To democratize and further boost decentralization of mining Ethereum, apart from introducing the Ethash algorithm, Ethereum has endeavored to remove mining altogether by introducing Proof of Stake for block creation and confirmation of transactions.
As a recap, Proof of Work involves supercomputers carrying out complex hashing to discover valid blocks in the hopes of obtaining the reward in the form of new coins.
Proof of Stake is different because it allows anyone who is operating in the blockchain to set up a master node, and stake an amount of ether to be allowed to become a validator. The community will then agree on a way of assigning the rights to create and update new blocks using any consensus algorithm to those who hold these master validator nodes, thereby eliminating mining altogether.
Some of the advantages associated with this change are that
- generation of ether will be less costly
- users will participate more in the generation of new blocks and currency
- there will be a reduced risk of centralization
- and it will be possible to use penalties to discourage majority system attacks as opposed to mining.
Anyone who intends to enter the validation pool for Ethereum will deposit as much Ether as they want to use as a strength to encourage others to vote for them to create blocks and confirm transactions.
The PoS algorithm, dubbed Casper, will have ‘slashing rules’ that will be followed by the validators. On pain of losing the locked up Ether, validators will be assessed for misbehavior, and if found engaging in activities that endanger the blockchain, they will lose their locked up Ether and the privilege of being validators.
Casper will also control the number of validators in the pool to optimize chances of being nominated to create blocks for each validator. This will mainly be achieved by varying the validation compensation either up to incentivize more validators, or down to encourage some of the validators to leave the pool.
It will also be possible to counter any unwarranted inflation through ‘burning’ of part of the transaction fees. How? Inflation can be defined as the rate of increase in the prices of commodities, and the reduction in the purchasing power of money. In the world economies, a central bank controls the inflation of a currency by controlling the money that is in circulation. If there is less money, the prices of commodities will fall because not many people have ready cash.
In a digital eco-system, inflation can manifest if there is an over-abundance of the currency. Bad practices like paying transaction fees outside the blockchain can render ether less valuable over time, meaning that people will dump it for other coins.
However, because this will increase the currency in circulation, one of the ways to curb a reduction in the purchasing power is a requirement that each block must pay a certain percentage of the ether to the protocol, effectively burning that amount out of circulation.
Proof of stake has its challenges. Opponents see it as a possible source of conflict between the ‘haves’ and the ‘have-nots,’ because the more stake you have, the more likely your chances of successfully being assigned the role of creating blocks in most of the consensus models, which can have its own repercussions.