Proof-of-What? Why the Casper Update has Serious Consequences for Ethereum Mining.

A spectre is haunting Ethereum Miners – the spectre of Casper, an update to the Ethereum blockchain. By changing the consensus algorithm from Proof-of-Work to Proof-of-Stake, it is going to make mining obsolete. But let’s start at the beginning.

Introduction

Mining Ethereum is a hard job, and it has to be. If anyone could just create Ether out of thin air, for free, its value would rightfully drop to zero. For Ether to keep its value, the supply needs to be limited. To see what happens when there is no such limit, just look at the country of Zimbabwe, which had to issue a 100 trillion Dollar banknote after its government had started to excessively print money in order to pay its bills.

 Solid as a rock – the Zimbabwean Dollar.

Solid as a rock – the Zimbabwean Dollar.

Ethereum utilizes the so-called Proof-of-Work or PoW method to find consensus among all its users and to ensure its supply does stay limited. The idea behind PoW is simple – any user of a service or good needs to do some work before he can participate. Mining gold is good example; the fact that a lot of hard work is required to obtain even just an ounce of gold makes it valuable.

Cryptocurrencies like Ethereum also rely on this system, but instead of swinging a pickaxe and pushing a lorry, you need to do complex math by solving so called hash puzzles. This process is also called mining. But mining does not only create new Ether, it also fundamentally enables the Ethereum ecosystem to function correctly.

As you might know, the blockchain acts like a ledger to all transactions. The state of the leger determines the state of the network. If the ledger says a wallet has funds in it, it does. If the ledger says Alice sent Bob some Ether, she effectively did. If someone had control over the ledger, he could therefore also conduct malicious transactions, for example sending all funds to himself.  

To ensure this doesn’t happen, transactions in the Ethereum network need to be attached to the found solution (also called proof) for each newly solved mathematical puzzle in order to be processed. This combination of transactions and the proof is called block. Each newly solved block is also mathematically dependent on the previous one, thus creating the famous blockchain. If all mining activity suddenly ceased, you would be unable to send or receive funds – there would be no proof to attach the transactions to and the sent transactions would never get verified.

In the current system, the vote for the right to verify transactions is ultimately won by the party with the most processing power. As the majority of miners has interest in the system working correctly, they can therefore in the long term cut off anyone trying to conduct malicious transactions.

As mentioned before, mining is expensive. Besides for computing power, you also need to pay for physical storage and the electricity to power the computers. Currently, the Ethereum blockchain requires an estimated 17.6TWh of electrical energy annually. Which maybe doesn’t sound like much, until you realize that’s half of New Zealand’s annual electricity consumption. You don’t need a degree in either math or environmental sciences to know that this poses a problem.

Proof of Stake and the Casper Update

The calls for Ethereum to switch from Proof-of-Work to a less wasteful alternative of finding consensus have steadily increased over the last years and resulted in the so called “Casper” update. Casper is ultimately going to make Ethereum mining obsolete by switching Ethereum’s consensus algorithm from Proof-of-Work to a method called Proof-of-Stake, or PoS. This change will gradually be phased in, with the first update coming some time in 2018, making one percent of all transactions rely on Proof-of-Stake.

Proof-of-Stake suggests that the person with the highest stake in an investment also has the highest interest in the investment retaining its value. In the new system, transactions still need to be processed. But instead of attaching transactions to solved hash puzzles, there will be a new entity called a “validator”.

A validator takes the role of the miner in processing the transactions. Unlike in the PoW-based system where everyone with a computer could participate in the mining process, in order to participate in the new system, to-be-validators need to post a large stake of Ether in order to process transactions. They then essentially have to place bets on the correct block to validate.

If they bet on a block that has been tampered with, the new system results in the malicious actor losing his stake. This change makes 51% attacks far more expensive. Currently, a malicious attacker with over 50% of all the processing power within the network could attempt taking over the Ethereum blockchain without risking any tangible assets – in case the attack fails, he can just go back to using his processing power to verify correct transactions.

The exact details are still unknown, but supposedly a small number of validators (below 1000) is going to post stakes and then jointly vote on the next block. The size of the stakes will be very large, with Ethereum’s founder Vitalik Buterin hinting towards a minimum amount upwards of 1000ETH. As the stakes are high (cue a gong sound in an 1800s style western setting), attacks under PoS would be very expensive.

Effects on the Industry

As it must make economic sense for validators to post their money, the annual return on the staked capital is very likely between three and ten percent in order to be a viable alternative to traditional FIAT investments. This return would come from transactions fees, which would still be much cheaper than they currently are under Proof-of-Work. But with the proposed stakes of upwards 1000ETH sharply contrasting with the lesser contents of an average wallet, this change might lead to more centralization.

Many miners currently bundle their processing power in so-called pools, which enable even people with just one graphics card in their home computer to mine efficiently and obtain regular payouts.

The switch to PoS would massively complicate pooling, as right now the investment in form of mining hardware usually is physically still in control of each individual miner. While a pool owner might be able to steal the payout once, the monetary risk for the individual miner is relatively low. Possible Stake-Pools for Ethereum require massively more trust. Here, in case of a malicious pool owner, all staked funds would be lost.

But when only actors with currently upwards of 1000 Ether in stakes or massive amounts of public trust can take part in the validation process, the average user might be left out and Ethereum could end up being controlled by banks and similarly well-funded or trusted institutions. Karl Marx would probably turn in his grave if he had to witness the goods of production being taken away from the workers and put in the hands of the wealthy. On the other hand, Karl also never had to worry about global warming and excessive energy consumption.

Conclusion

Casper is approaching quickly and both miners and investors need to pay attention closely. The update is highly debated and it should be. While the massive savings in energy and supposed improvements in speed and safety are certainly positive, the possible centralization and shift from participating in a democratic network to being subjected to the vote of a few wealthy stakeholders is certainly worrying.