Sunday, February 5, 2023

Proof of Stake: Why It’s Not a Valid Option for Cryptocurrency

Proof of Stake: Why It’s Not a Valid Option for Cryptocurrency

Proof of Stake (PoS), it’s a mining algorithm popular with altcoins — the big one being Ethereum, which plans on switching to PoS from the “traditional” Proof of Work (PoW) setup it currently has. Many people believe Proof of Stake is better than the Proof of Work algorithm, made popular by Bitcoin. But that’s not really the case. In fact, it might be the worst hashing setup a cryptocurrency can have.

Also read: NEO Manager Pushes Back, Says Recent Node Woes an “Edge Case”

Proof of Stake: Why People Love it

PoS proponents mainly love this algorithm for its energy efficiency. Bitcoin mining via PoW, they say, consumes dangerous amounts of electricity. And, they continue, if PoW continues on as the primary hashing algorithm for cryptocurrency, our favorite monetary technology could create a global energy crisis.

This sentiment has reached the mainstream, with several articles making the rounds in 2017 warning of the dangers created by bitcoin mining.

Proof of Stake, on the other hand, boats a much higher level of energy efficiency, with blocks mined from “staking” wallets holding a certain amount of coins rather than specialized mining rigs. Essentially, anyone can mine a PoS coin if they have enough unspent currency in their wallets.

Thus, PoS essentially offers mining without mining. Perfect, right?


Unlimited Inflation

Why PoW Works

While many technical flaws in PoS have been highlighted, the biggest shortcoming is an economic one. Theoretically, with PoS, coins using the algorithm can have unchecked inflation, since it does not have a PoW-style mining difficulty calculation to limit the amount of blocks produced relative to the demand for money.

Under Proof of Work, mining difficulty adjusts based on the amount of miners currently on the network. And since miners work for profit, difficulty adjustments are linked to the value of the PoW coin.

Thus, when the price goes up, miners dedicate more resources towards that coin. In response, difficulty rises, making the process more resource-intensive and slows growth in supply, preventing the total supply from skyrocketing and devaluing the coin.

Proof of Stake

On the other side, when the price goes down, miners dedicate less resources to the coin. From there, difficulty drops, which helps remaining miners remain profitable. Simultaneously, since there are less miners on the network on the whole, the lower difficulty does not result in inflation, since there are a smaller total amount of machines mining coins.

What this process does is ensure that the growth in supply of the PoW coin is dynamic — regulated by supply and demand. And as long as demand for the coin remains constant or continues growing, the total supply will not reach an amount where inflation occurs.

So, under Proof of Work, the tech and the markets work together to ensure the coin remains deflationary — i.e., good money.

Why PoS Creates Bad Money

With Proof of Stake coins, no cooperation between the tech and markets exists to regulate and maintain a deflationary supply.

Mining is determined by balances in the wallets of coin holders. Blocks are produced on a set schedule, and the distribution of new coins is determined proportionately based on how many unspent coins staking wallets possess.

Essentially, Proof of Stake, removes the cost of mining entirely, leaving no room for a market mechanism to emerge and regulate inflation. Theoretically, then, the growth in supply of PoS coins remains constant, regardless of its value and staking profitability.

This completely destroys any market-sourced monetary rules that keep supply in check. As a result, even with a total supply cap, supply shocks will plague a PoS-based monetary system, leaving no room for stability and making it hard to have reliable economic growth.

The Worst Kind of Centralization

There also exists another insidious activity enabled by Proof of Stake. Under this algorithm, changes to protocol code is not determined by miner consensus, but by a vote from staking wallets. Additionally, the protocol weighs votes based on the holdings of staking wallets. So whoever has the most money has the most influence over a vote.

This means that a small group of wealthy stakers can control the entire network, voting on changes that benefit them — even at the cost of the rest of the network. Under such a system, a large entity or wealthy group, such as a central bank, can use fiat money to purchase vast quantities of a PoS coin, hold them until their wallets become eligible for staking, and then take over the network.

Once the network has been infiltrated and seized by these interests, they can do things that make the PoS system less efficient and more dangerous than it already is. For example, controlling interests in a PoS network could vote to remove the supply cap. And since they have the highest holdings of staking coins, they get the highest cut of the new coins — giving them majority control over the monetary supply.

Such a vote would essentially create a central bank, allowing controlling stakers to use and distribute newly-minted coins as they please. In other words, they can conduct central banking monetary policy.

Consequently, economic cycles, politics, and corruption will enter the equation, throwing the PoS-based economy into chaos.

Repeating History

If and when that happens, a PoS monetary system will be no different from a central banking fiat system. And in that case, what was the point of creating a cryptocurrency in the first place? Nothing will have changed.

From a libertarian perspective, cryptocurrency exists to remove centralized influence from the monetary system, facilitating sustainable growth and a gradual increase in wealth for everyone through deflation.

Cryptocurrency is supposed to bring back the era of good money, but PoS just enables the reign of bad money to continue with a tech upgrade.

In short, if you value monetary freedom, be very, very weary of anything PoS. Sure, Proof of Work is expensive, but it can change the world for the better.

What do you think about Proof of Stake? Share your thoughts in the comments section

Images via Pixabay

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