Category: Blockchain

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Blockchain Financial Services Software

Hyperledger fabric – what do you need to know about this enterprise blockchain?

Enterprises need to ensure a significant level of security, privacy, compliance, and performance. These processes are very complex and time-consuming. Problems frequently emerge with data incompatibility or lack of trust. How can Hyperledger Fabric help in such situations?

Blockchain is a distributed, decentralized public ledger. To picture it, it can be described as a constantly growing list of transactions stored on devices on the network called nodes. Cryptographic protocols connect the nodes and keep transactions confidential.

All the data on the blockchain network is visible to users, and each is responsible for their actions. Data is immutable and not controlled by one central authority. But what happens when we want to use blockchain for business so that we need to certify authorities and control who is in our network, and we want to keep all our data confidential from the outside world? One thing is for sure – in such a case, a public blockchain network won’t be suitable; you need a private network. To create blockchain applications meeting the above requirements, it’s best to use enterprise blockchain platforms.

What are private blockchain networks, and what are their benefits

Private blockchains are a version of blockchain technology that can be either open-source, consortium, or privately developed. There is a wide range of private blockchain platforms, but the most popular ones are Hyperledger Fabric (sometimes shortened to Fabric, or HLF) hosted by the Linux Foundation, and R3’s Corda.

Joining a private blockchain network

One feature that sets private blockchains apart is that participants can limit or grant permission to access this blockchain network. This is why it is also called a permissioned network. Network administrators have to invite you to join the enterprise blockchain. Limiting access to the network and implementing proper identity management ensure private transactions. Only entities participating in a transaction will know about it. “To achieve a higher level of privacy, it is sufficient to specify user identities, limit read permissions, and certify authorities. These measures provide a high level of data protection.

Transaction scalability across the network

Hyperledger Fabric is an open-source blockchain; its scalability depends on many factors. Software infrastructure design and complexity impact performance. The Hyperledger Foundation claims that its private blockchain is more scalable and allows more transactions per second than public blockchains. A 2019 study by Christian Gorenflo, Stephen Lee, Lukasz Golab, and S. Keshav even states that it has achieved a fantastic transaction flow of up to 20,000 business transactions per second.

One significant tradeoff for higher transaction processing rates is that private blockchains are more centralized, permissioned networks. Rather than public proof-of-work consensus, which Bitcoin and Ethereum use, Hyperledger Fabric networks use the Raft consensus algorithm.

Consensus in Hyperledger Fabric network

To reach consensus in HLF, you need an odd number of nodes, and there needs to be a simple majority of those working to confirm transactions. For example, if there are seven nodes in a network, four would need to be working to verify new transactions. However, having such a limited number of nodes also comes with risk.

Blockchain developer Tomasz Kaliszuk explained that “Raft [consensus] might lose more nodes, and it will continue to work. It is an approach to a consensus that enables actors in a network to gain a lot of power — so be sure it’s someone you trust. It is less secure because it does not protect against ‘bad actors,’ meaning ‘bad nodes,’ so it’s essential in enterprise blockchains to trust that such bad users will not gain access. Raft, however, is faster, much more scalable when it comes to network expansion.”

When designing blockchain systems based on Hyperledger Fabric, we approach it from a technical point of view using its built-in components like chaincode and ordered. But we also approach it from the perspective of business logic. We try to understand how our client’s business works, what problems we are to solve, and how we can combine technology and business to optimize processes and bring tangible benefits.

What is Hyperledger Fabric blockchain platform– need-to-know basis

Hyperledger Fabric supports transaction validation. This blockchain network is characterized by a modular architecture that breaks down transaction processing into phases. This separation is intended to optimize network scalability and performance.

Permissioned blockchain ledger and smart contract model

Distributed ledger technology includes blockchain technologies and smart contracts called chaincode. Moreover, we can build a traditional application using, for example, node.js technology and use blockchain as a layer for synchronizing, processing, and securing data. That can work well in the context of financial sectors, for example.

Secure transactions based on blockchain infrastructure

Using Hyperledger Fabric allows a high level of security. The blockchain framework raises several concerns related to competitiveness, protection laws, rules regarding confidentiality of personal data, the risk of data leaks, and the management of private data. All of them can be mitigated thanks to partitioning the data in the network that is also available in Fabric.

