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.
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.