected from the available validators through a continuous approval voting system. These delegates will be in charge of the consensus process.
In EOS, these delegates are called “Block Producers.” In total, 21 block producers are elected from the list of validators. Anyone can participate in the block producer election. They will be allowed to produce blocks proportional to the total votes they receive relative to all other producers.
To summarize the main roles of the block producers:
- Make sure that their node is always running and healthy.
- Collect transactions into the blocks.
- Validating the transactions by signing and broadcasting those blocks.
- Maintaining the overall health and well-being of the network.
Why use DPOS?
As you can imagine, DPOS is much faster than POS simply because the nodes involved are a lot less. EOS has achieved a high of 3,996 transactions per second. The screenshot below also shows us that blocks get confirmed in EOS in just 0.5 seconds.
The DPOS system doesn’t experience a fork because instead of competing to find blocks, the producers will have to co-operate instead. In the event of a fork, the consensus switches automatically to the longest chain.
What is TAPOS?
Transaction As Proof Of Stake or TAPOS is a feature of the EOS software. Every transaction in the system is required to have the hash of the recent block header. This does the following:
- Prevents transaction replay on different chains.
- Signals the network that a user and their stake are on a particular fork.
- Prevents validators from acting maliciously on other chains.
EOS staking for resources
While EOS and Ethereum are both smart contract platforms, there is a fundamental philosophical difference between the two projects. Ethereum acts as a global supercomputer which rents out its power to developers to build their dApps. EOS, on the other hand, is built on an ownership model. Instead of paying rent for resources, you own them.
The moment you stake EOS tokens, you are given resources like Network Bandwidth, and CPU Bandwidth in return. Since RAM is a rare resource, you will need to buy it from the RAM marketplace. When you sell your resources like CPU and Network Bandwidth, you get back your staked tokens.
Tezos is a decentralized, self-governing smart contract platform co-founded by Arthur Breitman and Kathleen Breitman. The company is headquartered in Switzerland and raised a $232 million in an uncapped ICO in just two weeks, accepting contributions of both bitcoin and ether. Tezos uses a liquid proof-of-stake or LPOS for consensus purposes.
So far, we have seen two forms of proof-of-stake (POS):
- Ethereum’s Casper, which takes a majority of the entire network.
- EOS’ DPOS that elects delegates from the network, who in turn takes care of the consensus.
LPOS combines facets of both these approaches to create a consensus mechanism which is built on the principles of liquid democracy.
It is a system that fluidly transitions between direct democracy and representative (delegated) democracy.
The process has the following features:
- People can vote on their policies directly.
- People can delegate their voting responsibilities to a delegate who can vote on their policies for them.
- The delegates themselves can delegate their voting responsibilities to another delegate who can vote on their behalf. This property is called transitivity.
- If a person doesn’t like the vote given by their delegate, they can take it back and vote on the policy themselves.
So, what are the advantages of liquid democracy?
- The opinion of each person counts and plays a part in the final policy creation.
- To become a delegate, all that one needs to do is to win a person’s trust. They don’t need to spend millions of dollars on expensive election campaigns. Because of this, the barrier to entry is relatively low.
- Because of the option to oscillate between direct and delegated democracy, minority groups can be fairly represented.
- Finally, it has a scalable model. Anyone who doesn’t have the time to vote on their policies can simply delegate their voting responsibilities.
What is Liquid Proof of Stake?
Unlike DPOS, there is no hard and fast rule that delegates absolutely need to be selected. It is entirely up to the participant as to what they want to do. Alright, so let’s get started with the LPOS.
Tezos’ LPOS requires one to stake a certain number of Tezos tokens to participate in the consensus over the blockchain. The process of staking Tezos tokens (XTZ) is called baking.
Token holders aka “bakers” can delegate their validation rights to other token holders without transferring ownership. Unlike in EOS, delegation is optional.
You find and add blocks to the Tezos blockchain through a process called “baking.” This is how it works:
- Bakers get block publishing rights based on their stake.
- Each block is baked by a random baker and then notarized by 32 other random bakers.
- If the block is good to go, then the block gets added to the blockchain.
- The successful baker gets a block reward and can charge transaction fees for all the transactions inside the block.
