[Draft] Pure Proof of Stake Systems and Faulty Economics


#1

Masternodes function in a pyramid scheme system, whereby participants must hold a certain number or percentage of the supply of a coin in order to participate in staking. This system promises a consistent change of a return and is generally sold on the idea that individuals can make money even while sleeping. The barrier to entry is low as well, as masternodes can be hosted on computers with low or limited technical specifications, and an even lower electricity cost. However, for individuals to participant, there are generally quantity requirements which serve as the barrier to entry. For example, Dash requires an individual to hold 1000 Dash in-order to participate in staking. This model however is flawed in that it requires individuals after the initial buyer to purchase a part of the supply in order to stake further. IE, those in line first will see the greatest returns and will inevitably sell their bags into the hands of later participants who falsely assume the trend will continue. Early participants will receive larger block rewards which diminish as an increase in other stakers begin to compete. As the value of the coin recedes, more and more selling off will occur, leaving the chain inactive and with few participants. For a pump-and-dump scheme, this is acceptable, but for a global currency it is not.

One of the economic driving factors of the required staking amounts, malevolent or not, helps create illiquidity in the coins market. By keeping and incentivizing the locking up of large percentages of the supply locked up, whales can push price up and down in a much easier fashion. This is a mechanic few think about or discuss as it may not be self-apparent. Those who criticize pure PoS systems for being affected by “Rich get Richer” mechanisms are right in this case. Those who hold the most, will consistently make the most with no economically driven competition like PoW due to low overhead cost, and their profit will increase as larger returns will allow for more masternodes and continued profit. This also means that the distribution of supply will be centered in the hands of a select few participants. Proof-of-work miners generally are required to sell a large portion of their mining rewards in order to pay for the cost of mining for the given period. For those with a good memory, Dash had nearly 15% of its total possible supply mined in the first few hours, during a particularly shady launch. Those who wish to know more can watch this video and draw their own conclusions: https://youtu.be/xBxbiH_Mg44. Unfair premines or instamines cause massive imbalances in not only the economics, but threaten the value of the coin as the early mover could dump a majority of the supply even at a massive loss. This is in part encouraged by exchanges and services which require an initial payment for the use of their services which comes from the premine of the currency. True decentralized and fairly launched coins will have difficulty meeting these requirements for acceptance as they don’t hold a large percentage of the coin. Coins given a fair launch will allow a distribution equal to the engaged participants.

Distribution of a coin is a necessity for a coin or currency to work as a medium of exchange. A large number of buys and sellers creates a liquid marketplace which furthers facilitates the currency’s use. If a currency was printed and held only by one individual, it would be rare if not impossible to use as no other participants can exchange for it. Healthy currencies require a healthy distribution of participants and of the supply to create a functioning ecosystem.

A new participant also cannot enter the PoS competition without directly affecting the price and supply of the given coin. This again contributes to the pyramid scheme where a greater fool is required to follow the previous participants. With PoW systems, a participant can purchase a mining rig without ever directly purchasing Bitcoin. This allows the flexibility to be able to mine any coin they wish without ever making a direct purchase. Again, these for-profit PoS systems must require an individual to purchase a percentage of the supply, valuing it for other participants.

PoW on the technical side serves as the security backbone for chains, utilizing the scarce resource of power as the economic driver, with increases in efficiency as economic the driving factor for increases in efficiency. In PoS, having better hardware, or a better connection does not increase the chances of receiving a block reward. On the economic side, PoW serves as the source of distribution for the coin. This in part gives true valuation to PoW coins, but also provides economics for valuation. The cost of mining is the communication of the value of the perceived value of the coin, although some delay may be experienced. Miners rarely if ever mine for a loss which helps protect not only their mining investment, but the security of the chain. As profitability of mining decreases, fewer and fewer miners participate, dropping the security of the chain leaving it open to being compromised by events such as 51% attacks. During this current bear season (2018), a growing number of coins have become susceptible to these attacks, indicating the insecurity of the chain.

However, PoW is both a costly investment, as well as not energy effective when applied to a global scale. The increased size of the network means more and more wasteful mining. Satoshi discussed this mechanic on August 7th, 2008 (“Re: Bitcoin minting is thermodynamically perverse”).

