🌐 MCS Crypto 101 - Issue #3 🌐

Crypto Topics Made Simple - Straight to your inbox, every Tuesday and Friday.

Hello and welcome back to MCS Crypto 101.

In our last issue, we discussed the different types of blockchains - with a focus on public chains.

What is it that really makes these chains work? What makes them tick? The answer is clear - consensus mechanisms. Let’s dive in.

🎭 Introduction: The Unsung Heroes 🎭

Welcome to the world of consensus mechanisms, the unsung heroes of blockchain technology. They are the protocols that maintain the integrity and security of a blockchain, ensuring trust and reliability in decentralized networks. Let's briefly introduce you to this vital aspect before we delve deeper in our upcoming issues.

Why are they Essential? 💓

Consensus mechanisms are the heartbeat of blockchain technology, acting as the rulebook that guides all participants to agree on a single version of the truth. They prevent fraudulent activities and secure the data stored on the blockchain, essentially fostering trust and reliability in the system.

Stay Tuned: Unveiling the Giants 🌏

Brace yourselves as we unravel the mysteries of Proof of Work (PoW) and Proof of Stake (PoS), two titans that dominate the blockchain landscape. Is that it? NO! We shall also unveil the hidden treasures of unconventional approaches embraced by diverse blockchains. Prepare to be enthralled by the secrets that lie within these digital realms.

🌎 Real-World Analogies 🌎

The Classroom Setting: Proof of Work (PoW) 🏫

Imagine a classroom where the teacher poses a challenging math problem. The students race to be the first to solve it correctly, with the winner receiving a prize. This scenario is much like the Proof of Work mechanism.

In the blockchain world, "miners" compete to solve complex mathematical problems first. The winner gets to add a new block of transactions to the blockchain, securing a reward in the form of cryptocurrency.

However, just like the fastest student isn't always the one to solve the problem correctly, miners must ensure accuracy, which demands high computational power and energy, making it a bit of a strenuous process.

Community Voting: Proof of Stake (PoS) 🗳️

Picture a community meeting where important decisions are made through voting. Here, individuals with a larger stake in the community, perhaps due to owning larger properties or having lived there longer, have a more significant say in the decisions.

This is akin to the Proof of Stake mechanism. In this system, the more cryptocurrency one holds and is willing to "stake" or lock up as collateral, the more likely they are to be chosen to create the next block of transactions on the blockchain.

🌌 Popular Consensus Mechanisms 🌌

Proof of Work (PoW) 🛠️

• How Does it Work?

  • Miners compete: Miners compete to solve a complex mathematical problem first, a process that verifies transactions and adds new blocks to the blockchain.

  • Reward system: The first miner to solve the problem is rewarded with newly minted cryptocurrency and transaction fees.

• Pros and Cons

  • Pros

    • Security: Highly secure and tested over many years, making it resilient to attacks.

    • Decentralization: Maintains a high level of decentralization, as anyone can participate in the mining process.

  • Cons

    • Energy consumption: Requires a significant amount of computational power, leading to high energy consumption.

    • Resource intensive: Can lead to centralization as individuals with more computational resources dominate the mining process.

Proof of Stake (PoS)🌱

• How Does it Work?

  • Staking: Participants, or validators, are chosen to create a new block based on the number of cryptocurrencies they hold and are willing to "stake" or lock up as collateral.

  • Incentive: Validators are incentivized to act in the best interest of the network as they stand to lose their staked cryptocurrencies if they are found to be acting maliciously.

• Pros and Cons

  • Pros

    • Energy efficient: Far less energy-intensive compared to PoW, making it more environmentally friendly.

    • Security: Offers security through validators who have a high stake in the network, promoting honest behavior.

  • Cons

    • Less proven: Though promising, it is less proven than PoW, with fewer networks utilizing it.

    • Potential centralization: There is a risk of centralization, as those with more cryptocurrencies have a higher chance of being chosen as validators.

Delegated Proof of Stake (DPoS) 🏰

• How Does it Work?

  • Delegates: Cryptocurrency holders vote for a small number of "delegates," who are responsible for validating transactions and maintaining the blockchain.

  • Efficiency: This system aims to improve efficiency and reduce the time required to reach consensus compared to PoW and PoS.

• Pros and Cons

  • Pros

    • Speed: Transactions are validated more quickly, enhancing the performance of the network.

    • Energy efficient: Like PoS, it is more energy-efficient compared to PoW.

  • Cons

    • Centralization risk: There is a higher risk of centralization compared to PoW and PoS, as only a small number of delegates are responsible for validation.

