Mining & Staking
Different cryptoasset projects have different features affecting asset security, the generation of new assets, and the establishment of consensus or governance mechanisms. Consensus mechanisms refer to systems of rules that let a widely dispersed group of strangers (or computers) come to an agreement about anything. Governance mechanisms enable the same diverse groups of entities to set or amend rules that govern the behaviour of their projects or userbase.
When you research cryptocurrencies, it won't take long before you'll see references to phrases such as Proof of Work (PoW) and Proof of Stake (PoS), with variations on each. Proof of Work and Proof of Stake are the two most common systems that have been adopted by various cryptoasset projects, but in addition to explaining those, we'll mention a few other consensus systems that you might come across.
Mining, and Proof of Work
Mining is the process by which some cryptocurrency transactions are verified as being legitimate transactions, and are then added to the public ledger (the blockchain). Mining is also a means through which new coins may be released for many projects. The mining process generally involves two steps: Compiling recent transactions into blocks, then solving a computationally difficult puzzle. All miners are competing against each other. The participant (miner) who is first to solve the puzzle wins the right to place the next block on the blockchain, and claims a reward. The reward for "mining" a block is typically a combination of all of the transaction fees associated with the transactions compiled in the block, plus some newly released coins.
Using Bitcoin as an example, the block reward is currently set at (Transaction Fees + 12.50 BTC). Needless to say, when you think about the current price of Bitcoin, it's obvious that you would make a LOT of money if you were able to mine even a single block! The only problem is that there are a very large number of people around the world that you're competing with, so it's very difficult to mine a Bitcoin block these days. Most new Bitcoin blocks today are mined by "Pools," which are collections of thousands of small miners who pool their computing resources together and share the rewards any time their pool is successful at mining a block.
Not every cryptoasset project uses mining to process transactions and to create new coins, but it is one common approach. A "Proof of Work" system is one which relies on mining. In theory, anyone who owns some decent computing hardware and has internet access can participate in mining. In practice, however, mining for some cryptocurrencies has become so challenging that only large-scale mining farms using specialized equipment referred to as ASIC's are now able to mine profitably. This is a "problem" for Bitcoin. Bitcoin mining is no longer attractive (profitable) for small individual miners. However, this "problem" is also something which is very good for Bitcoin itself, and helps to keep Bitcoin secure. We'll explain shortly.
To understand mining you need to understand blockchain technology. More specifically, you need to understand what the "blocks" in the blockchain consist of, in other words, what kind of data and information is contained in each block. A single block contains cryptographic signatures for that block, and also for the transactions within the block. The transactions are collected from the network, typically with a small fee attached. Those fees become a part of the block reward.
In addition, there is usually some kind of difficulty value attached to the solution for the block, which can scale up or down over time. The goal of this difficulty value is to keep the generation rate of new blocks relatively constant. As we've mentioned, the goal for Bitcoin is to generate new blocks approximately once every ten minutes, averaged over long periods of time. If the average time to mine Bitcoin blocks gradually drops to less than ten minutes, the difficulty level increases, to compensate and slow down the miners. If the average time between blocks starts to increase significantly, the difficulty level decreases.
Understanding mining requires an understanding of block rewards. For most coins, block rewards are given to the person/group that finds a valid solution to a cryptographic hashing algorithm. To simplify this, we can say that each block has its own mathematical puzzle that people all around the world are simultaneously trying to solve. The first person or computer that discovers the correct answer "wins" the block as a prize. Only one person (the first to discover the correct solution for the block) gets to collect the reward for that specific block. The system then moves automatically to the next block, and there is no longer any potential value in trying to find the solution to the previous block. Blocks are therefore released sequentially and one at a time as their puzzles are solved.
Solving a block's "puzzle" generally entails having a computer perform a very large number of calculations. Each of these calculations is called a hash. A kilohash (khash) is a thousand hashes. A megahash (mhash) is a million hashes. A gigahash (ghash) is a billion hashes. A terahash (thash) is a trillion hashes. Depending on the particular cryptocurrency, the complexity of the puzzle may require thousands to trillions of guesses before someone solves the puzzle. As more miners start competing to find the solution to the next block in the blockchain, the system eventually adjusts itself so the answer to the next block puzzle becomes harder to solve. This leads to an increase in the number of hashes being performed by all miners. The global hashrate for Bitcoin, the cryptocurrency which currently has the largest amount of miners working on it, is currently extremely high and consumes very large amounts of electricity. The Bitcoin mining system is frequently criticized due to this heavy consumption of our global energy supplies.
