One of the important things to know about a cryptocurrency is whether it operates using the proof of work protocol or the proof of stake protocol. The two protocols work in very different ways and have very different energy requirements (which affect the cost.)
Ethereum now uses Proof of Stake for securing the network. Prior to September 15 2022, it was Proof of Work.
More about Ethereum
Ethereum (ETH) is currently the world’s second largest cryptocurrency, second only to Bitcoin. There are currently approximately 120 million ETH in circulation. Unlike some other cryptocurrencies there is no upper limit of how many ETH can be created. Its current price (July 2022) is around $1100.
As well as being a cryptocurrency, Ethereum is also much more. While cryptocurrencies are usually used to simply carry out financial transactions, or for saving and investment purposes, Ethereum has the capacity to carry out much more complex transactions. It can also store data and run applications over its decentralized network. This gives users an alternative to the centrally controlled servers of big corporations such as Google. Another exciting capability of Ethereum is its ‘Smart’ contracts, in which parties use the blockchain to agree a contract for goods and services. Once the conditions of the contract are met, it self-executes and makes the payment. No lawyers required!
Proof of Work — background
As discussed earlier, Ethereum currently relies on the proof of work protocol. So let’s have a look at what that means.
Proof of work is not an invention of the cryptocurrency industry. It was developed as a way of preventing undesirable things such as spam email or denial of service attacks. It requires work from a service user, and gets them to prove that a certain amount of computational power has been expended, making it unlikely that an attacker would spend the time and resources required to do so. An example of this is that when you send a single email, you wouldn’t even need to be aware of the proof of work protocol at work. It would take seconds at the most and use a small amount of energy. However, if an attacker tried to maliciously send millions of spam emails, the proof of work protocol would take time and use a large amount of energy.
Ethereum and Proof of Work
In terms of Ethereum’s blockchain, the participants compete to be the first to solve a complex math problem. This is known as ‘solving the hash’ and this proof of work allows the participants, who are anonymous entities across the network, to trust each other. The miners, as we call the participants because when they are successful in solving the hash, they win the right to record and verify a block of transactions, are rewarded in ETH.
The process goes as follows: owners of ETH make transactions. These transactions are grouped and the data is put into a ‘block’. Miners compete (via the proof of work protocol) to solve the hash and win the right to verify and record the block. The block is added to the blockchain and the process begins again.
The advantage of the proof of work protocol is that it enables secure peer-to-peer transactions over a decentralized network. This removes the need for a central authority such as a conventional bank. By incentivizing miners to verify and record transactions, it prevents double spending of digital currency. However, the proof of stake protocol also has the same advantages, but without the main disadvantage of proof of work which is its huge energy use. There is a lot of criticism of the proof of work protocol for this important reason.
Proof of Stake
In this protocol, the participants have to own some of the currency and ‘stake’ a certain amount of it (currently set at 32 ETH). In return the protocol randomly chooses users to verify transactions, and they are rewarded with new ETH. The process of being rewarded with new ETH is known as minting rather than mining. This protocol is much more efficient and greener than proof of work. It doesn’t demand work from a huge amount of participants and consequently uses 99% less electricity.
Ethereum are moving over to the proof of stake protocol as part of the long awaited upgrade, Ethereum 2.0. This is an ongoing process. Whether the proof of stake protocol will take back control of the industry from the big tech firms is yet to be seen. While these firms have a major advantage under proof of work due to superior resources, the required 32 ETH stake at current values would cost almost $35K. Some would say that for the individual the competition is as tough as ever.