Separation of Work and Stake
Part 1 of 3 of Pongo's "Political Principles in Crypto" Series
When Thomas Jefferson wrote the establishment and free exercise clauses in the First Amendment, now paraphrased as “separation of church and state,” the original intent was to ensure that the government of the United States did not establish an official religion for the country. Of course, religion and politics do overlap in some capacities: Many elected officials hold denominational beliefs, and religious groups can engage in lobbying activities. Regardless of your position on whether or not religion has an impact on politics, it is clear that there remains no government-imposed religion in the U.S.
Since Jefferson’s addition to the Constitution, secularism has become widely adopted by countries across the world. The impact of this shift is as profound as it is simple: The state is to focus on governing, and religious institutions are free to pursue their creed. Each sets out to accomplish a different goal.
In recent years, the topic of cryptocurrency mining has been criticized by governments around the world under the guise of environmental concerns. The crypto industry has been making efforts to draw attention to the low-carbon and renewable energy sources used by Bitcoin miners, a topic I previously touched on, with limited political impact. Sadly, these essays fall largely on deaf ears, as elected officials and business leaders alike point to a commonly referenced alternative Bitcoin’s proof-of-work (“PoW”) mechanism: A system called proof-of-stake (“PoS”).
I will add to the ongoing conversation of PoW vs. PoS by highlighting a common thought error, highlighting the pros and cons of each system, and concluding with this thought: Proof-of-work and proof-of-stake have different applications.
The First Resentment
A misconception prevalent among technologists is the idea that everything can be improved by some advanced computing solution. Yes, the cellphone has changed the way people live (for better or for worse), but that cat-robot waiter is gimmicky, annoying, and less effective than a human. When it comes to crypto, there are some zealots that believe everything should be on a blockchain. (Generally, the idea that everything should be on the blockchain is totally irrational.)
The deeper down the crypto-rabbit hole you go, the more you will notice the debates among builders, investors, and users over specific issues across a wide variety of projects. For some time now, there has been a palpable animosity between PoW and PoS blockchain advocates as to which consensus mechanism is superior. Bitcoin uses a PoW mechanism, which secures the network using energy and computing power, whereas Ethereum plans to transition to the more energy efficient PoS system. (Some other blockchains currently use PoS, but Ethereum is considered the “original” PoS chain, despite not having changed over yet.)
The tradeoffs are hotly debated to the point of tribalism. Ironically, both sides are generally right, yet they often ignore how PoW and PoS might be complementary to one another. (But that’s a topic for Part 3.)
This isn’t to say that there isn’t intelligent debate on both sides. For example, take Noah Smith’s Bloomberg Opinion piece on the sustainability of PoW mining, which points out how PoS might be a necessary pivot for Bitcoin. That piece was then critiqued by the pro-PoW Nic Carter, point by point. Even better still, Nic’s rebuttal received a response by Noah Smith on his blog! Further, the unofficially appointed figurehead of PoS opposes an outright ban of PoW:
Vitalik Buterin is one of the co-founders of Ethereum and has always promoted the benefits of PoS over PoW, yet he opposes bans on PoW. (Granted, Vitalik’s opposition here is likely more rooted in his views on government intervention in business…) The significance of Vitalik’s defense is the implication that the industry is still discovering what’s possible and that innovation shouldn’t be stifled.
(Anti)Establishment Clause
Proponents of PoW blockchains point to energy use for mining as a necessary component, because the ongoing operating costs are real-world stakes. A miner of a PoW blockchain is incentivized to honestly serve the network because acting maliciously threatens their own profitability. In other words, while their input costs remain the same, the revenue generated from their output is reduced. Computers, electricity, and overhead are typically paid in fiat currency, but the resulting drop in crypto prices due to their malicious actions will affect their bottom line.
Typically, PoW blockchains are viewed as more resilient to hostile takeovers than PoS networks because of the input costs. Having operated a Bitcoin mining farm at scale, I can attest to the difficulty of remaining profitable while sourcing hardware, setting up colocation, and maintaining mining uptime. Further, the ongoing operating costs are paid in fiat currency as well, with electricity being the largest expense for most miners, so organizing a hostile takeover needs to account for a wide set of variables.