Use case of Hyperledger Fabric blockchain technology for business

I want to present the case of our recent Hyperledger project. On the high-level architecture above, you can see the structure of the decision-making business processes before the implemented changes. Making and confirming a decision or approving a document requires that all parties communicate with each other to agree to the changes at the same time.

Communication between the systems of partners or branches in one organization was processed without a central trusted data source that would guarantee that the transaction details confirmation of all members of this network would be fast and saved information in the database would be the same. This structure’s convoluted and time-consuming.

Central database solution pros and cons

As shown in the diagram above, we can add a back-end system with a database as a central solution. This solution could improve the process between participants in business networks like this one. However, we still have a problem with distrust and a lack of immutable data. The data transferred between participants can be changed without the consent of the settling parties, resulting in a potential asymmetric version of data in at least one of the system participants. The lack of trusted data affects future transactions and will not resolve our problems. The optimized, centralized database could be faster and easier to search in than decentralized solutions.

Distributed network pros and cons

Data immutability and trustless data exchange were essential; we decided to use DLT as a private blockchain infrastructure with intelligent contracts to resolve these problems. The blockchain will become a root of trust that makes communication between peers symmetrical and eliminates levels of trust fluctuations or its complete lack.

Solution

A private blockchain is the most relevant solution in this use case. We solved this problem with smart contracts and created a blockchain network – Hyperledger Fabric decentralized ledger technology is one data source in which all saved changes are visible to users. Each participant in the blockchain network can be transparent with others.

By implementing the private blockchain as distributed ledger framework, the client gained one common root of trust – a database with consistent data, which solved the problem of lack of trust. By optimizing current manual or semi-automation processes, decision-making time has been shortened, which also reduced the costs of the process and decision delays.

We are helping various businesses with powerful enterprise blockchain solutions based on Hyperledger Fabric. Contact us, and one of our experts will get in touch with you.

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Blockchain Software Technology

Multi-cloud deployment of blockchain infrastructure

Cloud (or Cloud Computing) was one of the largest buzzwords of the last decade. Still many people identify “the cloud” with Amazon Web Services. Despite that, there are several other cloud computing vendors that are worth looking at, especially if you’re building a blockchain solution supporting a large group.

These are primarily cloud service providers Google Cloud Platform, Microsoft Azure, Oracle Cloud, IBM Cloud, Rackspace and Hetzner Cloud. Below, I’ll discuss their advantages and show how we deployed our blockchain infrastructure.

Multi-cloud deployment of blockchain infrastructure

Table of contents:

  1. The domination of AWS
  2. Location, location, location
  3. More pros and cons of other cloud computing vendors
  4. Espeo’s solutions
  5. Let’s take a look at our entire blockchain infrastructure:
  6. Conclusion

The domination of AWS

Amazon’s domination among cloud providers in the minds of people is somewhat justified because Amazon was the precursor and main promoter of the concept of cloud computing. Amazon’s services are the most known, have the highest reliability, the best documentation. In short, they’re the role model for the competition.

But there are also a number of other vendors that provide private clouds and public clouds. Some examples are the Chinese Alibaba Cloud or the Polish e24cloud. These are more or less successful AWS clones and have even more or less similar APIs. Most often, technologically they don’t bring anything new, but they operate in regions poorly handled by competitors (e.g. Alibaba Cloud in China).

Location, location, location

Let’s begin with data center locations. As I’ll show later, this might be an issue for blockchain infrastructure. With the increase in the physical distance between the client and the data center, network delays increase. In transaction systems, this may determine the order of transaction processing from individual clients, and consequently, profitability or other economic parameters.

AWS covers most of the world but doesn’t have data centers in Africa, China, and Russia. The data centers in India, Brazil, and Australia don’t offer a full range of services. So if we want to start a service strongly dependent on the quality of connections (e.g. blockchain network or high-frequency trading), then it may be reasonable to take multicloud approach and use several different cloud vendors at the same time.

