Where does money come from? Dollars are printed by the US Mint. For cryptocurrencies, the answer is more complicated. Until now, both of the most widely used digital tokens, Bitcoin and Ethereum, have only been issued to pay for tasks performed by so-called miners in what are known as proof of work systems. It’s an approach that has drawn increasing criticism for the large amounts of energy consumed and pollution produced. Ethereum is switching to a different system, called proof of stake, in a process known as the Merge. Proponents say the approach can cut Ethereum’s electricity use by 99%.
1. What are the ‘proof of’ systems for?
Cryptocurrencies wouldn’t work without blockchain, a new technology that performs the old-fashioned function of maintaining a ledger of time-ordered transactions. What’s different from pen and paper records is that the ledger is shared on computers all around the world. Blockchain has to take on another task not needed in a world of physical money -- making sure that no one is able to spend a cryptocurrency token more than once by manipulating the digital ledger. Blockchains operate without a central guardian, such as a bank, in charge of the ledger: Both proof of work and proof of stake systems rely on group action to create, validate and safeguard a blockchain’s sequential record.
2. How does that happen?
In Bitcoin and Ethereum’s main network today, transactions are grouped into “blocks” that are published to a public “chain,” but only after “proof of work” ordering is performed. With Bitcoin’s software, that happens when the system compresses the data in the block into a puzzle that can only be solved through potentially millions of trial-and-error computations. This work is done by miners who compete to be the first to come up with a solution and are rewarded with free cryptocurrency if other miners agree it works.
3. What are proof of work’s drawbacks?
When Bitcoin was worth pennies, mining was also cheap. But as the currency’s value rose, an arms race of a sort set in, as miners poured in resources in the quest to win new coins. Bitcoin’s software responds to increased competition by revving up the computational difficulty. The resulting sky-high electricity usage led to calls from the environmentally conscious to shun Bitcoin. The European Union considered banning the practice before deciding that cryptoasset providers should be required to disclose the energy consumption and environmental impact of the assets they choose to list. The proof of work system has also led to a growing dominance by huge, centralized mining farms, a development that’s created a new vulnerability for a system designed to be decentralized. In theory, a blockchain could be rewritten by a party that controlled a majority of mining power.
4. What is proof of stake?
The idea behind the proof of stake system being adopted by Ethereum is that its blockchain can be secured more simply if you give a group of people a set of carrot-and-stick incentives to collaborate. People who put up, or stake, 32 Ether (1 Ether traded at around $1,900 in mid-August) will be able to become “validators,” while those with less Ether can become validators jointly. Validators are chosen to order transactions into a new block on the Ethereum blockchain. If a block is accepted by a committee whose members are called attestors, validators are awarded Ether. But someone who tried to game the system could lose the coins that were staked. Ethereum’s proof of stake system is already being tested on a blockchain, called the Beacon Chain, that’s separate from the proof of work system; so far $25 billion worth of Ether has been staked there. The two blockchains are expected to merge in September.
5. What are the system’s advantages?
It’s thought that switching to proof of stake would cut Ethereum’s energy use, estimated at 45,000 gigawatt-hours per year, or a bit more than New Zealand’s, by 99.9%. In terms of its carbon footprint, it would essentially be like any other internet operation whose energy use involves nothing more than running a network of computers, rather than a venture resembling a collection of gigantic digital factories.
6. What are its vulnerabilities?
Proof of stake is less battle-tested than proof of work, whose security has been scrutinized for more than a decade. So new vulnerabilities could be found. Its proponents think the risk is worth what would be gained in terms of environmental benefits, as well as from bringing a broader group of users into the process.
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