As an individual miner, you would have an extremely low chance of solving the puzzle for the next Bitcoin block, due to heavy competition from hundreds of thousands of other miners around the world. You may wonder if you can increase your odds by targeting a block that is a few thousand blocks into the future, and working on that puzzle in advance? No. The solution to each block's puzzle is a mathematical calculation that incorporates the answer to the puzzle from the previous block. Therefore, there is no way to pre-calculate the correct answer for a future block without knowing the solution to the block before it, and by extension, all of the previous blocks before those. There is no way to predict the exact mathematical puzzle for a specific future block until the puzzles are solved for all of the blocks that come before that one. Since there is no way to start working on the puzzle for future blocks, and there is no longer any reward for trying to solve the puzzles for past blocks, every miner concentrates all of their attention on the block that currently needs to be mined (solved mathematically).
Each cryptocurrency has a target for the average block mining time. That average time depends on the design of the cryptocurrency in question. Bitcoin, as mentioned, has an average mining time of approximately ten minutes per block. Litecoin and Vertcoin each have an average mining time of approximately 2.5 minutes per block. Monero has an average mining time of approximately two minutes. Dogecoin has an average mining time of just over one minute. Each cryptocurrency uses a different hashing algorithm with a different cryptographic formula and level of difficulty. Incidentally, we're not going to explain hashing algorithms here, because that topic is quite complex, and would only be of interest to people who are fairly comfortable with math and computers. However, we have an appendix to explain hashing algorithms in the back of our print book (Fomo, Moon, Lambo), which might be of interest to some advanced readers.
For some cryptoassets, mining can be performed by a computer that isn't very powerful, ie. a machine with a fairly low processing capability. There still exist a number of cryptocurrencies that can be mined using CPU's, although this is becoming more uncommon. The CPU is the Central Processing Unit, or "brain" of a computer. For many cryptos now, mining is predominantly done by GPU's (Graphics Processing Units), which are graphics cards with much more computational power than typical CPU's. When a crypto project is "ASIC-resistant," a GPU is the most powerful device which can mine that cryptocurrency effectively. Vertcoin is an example of such a cryptocurrency. Thanks to ASIC-resistant projects, just about anyone with a decent computer (including most gaming rigs) might be able to be a successful miner, potentially earning several dollars per day after factoring in electricity costs. However, electricity costs are the biggest obstacle to successful mining. In many countries, the cost of local electricity makes it impossible to mine any coins profitably.
An ASIC (Application Specific Integrated Circuit) is a type of integrated circuit that is designed and created for a specific application or purpose (in this case the mining of PoW coins). Compared to a general-purpose integrated circuit, an ASIC is faster and more efficient because it is specifically designed to perform one task. ASIC's can be designed for anything ranging from portable audio recording units to image processors in digital cameras. In terms being useful for cryptocurrency mining, they are commonly designed to mine just one specific type of cryptocurrency, and are frequently used for Bitcoin and Litecoin. ASIC's are considered proprietary technology as they are custom-made, and each model is designed specifically by the company that manufactures them. The efficiency of an ASIC compared to that of a CPU or even a GPU has led to criticism of the general suitability of PoW as a consensus mechanism, because ASIC miners have come to dominate the mining industries of certain types of crypto. ASIC's are usually quite expensive, and often become obsolete within several months of being manufactured. There is also a risk to buyers, because if the mining algorithm of your target crypto changes, it renders the ASIC useless. This is a fairly strong deterrent that keeps a lot of small individual investors from purchasing an ASIC. In fact, this possibility may also be a deterrent that keeps some companies from developing ASIC's for certain cryptos. For example, Monero appears to be changing its mining algorithm approximately once every six to twelve months, in an attempt to prevent companies from developing ASIC's. The reason for this is that the Monero community wants to keep mining accessible to smaller players, ie. individuals with home computers who are interested in mining.
Forging, and Proof of Stake
Forging is a similar process to mining. However, forging occurs in a Proof of Stake system. In a Proof of Stake system, the creator of the next block is chosen via various combinations of random selection and wealth or age. The "wealth" (size of holdings) and "age" (duration that holdings have been sitting in a wallet) are two main characteristics of the stake. Once the creator of the next block on the blockchain is chosen "randomly" by the forging algorithm, the assigned creator automatically "forges" or creates the block. Whereas mining is a race, with people competing to find the next block, the process of forging is a "random probability" process. Once a creator for a block has been determined, there is no longer any competition, which means that staking is not characterized by the same massive consumption of resources (computers and electricity) that characterizes mining.
Proof of Stake (PoS) still involves an algorithm, and has the same purpose as PoW. It just uses a different process/approach to picking who creates the next block. PoS systems have no block reward. Instead, the creators of blocks only receive the transaction fees in those blocks. The creators of blocks in a PoS system are called Forgers rather than Miners.