Multicloud strategy translates into various advantages, for instance one of the main pros of Microsoft Azure is having over 50 data centers in various regions of the world. These include the central states of the USA, Eastern Canada, Switzerland, Norway, China, India, Australia, South Korea, South Africa or the United Arab Emirates — in these regions AWS offers relatively large network delays.

More pros and cons of other cloud computing vendors

Google Cloud Platform

In addition to services based on open-source software (Linux, Docker, MySQL, Postgres, MongoDB, HBase, etc.), also provides its own services. These are, for example, BigTable and Realtime Database. They allow more efficient operation of large amounts of data than if you’re using only open source technology, as well as more efficient load balancing than AWS services. The price for this, however, is vendor lock-in, i.e. the impossibility of departing from this particular vendor.

Microsoft Azure

In addition to a number of locations, is also the best place to run all kinds of solutions based on Windows. This can be important if in our blockchain stack we use ready-made .NET libraries that don’t have their own implementations for Linux.

Hetzner Cloud

It’s a relatively new service of Hetzner Online, so far specializing in web hosting and low-cost dedicated servers. The Cloud offer brought a significant improvement in quality in relation to the current offer while maintaining very low prices. It still can’t compete with AWS in terms of stability, but it seems to be a matter of time. Its unique advantage is a data center in Finland.

Espeo’s solutions

Let’s take a look at the solutions we’ve used in Espeo for multi-cloud infrastructure management as well as the blockchain platform itself for blockchain infrastructure.

First approach — manual management

Our blockchain journey with working on distributed ledger technologies on cloud was, of course, manual management. By this, I mean logging into different cloud consoles from several different browsers. This approach worked quite well until we were in control of about 5-6 AWS accounts and one account for each other cloud vendors. With so few accounts, it was still possible to manage them so efficiently “on foot.” It seemed that the investments in the implementation of appropriate tools would take way too long to start paying off, especially that we didn’t know what technologies to stick to and which ones to avoid.

Second approach — tools. Open source?

The second approach was to analyze the available tools, but we wanted them to be open source tools. We were interested, among others, in the Terraform tool (from the creators of Vagrant). Very quickly, however, we got the impression that almost all existing open-source tools didn’t line up with how we work. So, either to manage your own infrastructure (for one company or one group of companies) or in the best case for managing large projects in the Infrastructure as Code model. The latter means describing the infrastructure elements in the form of a language specially created for this purpose.

Infrastructure as Code is, of course, a very sensible approach, but it has a disadvantage. It doesn’t work well for very small projects, which are often at the MVP stage and operate on a single server. In such cases, the Infrastructure as Code approach is to shoot a fly with a cannon. You’ll achieve it, but clients will want to know why they’re paying so much for it.

Third approach — Polynimbus

Ultimately, we decided to use the Polynimbus tool. It supports multicloud environments – eight different cloud vendors and have a competitive advantage of being a relatively simple (compared to Terraform) cloud resources pool, which perfectly suited our needs. Polynimbus supports an unlimited number of AWS accounts and requires minimum configuration for each of them. It basically covers only issuing the access key, secret access key, and the default region. All the rest, including e.g. fast changing AMI ID numbers of system images, are detected automatically.

Let’s take a look at our entire blockchain infrastructure:

As you can see, Polynimbus is one of the elements of a perfectly integrated stack. It covers the management of the full lifecycle of the instance, regardless of whether they are instances of AWS (EC2), Azure, Oracle or others. Creating an instance looks like this:

  • Polynimbus – proper creation of a new instance.
  • ZoneManager – adding a DNS record to Amazon Route53, binding the destination hostname to the IP address returned by Polynimbus.
  • Server Farmer – provisioning of the instance; at this stage various aspects of server security are configured. Central logging of events, backups, automatic updates, and then the instance is plugged into the farm (ie the central management system).
  • Ansible – application provisioning, starting with Docker and support tools. Then the Go stack is built (non-standard due to Hyperledger requirements), after which Hyperledger Fabric and Consul services are installed and configured. The latter in client or server mode. In general, there is no real need to run more than two Consul instances per single availability zone.
  • Next, the integration with a separate Apache Kafka cluster is configured, as well as with CircleCI.com responsible for the CI / CD processes, ie deployment of new versions of the application. So, the next step would be to start the Fabric node by CircleCI.com.

