[I explain the concepts of this article in both video and podcast format]

In the first part of this series I wrote about the main difference in ideology between these two assets and how they came about. In the second instalment I want to dig a bit deeper into how they work and a fundamental debate going on right now in the crypto space. Proof of Work (POW) against Proof of Stake (POS).

As of today, both Bitcoin and ETH use the POW system, but the plan is already in motion for ETH to switch and adopt this new feature. Many are sounding the alarms against this move, while others are welcoming it with open arms. Let’s explore this, so we can understand these assets a bit better, hopefully then we can make an informed decision if we plan to buy them or participate in the ecosystem they are creating.

To understand this subject better you need to be familiar with the concept of “Crypto Mining”. I'll be making a separate article on this subject, otherwise this one would be extremely long. In short, all blockchain and cryptos are (in essence) simply a ledger. A list that determines who owns what. The people that update the ledger, making transactions possible are called “Miners”. In exchange for doing this they get rewarded with coins, acting as incentives, so that many people would seek to participate in the mining. The more miners a network has, the more secure it is (again, I’ll dig deeper into this subject in future articles).

Now, both Bitcoin and ETH need miners. Bitcoin’s system (POW) requires people’s computers to be connected to the Bitcoin Network, constantly running a program that updates the ledger in exchange of BTC. This has been the way Bitcoin has worked since its inception and so far the system has proved itself to be extremely reliable.

The complaint many have with this is that the more computers that run the program, the level of complexity rises. This forces people to invest into faster and more powerful computers every time. There is also an energy cost that has been a point of attack to BTC lately. I’ll probably have to do a POW article to go more in depth, but as a summary, all these complaints are actually features, not bugs.

Keeping the investment required to participate high is crucial. The more money you spend to get your Bitcoins, the more you are invested in its wellbeing, the less likely you are to try and do things to mess with the network. Also, in order to attack the network from a miners point, you would need to acquire 51% of all the computing power used to run it. As the cost of this goes up, the chances of one individual or even a group of them to attain enough power diminishes radically. In essence you create a defense that if you wanted to break it to have access to all the BTC in the world, you basically need to spend more than that to do it. 

Energy consumption is another topic, but it also has more layers than simply “Bitcoin consumes a lot of energy, therefore it’s bad”. Once again I’m afraid this topic requires its own article. So to sum up, energy cost is one of the main points of competition between miners. Having such high incentives for low cost energy is driving a lot of capital to be deployed just for this. We are sure to see a ton of innovation in this space, as a big move towards renewable energy (a trend already in motion). The hardest part of energy production is to transport it, this creates further incentives for mining facilities to be located in remote areas, where producing energy was previously unprofitable. This energy would otherwise go unused, so the network is consuming energy but bringing new energy as well. When located in these remote areas they also provide incentives for services to be built there, creating a ton of jobs unrelated to the mining itself.

In short, a lot of the complaints about the POW system are made from people who either don’t understand it, haven’t done the intellectual work of learning about them, or worse, are deceptive and have ulterior motives.

Now, ETH is using these “reasons” against POW to make a switch to POS. This would get rid of the traditional miners. Instead of having a computer running a program, you would have a computer with an ETH wallet connected to the system. In this way, there is no “competition” aspect, so the computer can even be an old laptop. Because the computer only needs to be online for this to happen, the energy consumption is immensely lower than traditional POW. In addition, the rewards that would normally go to the miner (as incentive for participating in the system) will now go to the owners of the wallets.

Effectively you connect your wallet, and by simply having ETH in it, you help update the ledger and get more ETH in return. Of course, the more coins you possess in the wallet the more you’ll get, almost like a bank account that pays you interest for having your money parked there. 

In theory it sounds really good, who doesn’t want their money to create more money? Plus, lower energy costs? Seems like a no brainer.

But here we run into a problem already stated in the previous article, decentralization. There is already a big problem in Ethereum that a small portion of members control the vast majority of it, as well as the decision power over the protocol. Its history has provided us with examples where its money policy has changed many times and is likely to keep doing so in the future. Once you add to this the capacity of the major holders of the coin to receive rewards at a larger rate due to their higher stash. Then you understand that all the concerns about POS make a bit more sense.

This creates “incentive traps”, especially if you take into account that there is no cap limit for ETH. So, the few people who control most of the coins will soon own most of the mining network as well.  This will grant them the ability to print more ETH, which would make everyone’s holdings worth less whilst increasing theirs. 

I’m not saying that this will happen but it is a risk, it COULD happen. Bitcoin was made with the sole purpose of not allowing this scenario EVER to play out. Even if you had 90% of the bitcoins you still have no power over the miners. If you wished to acquire 51% of the network to attack it, you would have to spend all your BTC to buy very expensive machinery and consume a ton of energy to do so. You would end up worse than when you started.

In fact the costs of mining and keeping it separate from the coins themselves is an extremely important element of why Bitcoin works. Most people don’t understand this and are eager for POS to be deployed on ETH. I’m not going to predict what will happen, as it could work for a while, even a long time. Yet, in my mind, the stable systems endure where the risky ones tend to encounter problems down the road.

My only objective with this article is to share with you what I have learnt and hope it is useful for you. I’m only one person so I would advise you to check everything I said and seek more sources. Having the right information is very important if you want to make the right decision. Have a great day!