- As we have said before, token holders have the option of delegating their baking rights to other holders without letting go of the ownership of their tokens. Upon the completion of the baking process, the baker will share their rewards with the rest of the delegates.
DASH is one of the most popular cryptocurrencies in the market today. Creator Evan Duffield came across Bitcoin in 2010 and was extremely impressed by the technology. However, he was not that enthused about the slow transaction speed and the lack of privacy.
This is why he decided to use the Core code and make his own cryptocurrency on January 18, 2014. Dash was formerly called Xcoin which later on became “DarkCoin,” which was rebranded to Dash. DASH is a portmanteau of “Digital Cash.”
Dash Special Features
- Send private transactions via the PrivateSend feature.
- Send neat instantaneous transactions via InstantSend.
- Since DASH is a fork of the Bitcoin protocol, it is a proof-of-work (POW) system.
As the last feature states, DASH is a POW protocol, instead of a POS protocol. So, the obvious question is, why are we talking about it in a guide about proof-of-stake coins? Well, DASH has a feature that allows its holders to host Masternodes and provide a service to the network.
What are Dash Masternodes?
Masternodes are like the full nodes in the Bitcoin network, except that they must provide a particular service to the network and must have some substantial investment in the system. To run a Masternode, one has to stake a 1000 DASH.
So, now the question that one should ask is, why does a Masternode need to make that sort of investment?
In return for their services, Masternodes get paid back in dividends on their investment. The promise of a reward incentivizes the Masternodes to work in the best interests of the ecosystem. Dash was the first cryptocurrency to implement the Masternode model into its protocol.
The masternodes create a second-tier network, following a Proof of service algorithm, and exists on top of the standard first-tier network of miners. This two-tier system creates a synergy between proof of service and proof of work mechanisms in the Dash network.
Once a Masternode is on, it is in charge of a certain set of functions like InstantSend and PrivateSend. They are also in charge of network governance.
Since running a masternode requires money and effort, in order to incentivize the node operators, they get rewarded for their efforts. The reward is usually 45% of the block reward. However, to get a more concrete answer, we will need to check out some parameters.
Reward System of the Masternodes
Since the number of Masternodes active in the DASH system keeps changing, the reward keeps fluctuating according to this formula: (n/t)*r*b*a
The variables in the formula are as follows:
- n is the number of Masternodes an operator controls
- t is the total number of Masternodes
- r is the current block reward (presently ~3.6 DASH)
- b is blocks in an average day. For the Dash network, this usually is 576.
- a is the average Masternode payment (45% of the average block amount)
Return on investment for running a Masternode can be calculated as: ((n/t)*r * b*a*365)/1000.
Advantages of Staking for Users
There are several advantages that a coin can gain from incorporating a staking mechanism. Let’s look at some of them in this section.
#1 Decreasing token velocity
“Token Velocity” is a metric used to determine the long-term valuation of a particular cryptocurrency. We can’t escape from the fact that the market is full of unnecessary tokens. These tokens serve no other purpose than being just a means for the developers and project creators to raise money via crowd sales. As such, these tokens are suitable only for speculative trading, and as soon as their price is around a certain level, they get sold. Since these tokens have hardly any holding value, they are said to have high velocity.
If you were to define Token Velocity in strictly mathematical terms, then it would look like this:
Token Velocity = Total Transaction Volume / Average Network Value.
If we were to flip the formula then:
Average Network Value = Total Transaction Volume / Token Velocity.
Now, that leads to two conclusions:
- More token velocity = Less average network value.
- More transaction volume = More token velocity.
An effective way to decrease token velocity and general token movement are to lock them up within the network as stake. This is the reason why a POS crypto coin has inherently low token velocity.
#2 Earn Passive Income
Staking your coins is also a great way to lock up and appreciate your investment. If you own a large portion of a particular project’s tokens, then it means that you are extremely invested in its success. If that’s the case, then it makes sense for you to take part in its staking process, if it has one.
Proof of Stake Coins: Conclusion
Many crypto-projects have started incorporating staking features one way or another into their system. While many of the newer projects are opting for a Proof-of-Stake consensus mechanism, DASH shows us that a proof-of-work coin can also integrate staking features to reap its benefits.
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