Conclusion

What’s important for both us and our clients, Polynimbus gives us full independence from any cloud vendor. Therefore, if we get a dedicated, more advantageous price offer, e.g. from Oracle, we don’t have to stay with AWS to provide blockchain services to our clients just because of some technical reasons.

One must remember real limitations. Not all power of each subsequent instance can be allocated to the proper application because one must remember about Consul cluster — so that Hyperledger connects to Consul in its own availability zone. And therefore, each of them must contain one or two Consul instances.

Thanks to this, we avoid a situation where global network failure causes problems with the correct operation of the application. In a correctly configured multi-cloud environment, multi-region, multi-AZ… In the case of global network failure, selected nodes simply cease to support current traffic. However, this failure doesn’t result in any other consequences. Thanks to an efficient management stack, in this case, if we anticipate longer problems, we’re able to add new blockchain nodes in other cloud vendors and regions.

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Blockchain Finance Financial Services

Stablecoins, rather than cryptocurrencies, might be the future of money

Euro stablecoin currency business and digital money symbol digital concept. Network, cyber technology and computer background abstract 3d illustration.

Over the last five years, blockchain has demonstrated the potential to disrupt almost every sector. The global fintech industry aims to build a revolutionary decentralized transparent payment system that uses digital currencies as a means of exchange.

The financial sector will benefit most from this emerging tech, but the prices of the first generation of digital assets, like Bitcoin and Ethereum, are highly volatile, speculative assets. For cryptocurrencies to replace fiat currencies as the future of money, they must have stable prices. This is what led to the creation of stablecoins. In this article, we will discuss what stablecoins are, the various types of stablecoins, and their importance. We shall also look at the recent interest of governments in issuing their digital currencies backed by their native currencies.

Stablecoins, rather than cryptocurrencies, might be the future of money

Table of contents:

  1. Finding the right application for blockchain
  2. Types of stablecoins
  3. Why are stablecoins important?
  4. The case for central bank digital currencies (CBDCs)
  5. Conclusion

Finding the right application for blockchain

As the name suggests, stablecoins differ from mainstream but highly volatile cryptocurrencies, like Bitcoin, Ripple, and Ethereum, in their focus on price stability. In achieving stability from the beginning, stablecoins aim to prevent a scenario like that experienced by Laszlo Hanyecz in 2010.

Hanyecz is an American software programmer who bought two pizzas using 10,000 bitcoins (at a time when one bitcoin was a fraction of a cent). Currently, this transaction would be worth $100 million. Hanyecz wanted to prove a point — this was the first time someone accepted bitcoin as a medium of exchange, but the now-famous story has also become a symbol of the drawbacks of using volatile currency for regular purchases.

Stablecoins allow buyers and sellers to lock in prices. They have their prices pegged to real-world assets, like the U.S. dollars, precious metals, commodities, or property to name a few. Because of their stability, stablecoins are the ideal tools that can link blockchain networks with traditional economies. They help users streamline payments through automation while maintaining liquidity, security, and transparency.

The issue of connecting the blockchain ecosystem with the traditional banking system has persisted for a long time now, but, with the introduction of stablecoins, businesses and the masses will soon be relying on these digital assets to make cross-border payments. Stablecoins bring the benefits of cryptocurrencies with an added advantage of price stability, which is attractive for users looking for cost-effective, instant, and safer means of transactions in day-to-day spending.

Types of stablecoins

Fiat-collateralized

These stablecoins are backed by a fiat currency, like the US dollars. The issuing firm holds real-world assets in a financial institution or partners with a third-party financial provider to keep money on their behalf. The tokens act as a claim of the underlying assets. The same applies to a scenario where commodities, such as precious metals, and bonds back the coins.

Fiat-collateralized stablecoins were the first stablecoins and the easiest to understand for crypto newbies since they are the most common onboarding tools into the crypto space. They are simple, elegant, and more easily trusted by retail users compared to other digital currencies. However, the coins are mostly issued by centralized companies with their governance mechanisms, and in the case of full custody integration, they are vulnerable to fraud.

