Proof of Stake: How Exchanges Will Rule Ethereum – Trustnodes

Proof of Stake: How Exchanges Will Rule Ethereum


The second biggest cryptocurrency is to engage in a big experiment that changes the balance of incentives with potentially decisive consequences.

Unlike the current fairly egalitarian Proof of Work (PoW) system, ethereum will move to a more abstract Proof of Stake (PoS) system which can leave it open to capture even by just one person.

Justin Sun recently revealed the illusion of decentralization in Steem, a delegated Proof of Stake (dPoS) system, by showing it is actually a fully centralized and controllable system to the point they’re now moving to freeze accounts.

The ease with which he took control is revealing because it only took three men, and three exchanges. One of the men being Justin Sun, and one of the exchanges being Poloniex which he owns. The other two were Huobi and Binance.

The exchanges simply used the tokens deposited in them to ‘vote’ on the new protocol rules or to vote against proposed protocol rules depending on what Justin Sun wants.

For background, Steem holders wanted to freeze his steem, so he didn’t do all this for fun, with some sort of fork war now going on as most went to Hive, a copy clone of steem.

The hivers froze on their new chain the tokens belonging to those that from their point of view took part in the coup. Justin Sun is now trying to freeze the assets of the hivers.

This coup can’t happen on eth, Vitalik Buterin said, because “PoS validator’s just verify blocks, they are not voting on decisions,” but is that true?

Proof of Stake, Always Flawed?

The taking of control by the exchanges in dPoS was by those exchanges choosing a change of rules code upgrade in a fork.

The mechanics of how they make the choice are a bit different as in dPoS you ‘vote’ for ‘delegates’ who then choose the fork.

So an extra step is added here because in PoS everyone is a delegate. You don’t vote others in, you instead lock your token and are yourself a delegate.

In PoS then the process is pretty much the same. Someone codes the new rules, and stakers choose whether to adopt them in a fork upgrade or not.

Instead of these three exchanges therefore voting in puppet delegates, they’d have to lock the eth and ‘vote’ themselves on the upgrade or reject it.

Except while what occurred in steem is an obvious breach of trust that can potentially leave open the exchanges to lawsuits under tort or contract law, in eth they could do the same but very legitimately and without a breach of trust.

That’s because in eth they don’t need to use the deposits, instead they can use the eth that has voluntarily been given to them to stake.

Because staking in ethereum is a somewhat complicated business as there are penalties and requirements to be online and so on, there will of course be a few people who will do that on their laptop, but the vast majority will probably just let Coinbase handle it all or Bitcoin Suisse which has confirmed they will provide staking services, or some other entity where people currently already deposit eth either to trade or for them to be kept safe.

The two entities mentioned above are reputable, so it is unlikely they’d place themselves in any breach of trust circumstances, but it’s not actually quite easy to establish what the proper thing would be to do if there’s some sort of general dispute.

Exchanges Voting in Proof of Stake

Let’s imagine for example something like ProgPoW is suggested that aims to decentralize staking, instead of PoW, and there’s a split here similar to the blocksize debate where there are two sizable sides with genuine differences and both are kind of right maybe to a 60/40 degree.

In this situation it is probable many would vote and Coinbase would probably give them the option, but first of all we can’t verify these are actual people voting as presumably they would do so through some centralized interface on Coinbase.

And we’re saying Coinbase. Let’s say instead it’s Bitfinex, making that question of trust a bit more realistic as they could well say they’re giving people the option to vote, but any one voter can’t see the aggregate results, so they could well lie about how people voted, with ‘voting’ here being which fork they chose.

Something like Bitfinex could well even do that openly, declare they’re for A or B and whoever doesn’t like it should leave.

Bringing us to the second and more pervasive problem. Some people would probably leave, but by far most probably wouldn’t even care if they even know there is some fork discussion going on.

People have jobs, families and stuff to do, and a big chunk of them don’t turn out to vote even in war and peace elections, let alone some fork debate among geeks that requires a mini PhD even to know what they’re talking about, let alone to form an opinion on A or B.

So if we go back to Coinbase, what do they do with the stake of people that don’t bother to vote?

If Coinbase has an opinion itself, if they wanted to then they could well vote on their behalf. If this was the blocksize debate, for example, they may well even have said: we’re for A, if you don’t like it, leave. Meaning depending on what exactly is being voted on, even legitimate exchanges may well not give their users a voice option, and holistically thinking, they may well be within their legitimate right not to do so.

There are many other problems that derive from what can succinctly be called the merger of miners and exchanges in Proof of Stake, and to see those problems, let’s go to Proof of Work.

Proof of Work, The Egalitarian?

There are only two ways you can get bitcoin. Either someone gives it to you, or the network gives it to you after you show it some Proof of Work. That is, either you buy it or you mine it.

In PoS eth, there is only one way, you have to buy it. That in itself is a significant difference because it’s like taking out the judiciary, or parliament, you’re removing a whole pillar.

Without that free access to the network it is difficult to say the network is decentralized or permissionless because to gain access you have to go through an intermediary.

Abstractly for bitcoin one can easily argue that applies too in as far as you need to get asics, but that’s more a question of laziness or a question of resources or potentially if it’s some genius even a question of wit.

Yes you do need a lot of things to get some coins in a fully permissionless and anon way through the network itself, but that’s for many good reasons.

Mining is a business not for the fun of it but out of necessity as the significant work it requires makes it one’s livelihood or even their identity.

