Vincent A Saulys' Blog
"Re-Centralization" of Crypto with Proof-of-Stake
Tags: crypto
October 19, 2021

Cryptocurrencies have enabled a mass decentralization amongst the world.

It's permissionless nature means your money isn't tied to any one institution and can't be frozen.

It's deflationary nature means it's not reliant on the goodwill of a government to not manipulate.

But there has been a recent shift to proof-of-stake and this has profound consequences for cryptocurrencies.

Why use Proof-of-Stake? Permission-less

Bitcoin, the first crytocurrency, had a profound insight in "anarchizing" its market: anybody can verify it.

Government budgets are notoriously opaque and details of business balance sheets are held very closely. But Bitcoin can be verified, i.e. can be mathematically proven, by anybody. All you need to do is run a verification node. Such nodes have extraodinarily low requirements -- they can even be run a raspberry pi (~$35).

You don't need anybody's permission to participate in this.

This is beccause Bitcoin relies on something called "proof-of-work" (and having a small block size).

To make sure that no nodes in this large network of computers -- most of which are anonymous, unknown, and thus can't be trusted -- don't misbehave and purposely record the wrong transactions in a block, everybody has to solve a really difficult math equation. Proof-of-work is that complicated equation.

Note: validation is separate from mining. The former confirms transactions are acceptable while the latter competes with other miners to generate new bitcoins for the network. Because you compete with other people, Mining requires more intense computation to run.

The benefit of such a setup is that anybody can participate. Bitcoin is unusual in that it has low requirements for running a node while Ethereum is higher, but both don't require permission to validate the blockchain and run a participating node.

Then somebody came up with the idea of Proof-of-Stake.

Why use Proof-of-Stake over Proof-of-Work?

Proof-of-stake (PoS) requires participating nodes to put up their own cut of cryptocurrency in a process called staking. Misbehavior results in "slashing," potentially losing all of their cryptocurrency. Normal, behaving nodes will not lose anything.

The benefits of PoS is a much higher bandwidth. PoW's computationally-intensive process means transactions are inherently slow. This means slower and more expensive transactions.

Price of Gas on ethereum network
(gwei)

PoS has the downside of introducing gate keeping that PoW eliminated. Not everybody can run a validation node on Polkadot, Cardano, or Binance. [1] The end result is a de-anarchizing of the market that Bitcoin ushered in.

Unlike PoW, PoS (usually) incentivizes validators by giving them a cut of gas and transaction fees on the network.

Can we Stop it? Does it matter? Why is this happening?

It seems unlikely to stop.

Ethereum will, eventually, will move to PoS instead of PoW. This will massively improve the transactions-per-second (TPS) on the network which is currently a huge pain with fees exploding in recent months.

But it will also mean not everyone can run a node.

Why care if nobody can run a node? Well, can you trust a system in which only a few select people can participate?

To be sure, it's very unlikely that people form a cartel to mess with the network. Your crypto is almost certainly safe.

But it does prevent how decisions can be made. Should these blockchains decide to sharply curtail new minting or modify the fee structure, you will be at their mercy. The implications of what that control could mean is extravagant.

But, as stated, people seem to be unwilling to have that change. DApps like Uniswap are super popular even if they are prohibitively expensive to use. The roar of demand will move us forward.

It should be noted that while not anybody can run a validator node, anybody can participate. Because validator nodes are expensive to run due to staking requirements, most validator nodes accept a pool of cryptocurrency to which that anybody can contribute. Any fees are split amongst the participants.

Does it matter?

If the future is Proof-of-Stake, then owning a validator and owning a lot of cryptocurrency becomes hugely important.

Polkadot currently requires 10k DOT to run a validator node. That is roughly $ 400 thousand dollars (!)

Right now, we appear to be in the wild west era of Cryptocurrencies. Much like the internet, there may come a time in which not everybody can participate in crypto as a few winners come to dominate though network effects.

That's the takeway to keep in mind.

Footnotes

[1]: Some call their validator nodes "stake nodes" to different from those who watch the process of validating blocks and those who actually participate. While the transparency is nice, its better to be a participant in case people abuse their position.

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