    • Less secure: Potentially less secure compared to PoW, as it relies on a smaller group of validators, making it more susceptible to collusion and malicious attacks.

🌌 How Consensus Mechanisms Really Work 🌌

Okay all of that was great.. but how does it really work?

Proof-of-Work

1. You buy a miner.

2. You set it up.

3. You let it run 24/7, and every so often your machine will win the race and your freshly minted cryptocurrency will be added to your wallet.

Miners look like this:

They use a lot of electricity, they run hot, and they’re expensive - so dont think you can simply buy 10 and throw them in your basement.

Profitablility depends on a few things:

• The price of electricity

• The mining rate

• The price of the coin your mining

Proof-of-Stake

Proof of stake has a much lower barrier-to-entry. Let’s dive deep.

How to stake your coins:

1. Acquire Cryptocurrency: Purchase or acquire the cryptocurrency of the specific blockchain that uses the PoS consensus mechanism.

2. Download a Wallet: Download the proper wallet that allows you to hold and stake your cryptocurrency

3. Hold and Stake Your Cryptocurrency: Transfer your cryptocurrency to your wallet and hold them there. In the wallet, you will find options to "stake" or "delegate" your cryptocurrencies. Choose the amount you wish to stake and follow the on-screen instructions to stake your coins.

4. Become a Validator or Delegate: Depending on the specific PoS mechanism, you can either become a validator by staking a significant amount of cryptocurrency or delegate your stake to a validator. Validators are responsible for creating new blocks and validating transactions. Delegating is much easier than validating yourself.

5. Keep Your Wallet Online: To actively participate in the staking process, keep your wallet online and running. This allows the network to select your wallet to validate transactions and create new blocks based on the amount of cryptocurrency you are staking.

6. Earn Rewards: As a validator or a delegator, you will earn rewards in the form of additional cryptocurrencies. These rewards are distributed periodically and are a share of the transaction fees and, in some cases, newly minted cryptocurrencies.

7. Unstaking: If you decide to stop staking, you can "unstake" your cryptocurrencies. Note that there might be an "unbonding period" during which your cryptocurrencies are locked before being released back to your wallet.

Here’s what PoS looks like:

One of the many PoS blockchains is the Cosmos Hub. Let’s look at an example of staking its native coin, ATOM.

Staking ATOM in the Cosmos Ecosystem uses the Keplr wallet. Here’s an example from one of my wallets.

When you go to stake your coins, you’ll see an interface that looks like this:

Note that the APR earned for staking ATOM is 18.65% (after commission paid to the validator). These are the rewards, or payment, for your help in contributing to the security of the network with your staked ATOM. These ATOM rewards are claimable throughout the staking process.

🌟 Emerging Consensus Mechanisms 🌟

Proof of Burn (PoB)

• How it Works: Participants send their coins to an unspendable address, effectively "burning" them to earn the right to record transactions.

• Pros: Discourages malicious activity by imposing a cost on participation.

• Cons: It involves the intentional destruction of assets, which some view as wasteful.

Proof of Authority (PoA)

• How it Works: Transactions are validated by approved accounts, known as validators. These validators are chosen based on their reputation and trustworthiness.

• Pros: High performance and scalability, with a lower energy footprint compared to PoW.

• Cons: Centralization concerns, as a small group of validators hold significant power.

Proof of Space (PoSpace)

• How it Works: Participants allocate a certain amount of disk space to the network to validate transactions. The more space you allocate, the higher your chances of being chosen to create a new block.

• Pros: Energy-efficient compared to PoW, making it environmentally friendly.

• Cons: Vulnerable to Sybil attacks, where a single adversary controls multiple nodes to undermine the network.

🌐 Conclusion 🌐

Dive deep into the world of blockchain, and you'll find a pulsating heart at its core - consensus mechanisms! These are the unsung heroes, the backstage crew that ensures every act in the blockchain theater runs smoothly, securely, and harmoniously.

Consensus mechanisms are sure to evolve as time goes on. Don’t worry - we’ll keep you up to speed.

Thank you so much for subscribing to Make Crypto Simple 🌐🔗

We’ll see you again tomorrow.

Chris Schawel

The content provided in this newsletter is for entertainment purposes only and should not be construed as financial advice. All information, including but not limited to market analysis, price predictions, and investment strategies, is purely speculative in nature. We strongly recommend conducting your own research and consulting with a qualified financial advisor before making any investment decisions. We are not responsible for any losses incurred as a result of the information presented in this newsletter.