PoS is becoming mainstream, but easy mining and high returns are still accompanied by risks

If you are not a new player in the blockchain circle and pay close attention to industry trends, you should be able to feel the two biggest trends in the blockchain in 2019:

1. DeFi (distributed finance) represented by MakerDAO

2. Staking Economy represented by Cosmos, Tezos, etc.

The most well-known platform-based public chain ETH also needs to switch from PoW to PoS consensus mechanism and transform to DeFi, which also confirms the two major trends in the next stage of blockchain development.

There are two points that are often mentioned about the advantages of PoS:

1. Energy saving and environmental protection. The block-producing nodes do not use mining machines to compete in computing power, but "mine" by holding coins, which is absolutely energy-saving and environmentally friendly.

2. Higher TPS. Generally speaking, the latency of PoS can be very low and the confirmation is very fast. In the PoS system, a transaction can be published and confirmed.

In addition to the two advantages mentioned above, the third advantage is that people have gradually discovered the participation of Staking after the popularity of PoS. Staking in PoS can be carried out by both institutions and individuals, and it is an important way to participate in network construction. The fundamental meaning of Staking Economy is to encourage coin holders to actively participate through incentives with annualized returns.

Simply put, token holders lock their tokens as collateral, and in exchange, they have the right to verify blocks and mining rewards. This process is usually called "Staking" or "Verification". We call block rewards "Staking rewards".

The PoS consensus mechanism system will set a certain inflation rate to encourage coin holders to participate in verification and achieve the purpose of maintaining the network. Of course, if the validator does evil, he will not only lose the Staking reward, but the collateral will also be confiscated.

Therefore, as a member of Staking, you must understand the tokens you hold: how much the staking rate of return is, what the rules are, how to choose nodes, and even how to participate in governance, etc. This in turn popularizes various knowledge about holding currencies and greatly enhances the subjective initiative of coin holders. In simple terms, it is to encourage token holders to participate in system maintenance and community building through economic incentives.

In the PoS staking method, all coin holders can participate, and coin holders are almost naturally participants in community governance. Relatively speaking, under the PoW mechanism, the threshold for ordinary users to participate is much higher. Take BTC as an example. The overlap between miners and coin holders involved in Bitcoin network maintenance is very low. Compared with coin holders, only a very small number of people participate in mining, that is, maintaining the system. The vast majority of coin holders do almost nothing and just want to wait for appreciation.

From this perspective, Staking Economy seems to be great in every aspect. However, is it really so?

Security Issues with PoS

From the perspective of system security, PoS has at least two major security risks.

1. Nothing at Stake: In simple terms, if the attacker forks the current chain, the "miners" holding coins do not need to judge which chain will win, and the best strategy is to "mine" on both branches at the same time. Because no matter which branch wins in the end, the coin holders of Staking will benefit, and the process is not like PoW, which requires money to burn computing power. PoS does not consume money throughout the process, so for the block nodes holding coins, it is completely feasible to mine on two branches at the same time.

This means that, in some cases, a malicious fork of a PoS chain is likely to succeed. Once the attack is successful, a chain may split into multiple chains, which will cause a series of serious problems such as transaction rollbacks and double spending.

2. Long Range Attack: This is a more difficult problem than the disinterested attack. Instead of forking the existing chain, the attacker creates a longer new chain from the initial stage, making the network mistakenly believe that it is the main chain.

If you want to build a longer chain on Bitcoin, you need to have more than 50% of the computing power of the entire system, which requires buying mining machines, consuming energy, and requiring huge capital investment to have a chance of winning. In contrast, PoS can "cheat" the algorithm to create a new chain, and this process does not require the investment of mining machines and energy consumption. The cost of attack is much lower than PoW. Once the attack is successful, the consequences are also very serious. The reconstructed chain may completely replace the original chain, and many properties such as immutability will be destroyed.

PoS is a closed system

PoW is often seen as “distribution according to work”, the more you work, the more you get, so it is compared to socialism. On the other hand, PoS is money making money, the more you hold, the more you get, so it is seen as capitalism.

This statement does not stand up to scrutiny. PoW is the real free capitalism!

PoW is an open model. New players can join the mining army at any time. They can build new mines to participate in mining, or develop more efficient and energy-saving mining machines to participate in the competition, which may affect the original competitive landscape.

From CPU mining to graphics card mining, to ASIC mining machines, and possibly quantum computers in the future, every upgrade of mining machines will cause a huge change to the original competition landscape. The dominant players who were originally at the top of the competition are likely to be replaced and overthrown by more advanced external technologies at any time. No one can guarantee that they will always be at the top. Therefore, the open PoW model is more like a free competition capitalism, just as gasoline cars replaced horse-drawn carriages before, and are now facing being replaced by electric cars.

PoS is actually more like an aristocratic inheritance system in the feudal era. In a PoS project where the majority of tokens are already held by the founding team and early investors, as long as they continue to maintain their advantage in the number of tokens they hold, it will be difficult for any new entrant to compete with them. This will increase the difficulty of new funds investing in the currency, and it will be more difficult for new capital to become a "big miner". This will lead to a centralization problem that may be more serious than PoW. The rich get richer, and external intervention will have a hard time affecting this result.

To go deeper, in PoS, "people who maintain the protocol" and "people who own resources" are the same group of people, and it is a relatively closed model. In the PoW model, miners have higher operation and maintenance costs. If they want to continue mining, they must sell coins. In the case of a bad market environment, uncompetitive miners will be eliminated. Therefore, the PoW model achieves the separation of miners and coin holders and the separation of rights through the consumption of external resources, survival of the fittest, and free competition. In the relatively closed PoS system, coin holders are miners, and the two roles cannot be separated. It is almost that the strong will always be strong, and latecomers have little chance of counterattack.

PoS's alarming inflation rate

In the PoS algorithm system, as long as you pledge the token, you can always enjoy the Staking income.

At the same time, the opportunity cost brought by staking can be calculated based on "the interest of lending the equivalent currency + the profit from arbitrage of price fluctuations during the period of locking the currency". Due to this opportunity cost, all PoS projects are inherently inflationary. Because only when there is inflation, the profit given to the staking holders can offset this opportunity cost.

The current inflation rates of several star PoS projects are as follows:

As we can see, most of them are concentrated around 5%-20%, and the inflation rate of some projects is as high as 155%. So the question is, if we take the median inflation rate of 10% for deduction, what will happen?

Assuming that a PoS project currently has a market value of 100 million, how much real money is actually needed to support this market value? In other words, how big is the corresponding plate in the trading platform?

For a market value of 100 million, if the liquidity is high, 10 million funds may be enough to support it, and if the liquidity is low, 1 million funds may be enough to support it. Then after inflation every year, the Staking reward is 10%, which is 10 million. The 10 million generated by the Staking reward is liquid. If this liquidity is traded in the secondary market, it is equivalent to using 10 million tokens to smash a trading market with a capital volume of 1 million to 10 million. What impact will it have on the currency price? What if the annual inflation is 20%, or even higher? The consequences are unimaginable.

Perhaps it was for this reason that EOS reduced the super node reward from 5% to 1%. The US dollar, the world's strongest hard currency, has such a huge volume, and its inflation rate in the past decade has only been around 2% per year.

For PoS projects that currently have almost no actual value support, can an inflation rate of 10% or even more than 100% really be sustained? This is a very serious question.

Summarize

Judging from the development trend of the industry, the PoS staking economy is currently driven by the general trend and is a major outlet for the industry in 2019. But this does not mean that the PoS staking economy has matured. There are still many problems to be solved, and continuous exploration and trial and error are needed. It is full of vitality, but also full of risks.