While PoS systems still require minor calculations to determine who will forge the next block, the amount of work is miniscule compared to that in a PoW system. Proof of Stake is much more environmentally friendly than Proof of Work, because it consumes much less electricity. If the cypto-investing public moves in a "greener" direction, the demand (and market prices) for cryptos that don't depend on Proof of Work will increase. The market has already shown some acknowledgement of this potential trend. For instance, Ethereum's eventual goal is to switch from a Proof of Work system to a more environmentally responsible Proof of Stake system.
Delegated Proof of Stake (DPOS) is a variation on the PoS system. In such a system, a specific number of delegates are responsible for the control of governance mechanisms. Rather than every single holder of a cryptocurrency having a vote in governance (which is both inefficient and difficult to manage), all holders of a cryptoasset assign their voting rights to specific delegates to vote on their behalf. The chosen group of delegates (which varies by cryptoasset) votes on behalf of the entire community.
This situation can be compared to that of holding a traditional stock that pays dividends. Over time, the investor slowly receives additional coins. These "dividends" are either of the original type of staked crypto, or of an alternative crypto that may be used in conjunction with the staked crypto. This passive income can be viewed as an asset distribution and slowly increases the stakeholder's position.
Some well-known cyptoassets that use Proof of Stake include Dash, Pivx, Stratis, OKCash, and Neo. For some of these cryptos, the asset dividends are the core tokens of that project. With Neo, any investor who holds their coins in an appropriate wallet will slowly collect (earn) a different secondary token called Gas.
An example of a cryptoasset that uses a Delegated Proof of Stake system would be the Ark platform. Investors who hold Ark in their wallets will gradually receive additional Ark coins over time. Ark uses a system of 51 delegates for governance issues.
Other Systems
Although PoW and PoS are currently the two most commonly used types of consensus systems, there are other systems which distribute rewards and act as verification mechanisms for various cryptoassets. Let's examine a few other consensus systems.
Proof of Authority is a system that can act as a replacement for PoW. It can be effective for private chain setups and is suitable for centralized blockchain projects. PoA does not depend on nodes solving arbitrarily difficult mathematical problems. Instead, it uses a set of "authorities." Authorities are nodes which are explicitly allowed to create new blocks and secure the blockchain. The chain has to be signed off by the majority of authorities, at which point it becomes a part of the permanent record. This makes it easy to maintain a private chain and keep the block issuers accountable. In an enterprise/consortium setting, there are no disadvantages to using a PoA network over a PoW. Proof of Authority is more secure and less computationally intensive. Since blocks are released at specific time intervals, it is more predictable. However, Proof of Authority is not a commonly used system for large public or decentralized cryptoasset projects.
Proof of Burn is a method for distributed consensus which is not used as commonly as PoW or PoS. In Proof of Burn, miners show proof that they "burned" coins or tokens by sending them to a verified "unspendable address." Any burned coins can therefore never be used again in the future, because they are sitting in an address from which they can't be accessed/moved/spent. Burning coins is expensive on an individual level, just like Proof of Work, but it consumes no resources other than the burned underlying asset. Many PoB cryptocurrencies work by burning separate PoW cryptocurrencies, so the ultimate source of scarcity remains the PoW efforts in those other cryptocurrencies. For example, SlimCoin uses a PoB system, and Bitcoin is the currency burned in that system. Binance also burns some of their BNB coins periodically, to help support the value of the remaining coins in circulation.
Proof of Research is a system in which each participant contributes to research by performing computations in the network. Gridcoin, which is associated with the BOINC network, is a good example of this type of system. Incidentally, if you don't know what the BOINC network is, you should look it up. It has been running for a few decades with dozens of projects around the world, and offers people all over the world the opportunity to donate computer resources from dormant home computers to the scientific community, by having those computers perform calculations for a variety of projects related to math, astronomy, chemistry, biology, geology, medicine, and other sciences. If you're not interested in setting up your home desktop computer system for cryptocurrency mining, and your computer usually sits overnight with the power on, you should consider installing the BOINC client and contributing to global scientific research.
The network average in a PoR system is similar to difficulty in PoW mining. As the network average hashrate rises, it becomes increasingly difficult to achieve the same "magnitude" (share of the overall hashrate). As such, increasing your computational contribution is necessary to continue to earn the same reward. When the price of a PoR-based cryptoasset rises significantly and more computing power is brought in (raising the overall network hashrate), it becomes harder for a single entity with a constant rate of research contributions to get the same reward.