Besides, not all fiat currencies are stable, as their underlying fiat may not be stable themselves. For instance, the US dollar is backed by gold reserves whose value keeps on appreciating and depreciating. A consumer must have faith in the US dollar to use a USD backed stablecoin, like Tether, TrueUSD, USDCoin, and Gemini Dollar.

Crypto-collateralized

This type of stablecoins is backed by a class of other decentralized crypto-assets. The advantage of this collateralization method is that it is decentralized; hence, it is not susceptible to a central point of failure. The disadvantage is that despite their blend of assets thought to minimize volatility, in the current crypto markets influenced by whales, any combination of digital assets will be considered unstable.

The typical use case is MakerDAI. It managed to maintain its peg in 2018 despite an 80% decline in Ether’s value as the only collateral.

Non-collateralized

These stablecoins achieve stability through algorithms, implying that they are actually not pegged to any tangible asset. Instead, users trust the system, expecting that the coins will appreciate, just like Bitcoin. Non-collateralized stablecoins are designed with two protocols: a stablecoin and a bond, promising profits if the currency increases in value. By buying the bond with the stablecoin, its supply is reduced.

Non-collateralized coins are the most innovative stablecoins and also the most complex to thrive. A good example is the Basis Project. However, hybrids have been developed to leverage fiat and crypto-collateralized models, like the Reserve and Carbon coins.

Why are stablecoins important?

Stablecoins have undeniably steered in a new dawn, especially for early adopters of blockchain and crypto traders. As their stability continues to attract institutional investors and governments, more entrants are expected to join forces. This is how the stablecoin market looked from 2014 to 2019.

Their application has been embraced for various reasons, such as:

They encourage crypto adoption

The first digital currencies, like Bitcoin and Ethereum, were hard to comprehend and difficult to appreciate and adopt. Technical terminologies and explanations made many people think that they were for geeks only.

It was challenging to prove their application of buying goods and services in the real-world. However, stablecoins- particularly the fiat-collateralized model- are quite different. When you tell people that stablecoins are a type of digital currencies, it is easy to visualize them. Besides, since they are pegged to the value of real-world assets, such as the US Dollar, it is easy to trust and embrace them.

They calm volatility

As the term suggests, stablecoins are designed to have price stability. The main reason for their creation is to minimize price swings prevalent in mainstream cryptocurrencies. All the three types of stablecoins have shown a lot of potential. But, the fiat-collateralized stablecoins are the biggest winners so far. For example, a coin like Tether has already achieved much success in this regard.

Crypto-collateralized stablecoins have not yet been widely embraced because of the underlying issues with cryptocurrencies generally being highly volatile. It is, therefore, challenging to convince people that a coin will be stable, yet it’s pegged to unstable assets.

Value is straightforward

Stablecoins, particularly the fiat-collateralized ones, are easily valued. It is as easy as getting an account balance and using the dollar sign to comprehend or communicate the price. For instance, if you have 5,000 Gemini Dollars in your wallet, you basically have $5,000 in possession. The easy it is to value a digital asset, the easier it is to embrace them in day-to-day spending and cross-border payments. For instance, if you want to buy an iPhone valued at $1,500, you only need 1,500 USDT. This implies that to facilitate payment at the point of sale, only a stablecoin payment option is required for the retail outlets. Once developers consider such aspects, everything else will follow suit.

They are cost-effective and immediate

Being a blockchain-based form of money transfer, stablecoins bear many benefits of electronic money transfer, such as instant and cost-effective money transactions. Consider a situation where it costs you $4 to do a cross-border transaction. These charges cover labor costs, power bills, and audits for human error. Blockchain eliminates central entities automate manual tasks so you will only be charged about $1. Unlike bank transfers that take several hours to days to be completed, your transaction will be processed instantly. That is how JP Morgan is facilitating cross-border payments using their JPM Stablecoin .

The case for central bank digital currencies (CBDCs)

CBDCs have been a primary subject for blockchain enthusiasts, futurists, governments, and lawmakers for some time now. They have evolved from a topic of interest to a high-potential tool for governments to address better the severe economic effects of the Corona Virus and beyond. Lawmakers, including politicians and central banks, are uncertain where, how, and which tools to leverage to save their economies as they deal with the pandemic and prepare for the imminent. This has led to a heightened interest in crypto innovation for the coming decade.

