In the blockchain metaverse, there is a massive learning curve when it comes to understanding the terminology and the building blocks.
The language spoken on the blockchain is so different from that of Wall Street and retail investors and can be difficult to understand.
This is because blockchain is basically just extremely complicated computer code and the value proposition are the parameters of that particular code. Some blockchain projects try to decentralize the finances and or even the money themselves. Others are trying to help artists keep making money from their work through NFTs. The list of uses for the technology is seemingly endless, even if many of these projects remain small or largely speculative.
But let’s ignore some of these side projects and focus on some of the original projects, minable coins that serve as a medium of exchange.
When you invest in Bitcoin or Ethereum, you are not investing in a startup that is popular but not profitable – on the theory that Palantir (PLTR) or Uber (UBER) will figure out how to monetize the business – but that the The service provided by the code will be so useful to consumers that the offering of new coins is enticing enough that people will invest in either mining machines or the crypto itself.
To understand what that actually means, you need to understand the difference between the classic proof-of-work model popularized by Bitcoin and the newer, more scalable proof-of-stake model that is used for the Ethereum 2.0 update.
Proof of work
The Proof of Work (PoW) model is the most widely used and longest established method for validating blockchain applications.
Under the PoW model, an extremely difficult math equation is shared with miners who race among themselves to solve the equation as quickly as possible. In fact, the equation is so difficult that it is more efficient for the miner’s computers to guess random answers than trying to solve them. And the longer the solution takes, the longer the transaction will take.
After the response arrives, the node (the single computer owned by the miner) verifies the response with every other node on the blockchain. After 51% of the computers have verified that the answer is correct, a block (transaction) is added to the blockchain (ledger) and the miner is compensated for his problems in new bitcoins (or other degradable PoW cryptocurrencies).
This verification step is where cryptos like Bitcoin derive their security as someone would have to control 51% of the mining capacity to validate fake transactions. This makes Bitcoin hackable on paper, but makes it very difficult in practice.
The PoW model, while great for safety, is terrible for the environment as it creates incentives consume more and more electricity. The more computing power a miner has, the more they earn. The environmental impacts therefore worsen every year as larger warehouses are built, filled and supplied with electricity.
In addition, companies can benefit from economies of scale in this way and displace smaller mining operations as they grow faster and take a larger market share with each transaction.
In this case, the approval of transactions moves from a very decentralized to a highly centralized process as large mining companies continue to have incentives to pool their resources to get a better hash rate. Basically, it just means companies are combining their mining resources to increase the number of math guesswork their equipment can spit out per second. This will help them continue to outperform other miners and can be used to gauge how many bitcoins they can mine with their current equipment.
Proof of commitment
Since PoW seems to limit scalability, while the incentive to mine diminishes over time and the security of this blockchain weakens through centralization, Proof of Stake (PoS) models have been proposed as an environmentally and digitally safe alternative to PoW models.
In the PoS models, investors “plug†their crypto into this coin in order to have the opportunity to approve transactions and earn the rewards for plugging them in. The staking makes it so that only those who are financially committed to the continued success of this coin have the opportunity to earn the crypto rewards from staking. And if they are caught approving fake transactions, they can lose the coins used.
But wait, doesn’t that make it just as prone to centralization when you can basically just buy the rights to authorize transactions?
Well, in theory, that shouldn’t happen.
First you would have to buy up to 51% of the coins on this blockchain.
Second, the factors that play a role in choosing the next person to review transactions are only semi-random. The time and amount held are both factored into your chances of being selected for a “staking reward,†also known as a mint bonus, interest or crypto dividends. Since the coins used can be confiscated if caught approving fraudulent allegations, stakers with heavily invested funds have no incentive to approve fake transactions.
Stakers can also give their coins to trusted entities to aggregate their coins. When this happens, the pool validates the stakers as a team and splits the crypto dividend based on their share of the stake. So if I have 90 IOcoins in the pool and two others both have 45 IOcoins in the pool, then I take 50% of our collective mint bonuses and both get 25% of the bonuses.
No math, hash rates, or computing equipment is required. Just a digital vault that you send some of your coins to to make some cash on the side.
