The term "protocol" refers to the framework behind a particular program or application. For example, an internet website works on HTML protocol. This framework is what determines the functionality, and how it is achieved. Another way to think about a protocol is a formula.. If you put X in, what is the result?
Every project has their own nuances and features, but generally there are two main methods for processing and supporting a blockchain. The first one, envisioned by Satoshi in 2008 is the Proof of Work protocol. While the new tech "proof of stake" was invented in 2012 to overcome the monumental maintenance cost of the BTC network. At that time, it costed more than $150 000/day to keep the network functional, and this price was absorbed by those choosing to contribute to the network.
The Proof of Stake invention solved a problem unique to Proof of Work - massive requirement of multi-factorial highly variable resources.
1. Proof of Work - PoW
Again, this is the first iteration of blockchain that was popularized by Satoshi. It relies on the miners completing a complex mathematical equation for an answer, submitting that answer to the network, and receiving payment if it is correct. Think of this like your computer is playing guess and check.. If you guess correctly, you get paid! This is the principle idea behind mining bitcoin.
The name itself "Proof of work" comes the idea that there must be computer processing occurring to provide the "work" to "prove" the transaction. From this point, we can begin to break down the fundamental problems that exist with this system:
- Requires intense computer processing.
- Computer processors require constant electricity.
- Processors produce heat which must be mitigated.
- Electricity has a tangible cost, and that determines profits.
- Price of BTC fluctuates, and therefore so does the reward.
Proof of work is an inefficient system, but it works! Bitcoin has been king, and will continue to be king simply because it was first on the market. Never underestimate the importance of first movers advantage!
2. Proof of Stake - PoS
Welcome to the future! Before we dive into the advantages of this protocol, lets explain how it works. The idea of community consensus is quintessential to how it works.Here is an example that should help you understand how it works:
Example: you live in a close knit community with houses lining either side. There has been a spike of crime recently, and everyone wants to figure out what is going on.
There are home owners who have a stake in the community and are invested in the communities best interest. However, there are renters which don't have the same level of personal investment in the communities integrity.
In this case, the home owners aren't likely to partake in questionable behavior because they are invested in the community. However, the renters are more likely to be insidious because they are not invested in the community.
It is only the opinion of the stake holders that matters to the community, the rest is simply noise!
If you hold a stake in a proof of stake network, you put forward the currency required as a stake in the network. By doing this, you're effectively saying you won't submit illegitimate transactions. Given that most people are on the same page, the blockchain is determined by community consensus - that is, the version of the blockchain that everyone agrees is legitimate is the one that is propagated across the rest of the network.
If people do submit illegitimate transactions, they won't be finalized because they are not in congruence with what the rest of the network says.
Phew that was a long example! Hopefully you got the key idea.. If you can contribute to the network via an investment/stake, you will be paid for doing so! This is true passive income because:
- Funds are deposited automatically.
- Your keys NEVER leave your own wallet.
- Payment is determined by algorithm, not a company.
There are a lot of advantages to how these networks function, but also some downsides because of their structure. As with anything, there are always pros/cons to either side relative to an alternate option. Lets compare some key features to PoW:
- Much less energy intensive (network still requires some mining).
- Lower cost to produce profits (no complex computation required).
- Higher network scalability and faster transactions with lower fees.
- Widely considered the "green" option compared to PoW.
- Opportunities for defi/decentralized finance.
It is very important to understand these ideas because you should only be investing into assets that you understand yourself. Blind investing is risky investing!
First, lets talk about making money via PoW mechanisms. This implies that you are mining for a project, and likely Bitcoin because of its low relative volatility. You must acquire computer processing power, cheap electricity, methods to cool down equipment, and an ability to sell them on the market. There are a lot of logistical reasons why, but mining is not profitable unless done by an experienced individual on a large scale. We're going to explain why in another blog post.
Second, lets talk about PoS monetization. All you have to do is acquire enough coins to hold a stake (this varies project to project), and then you need to do some network config and "attach" that wallet to the network. Each protocol is slightly different, but the key idea is the same. Acquire a stake, host a node, and receive payment into your wallet.
ETH will be switching to PoS in 2020, and there are many different coins like DASH, Horizen, PIVX, BNB that are already using this model. If you can acquire a stake in their network, you can start getting paid!
Renting a node is another great way to reduce the tech experience required to be successful. Every project has different rental services available, but always be sure to do your own research into not only the coin you want to host, but the people you want to rent from.
Until Next Time!Hopefully you learnt a thing or two from this blog post! It is the goal of Performante to provide high value content via all of our social media platforms. Our community is everything to us, and we appreciate every step you can take to help expand it. Spread the word and tell a friend: Performante is here to change the game forever.