“It’s the same situation as gold and gold mining. The marginal cost of gold mining tends to stay near the price of gold. Gold mining is a waste, but that waste is far less than the utility of having gold available as a medium of exchange. I think the case will be the same for Bitcoin. The utility of the exchanges made possible by Bitcoin will far exceed the cost of electricity used. Therefore, not having Bitcoin would be the net waste.”

As global adoption increases, miners must choose which chain to support with their mining. Pareto distribution allows the prediction that roughly 80% of the mining power will be dedicated to a mere 20% of the coin, leaving 80% of coins with insufficient protection. Coins with less than the majority of the hashing power are open to being attacked by any of the large coins. Imagine if a large percentage of Bitcoin miners suddenly turned to attack a smaller PoW project. Honest miners on the sidechain would be unable to overcome the overwhelming volume of attacking hash. As mining difficulty increase, the barrier for an investor to participate in mining increase, forcing them to trust in the miners who guard their chain and investment.

Security and economics must be married in order to create a viable currency (liquid medium of exchange and store of value). For a coin to survive on a global scale, it must remain secure even during periods where interest lacks, as well as having effective and fair distribution methods for the supply. Without effective means of distribution, any coin will become illiquid and concentrated in the hands of a few early moving individuals. With climate concerns, we have already seen a number of groups pushing to limit or discourage mining practices as they see it as wasteful. Pure PoS mechanics seem more environmentally friendly, but that is of little concern when it fails economically.

Masternode/pure PoS economics will fail on a global scale as economics will cripple their use on a global scale. PoW side chains competing with large coins such as Bitcoin will have difficulty maintaining their security. The dichotomy of a PoS/PoW coin seems to be the best system for making a coin that can scale on a global level, but also that is economically viable and secure. Peercoin was the first Bitcoin alternative that was propose to fill this role. Economic competition with PoW allows an effective distribution determined by participants. Using PoS allows for the average participant to stake (with no required minimum amount) and provide not only security to the chain, but a small return which protects against supply inflation. Coins looking to work on the global scale beyond the scams that have arisen from greed must face the reality of economics when coming to terms with a fully functioning economy and a large number of participants.

References:
Re: Bitcoin minting is thermodynamically perverse. (n.d.). Retrieved from https://satoshi.nakamotoinstitute.org/posts/bitcointalk/327/

Late night draft. Thoughts/feedback appreciated as always.

-Buckkets


#2

I am not sure that the first paragraph is describing a pyramid scheme - I think it is more like a bubble. So, perhaps the intro could say something like, “Masternodes function in an environment that may be likened to a stockmarket bubble”.

first para
This is very long - split at “However, for individuals to participant”

“participants must hold” - no need for “must”
“consistent change of a return” - reduce to “consistent return”.

“Dash requires an individual to hold” - I think this is better plural - “Dash requires individuals to hold”

Take the hyphen out of “in-order”

“This model however is flawed” - no need for “however”

“stakers begin to compete” - reduce to “stakers compete”

Will look at the remaining paragraphs later.


#3

It seems more malicious that a bubble since this mechanics that cannot otherwise function in any other way. I mean sure, stock market needs the same buyer/seller mechanics, but this fundamentally requires illiquidity and others to follow in the same purchases.


#4

This is an important article. It is widely understood why POW-only coins are a problem (energy, centralisation, etc.) but not so much why POS-only coins are problematic.

Para 2

The first sentence (One of the economic driving factors of the required staking amounts, malevolent or not, helps create illiquidity in the coins market) - suggest adjusting it to:

“The economic requirement of staking large amounts, whether for malevolent reasons for not, causes illiquidity in the coins market”.

The second sentence (By keeping and incentivizing the locking up of large percentages of the supply locked up, whales can push price up and down in a much easier fashion), suggest:

“By incentivizing the locking up of large percentages of the supply, and keeping it locked up, whales can push price up and down in a much easier fashion”.

(but I think you can safely remove “and keeping it locked up”, as it’s not necessary, and implied)

Regarding the third sentence (This is a mechanic few think about or discuss as it may not be self-apparent), suggest removing the words “as it may not be self-apparent”.

Regarding the fourth sentence (Those who criticize pure PoS systems for being affected by “Rich get Richer” mechanisms are right in this case), this can be reduced to:

“Those who criticize pure PoS systems for making the “Rich get Richer” are right in this case”.

