What is a Blockchain Protocol?
A blockchain protocol is a common term for consensus methods. These methods are different systems that are implemented to reach consensus and validate transactions within a blockchain network.
Some of them require investors to purchase physical mining equipment, while others require no physical hardware, and just the holding of coins.
Below is a list of some well-known consensus algorithms that you should be familiar with. Most coins most likely utilize one, or a combination of these blockchain protocols.
Proof-of-Work: Transforming Energy into Value
Lots of cryptocurrencies, including Bitcoin, use Proof of Work (PoW) as their consensus algorithm. As a result, miners are taking part in a PoW scheme.
In PoW schemes, miners participate in the network by contributing large amounts of computing power.
To participate, miners create physical mining rigs, commonly consisting of several graphics cards. More powerful rigs give miners a better chance of winning the next block and receiving the coins of the next block reward. Transactions within the blockchain also include fees, which are rewarded to the miners.
Source: BitcoinMiningCom YouTube Channel
The takeaway here is that PoW-based blockchain protocols rely on miners who have physical rigs. This means there is an upfront cost on the miner.
The miner has to spend real money (usually more than a few thousand dollars) to have any chance of winning a block reward.
In the case of Bitcoin, miners can pool their power together. When miners combine their power to add new blocks to the chain, the reward is distributed proportionately to each miner depending on how much computing power they contributed to the pool.
The Economics of PoW.
Users have to spend thousands of dollars on building mining rigs to be part of PoW networks. Without these invested miners, no coins would exist.
Many argue that the prices of the mining rigs in addition to electrical cost (your electricity bill will increase significantly from mining) sets a nice base value for a PoW coin.
Miners will not want to sell a coin for less than the ‘wholesale’ cost they paid to mine it.
If you want to find out the cost of mining of a coin that utilizes a PoW protocol, look at:
- The cost for miners to mine new coins (equipment + electricity)
- The block time and reward
Whattomine.com is an excellent starting place to explore the cost of mining different coins.
Consider it like this. If a PoW scheme has:
- Fast block times
- High block reward
- Low Total Supply
Then you can imagine that the total supply will hit its max quickly. As long as demand is there to fulfill the fast initial rate of supply, the coin should perform fine. Otherwise, it may be best to wait until all coins are mines, to see how the market reacts.
On the other hand, if a PoW scheme has:
- Slow block times
- Low block reward
- Low or High Total Supply (doesn’t matter much in this case)
Then less demand is needed to keep up with the slower inflation rate. In this example, the total supply isn’t as relevant because the inflation rate is so slow. Purchasing while the coin is new and scarce may be a wise idea here.
Proof-of-Stake: Say Goodbye to Mining Rigs
Proof of Stake (PoS) is a very different consensus model, which has been gaining an increasing amount of enthusiasm over PoW as of late.
PoS does not require its users to buy physical mining rigs or spend huge amounts of computing power to participate.
Instead, PoS allows all coin holders to contribute to the network easily. As long as you hold coins in your wallet, activate staking, and leave your computer on (contributing a relatively minimal amount of computing power), you will receive staking rewards by acting as a miner.
Generally, the more coins you hold, the more you contribute to a network and the better chances you have of solving the next block. In short, PoS incentivizes holding.
The Pros and Cons to PoS
PoS and PoW have similar problems but in different ways.
In PoS, a wealthy person can buy a majority of coins and reap most of the benefits. This does NOT provide for a safe or fair economic environment. That person can potentially sell their stash and crash the price.
Similarly, in PoW, a wealthy person can build many mining rigs to control the hash power of the network, reaping most of the block rewards.
In PoS, unlike PoW, you have no baseline of physical cost to create a coin. The only metrics you have are total supply, circulating supply, inflation rate, and current market price. So, you can analyze this market similar to a fiat currency – measuring supply and demand.
This makes it a bit riskier to some people because the price is not backed by anything physical, and instead, backed by people’s beliefs.
On the other hand, the upside is that you can gain staking rewards as a node much easier than in a PoW protocol. This is the main reason the community has been siding with PoS.
Delegated Proof-of-Stake: Electing Trusted Nodes
DPoS has been introduced to the scene after PoS and stands for delegated proof of stake.
The reason for this name is because there are delegates (or participants, or nodes) elected by votes to represent others and add new blocks to the chain.
Not anyone can to stake and verify blocks. Users can vote for delegates, which they hope are trusted participants.
Bitshares is a big proponent of DPoS. Delegates on Bitshares can tune network parameters such as block intervals, transaction times, and fee schedules.
On the other hand, different networks have delegates with different power, but the concept remains the same.
Ultimately, DPOS is meant to democratize PoS environments by creating an agreed upon trusted group of delegates responsible for validating the network.
The Downside to DPoS
The main downside here is that crypto enthusiasts can join a network early, buy lots of coins and vote for each other, essentially centralizing the network.
It is still challenging to perform this type of attack, but it is certainly possible, and a major downside to DPos for most people.
Additionally, users don’t trust to vote for other nodes which may not have good uptime. If the delegate does not have sufficient uptime and fails to contribute to consensus, then their reputation score will go down.
Generally, in these networks, delegates have a reputation which will affect whether or not they are voted again by the community stakeholders.
Proof of Weight: How Much Does Your Node Weigh?
Proof of Weight is another blockchain protocol gaining interest with projects that have more literal applications. For example, a file storage project would most likely use a Proof of Weight type of scheme.
In PoS, stakers’ effectiveness is judged by the relative number of coins they hold, while in Proof of Weight takes into account the number of coins in addition to the number of files (or any other measurable metric) they hold for the network. With regards to a file storage project, the metric would be the amount of IPFS (file) data users are storing.
This means that there is an incentive to hold coins AND contribute meaningfully to the network.
Which is the best blockchain protocol?
All these consensus algorithms were created to reach a specific goal: effective decentralization. Which means there should be a system which incentivizes and practically enables individuals to contribute to these networks, and not only wealthy investors.
The reality is that it is often much more expensive to buy all of the coins in an economy than it is to have enough mining rigs to dominate a new blockchain in terms of hashing power.
As a result, PoS is seen as a better alternative from a technical point of view, as it is much harder to manipulate and better protects against 51% attacks.
Even Ethereum has moved from a PoW model to PoS.
I am a fan of PoS. I enjoy staking coins on my computer to earn passive income and believe it is more difficult for malicious actors to attack the network.
Pos provides virtually no barrier of entry to act as a contributing node in the network to gain rewards. This is the reason why the crypto community favors POS.
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- Should You Invest in Bitcoin?
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- How Much to Invest in Bitcoin
- The Ultimate Crypto Tools Checklist