That in itself puts a huge barrier to intentional abuse as some hobby miner or small miner might play, but when you have a whole corporation trading on US stock exchanges where they are answerable to shareholders, then any intentional systemic abuse would be extremely rare if envisionable at all.

For PoS, there is not that bindness because for something like Binance, for example, eth is just one coin among so many. So they wouldn’t necessarily care what happens to it in the same way an asics miner would care because their income is primarily derived from those asics, meaning bitcoin.

Maybe they do GPU mining as well, but they are kind of different things requiring certain skills and knowledge. In addition the mining industry is constantly evolving, requiring one to keep up or go bankrupt.

Thus mining is a very specialized business. Exchanges too are very specialized and they have their own competitive forces. Running both in PoW is possible, but probably not as effective as either/or because they both require a huge amount of even specific talent. While in PoS, arguably you can’t really be an exchange without also providing a staking service as you’d lose a significant competitive edge.

So if we go back to something like ProgPoW or here even the real example of the blocksize, in PoW it can get very messy because exchanges can choose the ticker, while miners choose the fork, with investors then choosing which one to buy or hold but that choice is affected by the ticker and/or which fork is the longest chain with the highest total Proof of Work.

Neither being decisive necessarily in regards to what investors choose, but the degree of messiness would potentially even decisively influence what miners and/or exchanges choose.

Making cooption thus a lot more complicated, if at all possible realistically. While for eth maybe all it would take is three guys, just like in steem.

Real or Make Believe

Finally, among many things that can be said about Proof of Work, there’s also the fact it makes the coin a bit real and kind of concrete in as far as it didn’t come purely from nothing. It comes from all those scientists designing those asics and the hydro plants they’re building everywhere as well as the execution of the entire operation and its management which requires constant work and still can end in bankruptcy.

In PoS, eth comes from nothing, relatively speaking. No one needs to do any real work, there is no real industry, there is some risk but no real risk of bankruptcy, there is basically little ‘concrete’ to it.

That can lead to many problems, including no real floor to the price. As there is no real cost, except maybe the speculative cost of the purchase price, there is no concrete basis to evaluate the minimum worth.

In bitcoin you can say it costs this much to mine, and therefore you’d expect that to ignite some complicated events, like asics become too cheap and therefore more become ‘hobby’ miners who hodl instead of insta sell, as well as many other things. Leading to the speculative element of front-running, but also to the real factors that effectively floor the price.

Obviously thats not necessarily the case if trust has been lost completely for example or if there’s some other real cause to detach price from the cost of production to the point it ignores it fully down to maybe even zero, but if it is instead markets being markets rather than something ‘real,’ you’d expect the bear euphoria to eventually give way to not the laws of physics, but forces close enough to it.

While as eth in PoS comes from nothing, then it’s not clear why its value should be more than nothing.

Maybe a little something, but nothing compared to the far more objective bitcoin which because of its design can realistically act as a measurer of value and even as full on money at a significant scale.

That’s something it already does in international trade and some other niches which continue to grow as people discover uses for bitcoin, but not at scale because obviously money is something that can collapse societies, so its design is to grow slowly and gradually as well as incrementally and consensually.

Also because scalability is a hard problem which eth claimed it had solved and therefore attracted attention, but as it stands they have less capacity than bitcoin and realistically it may well be that bitcoin continues to maintain a lead in growing capacity because they are and have been working on a lot of things.

While eth is primarily focused on sharding which is unlikely to launch for years with no edge as it stands except maybe smart contracts and some cool things like zk-tech, but nothing that can be a real challenge to bitcoin with it more complementary really.

Nor can eth anytime soon gain real trust where value transfers are concerned in the same way bitcoin has for the reasons mentioned above, with its use being more niche in primarily defi which is an interesting playground, but of course not as interesting as the nature of money itself which is squarely for now only bitcoin’s playground.

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Comments (1)

  1. Complete nonsense article.

    The price of BTC is based entirely by price-matching at participating exchanges, NOT mining activities. For that, there is a total detachment between price and mining. The price of BTC can go up and down at the whims of traders with little to no stake in any mining operation. However, a miner has financial obligation to support the price from going too low lest his mining operation suffer losses. That does not mean miners have infinite money power to support BTC price indefinitely. It just mean miners have a little extra challenge to juggle. If you do not understand how BTC price is made, then you will never ever going to understand how money drives human action. Let me repeat, BTC price has nothing to do with mining operations. The price can go up and down depending entirely on trading activities.

    The price of ETH post-POS will be based on it being asset-backed. Thus the price and its fundamental value do not get detached as if they are nothing as you imply, unlike BTC’s price detached from mining. In the future, if ever the price of ETH falls below the value of assets backing it, enterprising individuals and institutions will be incentivized to provide the necessary price support to bring it at least back to par, if not higher. The same cannot be said with BTC. That is one superiority of POS over POW.

    You may even talk about BTC being a digital gold. But please smart up and realize it is not Bitcoin that decide whether it will be digital gold. It is the humans that make such a decision. And such decision is not made by stupid emotional humans that behave like sheep and follow the hype, but by smart and resourceful ones in power. In term of being used as cash, its 10-minute confirmation time already defeats the purpose. In term of being used as digital gold, anything can be programmed to have the characteristics of a digital gold, not necessarily Bitcoin, as if the world cannot make do without it.

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