Fifth sentence (Those who hold the most, will consistently make the most with no economically driven competition like PoW due to low overhead cost, and their profit will increase as larger returns will allow for more masternodes and continued profit):

I don’t think the sentence benefits from “like POW” - I would suggest taking that out, and introducing this point later in the paragraph, when you explain the solution/alternative.

You can also reduce “their profit will increase as larger returns” to simply “their larger returns” - and change the end of the sentence from “continued profit” to “therefore continued profit.”

Important: Regarding the part commencing “Proof-of-work miners generally are required to sell a large portion of their mining rewards” leading into the part on Dash, I am not following where this is heading, and how it feeds back into the critique of POS-only coins.
What you need is a short bit to act a sign post. For example: “POW solves the problem of POS-only coins by injecting economic cost, but the problem is that some POW-only coins premine to pay for this cost. For example, Dash, etc.”

No comments on the rest of para 2, but I don’t think you need “even at a massive loss”.

Para 3

Suggest changing the first sentence (Distribution of a coin is a necessity for a coin or currency to work as a medium of exchange) to

“Distribution of a coin is a necessity for it to work as a medium of exchange or currency”.

Para 4

“A new participant” - suggest making this plural - “New participants”
“PoS competition” - this threw me, suggest “POS staking process”
greater fool - put speech marks around this

Regarding the sentence “With PoW systems, a participant can purchase a mining rig without ever directly purchasing Bitcoin. This allows the flexibility to be able to mine any coin they wish without ever making a direct purchase”.

This can be reduced to: “With PoW systems, a participant can purchase a mining rig which allows them to mine any coin they wish without ever making a direct purchase”.

However, my main concern with this para, as with para 2, is that it needs more “sign posts”. The para starts with POS, then POW, then returns to POS, and I don’t follow the relationship. I think it will be clearer if you remove the final sentence (it repeats the first) so that the middle sentence becomes the concluding sentence, and make it more explicit: that POW - incorporated into a POS coin - is the solution to the pyramid problem.

Para 5

Regarding the first sentence, I would change “scarce resource of power” to "“scarce resource of electricity” (electricity is more tangible) and change “increases in efficiency as economic the driving factor” to “control of costs as the driving factor”.

“better hardware, or a better connection” can be reduced slightly to “better hardware or connections”

Regarding the two sentences: “This in part gives true valuation to PoW coins, but also provides economics for valuation. The cost of mining is the communication of the value of the perceived value of the coin, although some delay may be experienced”.

I would merge these two sentences, and remove the repetition of value, thus: “This in part gives true valuation to PoW coins, but also provides economics for valuation whereby the cost of mining communicates the perceived value of the coin, although some delay may be experienced”.

Final sentence: change “indicating the insecurity of the chain”. to “indicating the insecurity of their chains”.

Skipping ahead, past the Satoshi quote, to “As global adoption increases, miners must choose which chain to support with their mining”. You can safely remove “with their mining”.

“mere 20% of the coin” - it is important that you make coin plural - “coins”

(although you could change the references to coins to “chains” for this entire paragraph, since you refer to chains in the first sentence)

“turned to attack” can be reduced to “attacked”

“unable to overcome the overwhelming volume” - reads better as “unable to defend against the overwhelming volume”

“As mining difficulty increase” - change “increase” to “increases”

“the barrier for an investor” - make plural - “the barrier for investors”

“to participate in mining increase” - change “increase” to “increases”

For the para commening "Security and economics must be married"

I think “few early moving individuals” can be reduced to “few individuals”

“discourage mining practices” can be reduced to “discourage mining”

Final para

Regarding “The dichotomy of a PoS/PoW coin seems to be the best system for making a coin that can scale on a global level, but also that is economically viable and secure”.

Suggest: “The synchronisation of PoS and PoW in one coin seems to be the best system for making a coin scale on a global level, while also remaining economically viable and secure”.

“Peercoin was the first Bitcoin alternative that was propose to fill this role”. Replace “that was propose” with “which proposed”.

The next two sentences are important, so I would insert a colon and numbers, thus:

“… to fill this role: (i) Economic competition …”

And then a semi-colon:

“… determined by participants; (ii) Using PoS allows …”

I don’t think you need brackets around “with no required minimum amount”, since this seems to be a key condition - but you will need a comma immediately after “amount”

Hope all that assists.


#5

Greatly appreciated. Will be taking a look and making edits accordingly. I really appreciate not only your feedback on my work, but the various places you give feedback across the community.