Currently, the global economy requires a payment system with which you can make payments instantly, cost-effectively, and without intermediaries, like Visa and MasterCard. China is already piloting its “digital yuan,” with the US, Great Britain, France, South Korea, and other nations making tremendous efforts in developing their digital currencies backed by their native currencies.

Already 20% of the 66 banks have shown interest in issuing their digital currencies in the next ten years. With all these efforts happening quickly under closed doors, it appears inevitable that state-issued stablecoins will be prevalent in the next few years and eventually replace their fiat counterparts.

Conclusion

In general, stablecoins are revolutionary tools with huge potential to revolutionize the future of finance fundamentally. With blockchain as the underlying technology, they can scale rapidly globally and disrupt the traditional payment systems. Stablecoins are already thought-provoking people’s understanding of money, generating a paradox environment where they will thrive as the main currency.

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Proof of work versus proof of stake: Comparing major consensus mechanisms

Quantum computer. Machine Learning. Network structure of technology. Blockchain technology concept. Digital background. Neural network.

Consensus plays a crucial role in our day to day activities. Without it, we cannot make decisions on important issues affecting our countries, businesses, and families. Consider a scenario where there is a pressing issue to solve, and the whole nation lacks a mutual understanding. In such a scenario, lawmakers have to reason and come up with a mutual agreement to address the issue. There is no other democratic way around it.

The same principle applies to blockchain networks that use consensus mechanisms to enable participants to agree on various activities of a network, like transactions, forking, and voting. Without a consensus algorithm, a blockchain system cannot be an immutable database. Lack of consensus in a blockchain network would make the entire ecosystem of no use since miners or validators would be unable to process and verify transactions. I’ll compare and contrast the two major types of consensus mechanisms: proof-of-work and proof-of-stake. Before that, let’s define what a blockchain consensus algorithm is and the importance of a consensus mechanism.

Proof of work versus proof of stake: Comparing major consensus mechanisms

Table of contents:

What is a blockchain consensus algorithm?

A consensus algorithm enables members of a blockchain ecosystem to agree and commit new data to the blockchain. Consensus algorithms are essential for blockchain ecosystems since they lack central authorities. Because of the decentralized nature, nodes (also known as miners or validators) are responsible for maintaining blockchain systems through consensus algorithms. This ensures that participants conform to the set rules and regulations, achieving trustless transactions. In cryptocurrency transactions, this ensures that users can only spend their coins once.

The importance of consensus mechanisms

In this part, we will discuss the primary roles of consensus mechanisms to help us gain a better understanding of how blockchain algorithms work.
Facilitating a unified agreement : Centralized networks rely on third parties to run. But, consensus algorithms enable blockchain systems to operate without the need for members to trust each other. In other words, consensus algorithms achieve a unified agreement between network participants, ensuring that every transaction is valid and the database is up to date.
Aligning economic incentives : Since decentralized networks regulate themselves, it is vital to align the interests of the members/stakeholders to achieve optimal functionality. Consensus mechanisms employ economic incentives to reward users for proper conduct.
Ensuring fairness and equity : Consensus algorithms also ensure that justice and equity prevail among network users. Anyone can join an ecosystem — a public blockchain in this case — and all members should exercise equal voting rights.
Preventing doubles spending : Double spending is one of the major risks threatening digital payments as it affects the value of digital assets adversely, rendering them worthless in the long run. Consensus algorithms prevent double spending by guaranteeing that only verified and valid transactions make it into the public blockchain records.
Ensuring a fault-tolerant network : By warranting that a system is fault-tolerant, consistent, and dependable, a consensus algorithm enables a blockchain to continue functioning even in the face of severe threats and failures.

What is proof of work?

While the PoW mechanism existed way in the ’90s, Satoshi Nakamoto popularized the concept with the invention of Bitcoin in 2009. The Bitcoin network was the first significant use case of the PoW consensus mechanism. PoW is blockchain’s original consensus mechanism.
Early on in blockchain’s development, PoW was the most reliable method for blockchain consensus. It spearheaded the implementation of the decentralized vision and eliminated third-parties at the same time to guarantee valid network transactions. Nevertheless, as the technology continued to gain momentum, the drawbacks of this mechanism were increasingly apparent. Sometimes, it’s impossible to solve them.