If an organization aimed to co-opt Bitcoin for example, and had the capacity to establish and maintain the setup required, they would need to employ their operation slowly to avoid tipping off power users. Savvy Bitcoin enthusiasts have very sophisticated methods of identifying where mining is taking place, what kind of hardware they are using, and even make close estimates as to their carbon emissions. If the organization attempts to takeover the network but tips-off these power users, the rest of the Bitcoin network can conduct a hard fork and render the whole operation mostly useless. (The usurpers might still hold some “real” Bitcoin before the hard fork, but that likely would not cover the cost of the endeavor.)
Can a PoS blockchain do this? Theoretically yes, but the mechanics are much different. A PoS network doesn’t use miners, rather “validators” that stake their tokens on the network in order to add new blocks to the blockchain. A usurper would need to find a way to accumulate enough stake to make meaningful changes to the network - with some early theories pointing to that number as being between 33-66% of tokens.
Because the PoS consensus mechanism only requires a simple investment in (or loan of) the target cryptocurrency and minimal operating costs, it is feasible that a self-destructive attack would be profitable if the usurper also shorted the target token. Some speculators believe that this kind of self-destructive attack was used against the LUNA cryptocurrency (a PoS blockchain), and eventually led to its demise - though it’s largely irrelevant who conducted the attack, as the LUNA blockchain was doomed to collapse anyways… (20% yield? From where?)
A similar attack on Bitcoin is likely to be less effective because of the added cost of physical hardware, electricity, and operating expenses. In my purview, the establishment of physical stakes makes a hostile takeover of a PoW blockchain more difficult and risky than a PoS blockchain.
Free Excise Clause
PoS is the new kid on the block(chain), even for the relatively nascent crypto industry. Over the past 10 years, PoS networks have come and gone (I remember Peercoin back in the day), yet none have truly withstood the test of time quite like Bitcoin. I recall cryptocurrency staking gaining popularity during the 2017-2018 crypto bubble, and later exploding in the 2020-2021 cycle. I propose that its popularity is largely derived from those attempting to make easy money. After all, staking crypto gets you 4% up to 100,000%+ in just a few clicks!
In my previous post about DAOs, I wrote about how the larger an organization is, the more difficult it becomes to rally its constituents. Despite this, cryptocurrencies that offer some sort of “yield” enjoy very high staking ratios (or the amount of staked coins vs. the total amount of coins). By contrast, staking cryptocurrencies that don’t offer rewards have markedly lower participation rates. (Ethereum is an outlier below, based upon the size of the network and the fact that staking isn’t truly available yet.)
I’d venture to say that the vast majority of PoS network users are simply speculators chasing a return on their money or the prospect of passive income. Nonetheless, they are now users, which is what keeps software alive (and valuable). These brave new economic explorers were drawn to the network in search of excess, and were welcomed by low barriers to entry. Charging a tax (transaction fee) to others using the network requires minimal effort, and practically no electricity in PoS.
By and large, the PoS consensus mechanism can run on generic hardware, such as a desktop computer, making it an accessible solution for most users. In addition, PoS validators require minimal energy input, meaning the transaction fees rewarded to validators practically free after the up-front investment in the network (i.e. their “stake”). This makes staking an incredibly powerful tool to onboard a significant amount of users (speculators) to a network, which isn’t necessarily a bad thing. Sometimes new technologies begin to take shape when users pile in and offer feedback.
Crypto Secularity
On the one hand, PoW blockchain supporters believe that the physical infrastructure used to maintain the blockchain provides a critical layer of security for the network. Because the blockchain depends on real assets and ongoing capital expenditures, it makes PoW more secure, but less accessible to the masses.
On the other hand, advocates of PoS blockchains point the large energy cost for maintaining a PoW network (namely Bitcoin), and claim that the more energy-efficient PoS system is optimal. Without the physical constraints of mining, PoS networks can also grow larger and faster if anyone can stake their tokens on a computer at home.
While I agree with the points made on both sides of the argument, it isn’t clear to me anyone would feel that PoW or PoS consensus is inherently better than the other, and must therefore be implemented on every blockchain. The same technology isn’t always suited to the same problem!
If a particular application requires greater security than usability, then a PoW blockchain might make more sense. For example, recording legal documents might necessitate a greater emphasis on dependability over speed. Conversely, if an application requires user experience over reliability, then a PoS blockchain might be the better solution - like completing a purchase at a store, or settling a trade.
Despite this, users, businesses, and governments critique both systems for their shortcomings, devoting themselves to one or the other. Instead, they should focus on the strengths of each mechanism and where they may be best applied.
As I continue this three part series, I will argue for synergy between the two systems… But before that, I must offer some more context on the concept of layer-2 blockchains and sidechains.