How does proof of work function?

In PoW, miners must solve cryptographic puzzles to verify transactions. We can compare it to a race where runners are contending for an award. The race of this blockchain competition is referred to as a hash. For every confirmed transaction, miners are compensated with the network’s native cryptocurrency and a transaction fee.
It is important to note that blockchain puzzles are quite complex, and high computational power is needed to solve them. Below is a summary of the execution of the PoW consensus mechanism.
A new transaction is sent to a network.
Mining rigs begin to look for a hash value that aligns with that of the transaction.
The first to discover the hash gets a reward in cryptocurrency.
A new block is created, which comprises the recently completed transaction.
A section of each new hash bears the hash value of the last completed transaction in the block. This deters miners from confirming fraudulent transactions and the issue of double-spending. The complexity of a PoW puzzle is based on the number of nodes in a network. It is directly proportional to the computational power needed to solve it. This creates some severe consequences for a blockchain network using the PoW consensus mechanism. We will discuss these issues later with the proof-of-stake mechanism.

What is proof of stake?

As a result of the issues arising from the PoW mechanism, the blockchain developers started searching for a more economical method of reaching a consensus. Scott Nadal and Sunny King proposed the concept of proof of stake in 2012.
Currently, the Ethereum community is moving toward a PoS consensus mechanism through the Casper update. It aims to solve the problems of the PoW mechanism and those of PoS itself. For a comprehensive analysis concerning the Ethereum network developments, you can refer to this guide for more insights.
In proof of stake, computation power is replaced by currency power — the number of coins a node holds in its wallet. In a layman language, the ability to confirm a transaction depends on your network “stake.” Besides, miners are replaced by validators or forgers in PoS. Instead of mining coins in each transaction, all coins are minted by the developers during the network’s launch.

How does proof of stake work?

Instead of competing to be the first validator, the proof of stake mechanism picks a validator based on their stake in the blockchain. Assume you own tokens worth 25% of the block in your wallet, you will have the power to confirm 25% of the block only. When the Casper version launches, we will experience the reality of validator pools.
So far, we have learned what PoW and PoS are and how they function. Now, let us compare and contrast them.

Comparing PoW and PoS

There are concerns regarding the general security of the PoS protocol as it does not use real-world resources for validation. There is no cost required to create a new block on top of both branches in case of a temporary fork. This is a nothing at stake attack. On the other hand, PoW consumes electricity to mine blocks. Developers are still uncertain whether PoS protocols can offer the same security assurances over an extended period that Bitcoin, with its PoW mechanism, has provided for almost eleven years now.

Proof of work Proof of stake
  • Distributed consensus among untrusted and unknown nodes
  • Distributed consensus among untrusted and unknown nodes
  • Incentives are rewarded within the system for work done outside the system
  • Incentives are rewarded within the system for escrow inside the system
  • Relatively high cost of input with high returns
  • Low cost of input with low returns
  • Slow transaction rates
  • Fast transaction rates
  • Low efficiency that requires more power
  • High efficiency that requires less power

Another contrast between a proof of work and proof of stake protocol is that all validating nodes must be identifiable in a PoS protocol. The staked tokens are responsible for any network misconduct. On the other hand, a PoW mechanism does not require miners or nodes to be identifiable. As a matter of fact, it is a PoW aspect, that if a node receives a block, there are no further details regarding the miner of the block. What is essential is that the block and all its transactions are legit. You must trust the math to trust PoW.

Conclusion

Although proof of work protocols secure blockchain networks, it also negatively affects scalability and transaction output. Centralized establishments majorly run the PoW consensus mechanism, and its energy consumption is not sustainable.
While the proof of stake protocol offers less security, the validators use their own digital assets to the stake, forcing participants to have skin in the game. The mechanism also has recommendable scalability and transaction throughput.
The future of PoS relies on the up-and-coming shift of the Ethereum network. If the second biggest blockchain network can successfully transition to proof of stake and still exhibit the security of their ecosystem with the assistance of the novel Casper mechanism, it will convince the entire blockchain community about its power comparatively new Proof of Stake consensus mechanism.

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