Hackernoon logoProof-of-Stake vs Proof-of-Work by@mkogan4

Proof-of-Stake vs Proof-of-Work

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@mkogan4Michael Kogan

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There is a religious aspect to every conversation about cryptocurrencies. Some people have an unyielding belief that crypto is destined to go up in value no matter what and others have an equally strong and opposite conviction that cryptocurrencies as an asset class are utter and complete shit and the biggest bubble of all time.

Religious arguments aside, there must be a way to analyze long term value of crypto in a somewhat rational manner. I believe Proof-of-Stake vs Proof-of-Work is an important dimension that should be included in such analysis.

Suppose one allocates capital to any traditional asset class. The goal of capital allocation is to acquire a claim on future expected cash flows produced by the asset. These expected cash flows provide an effective price floor for the asset. In contrast, a Proof-of-Work coin doesn’t have this property. At any given point in time, a POW coin can cost X, 2X or 0.5X with no analytical framework to estimate fair value or a price floor. Certainly, it is possible to use statistical or technical analysis to calculate short-term supply/demand dynamics for a POW coin, but this is not helpful for Warren Buffet style value arbitrage, which is the force that acts as a long term price floor for traditional assets. Traditionally, Proof-of-Work coins have limited supply, which is used as an argument for supply and demand curves meeting at an ever increasing point. It’s not clear how persuasive that argument is, since there is a large number of POW chains today and an unlimited number of possible blockchains in the future.

In a Proof-of-Stake system, the coin holders get paid transaction fees for validating transactions. Therefore, Proof-of-Stake creates a clear and unambiguous economic incentive to hold coins for the long term. The price of the coin can be analyzed based on the expected future cash flows, which are generated in the form of network transaction fees. Essentially, a POS blockchain can be thought of as a decentralized Visa / Mastercard with all the additional distributed ledger functionality supported by the specific implementations. This is important, because a Proof-of-Stake coin value can be supported by traditional value arbitrage investing. A POS coin in a functioning network cannot be valued for too long below the present value of the cash flows generated by the network, similarly to any other cash flow producing asset — thus generating stability and dampening volatility, which in turn means POS coins should be better store of value than their POW competitors.

We don’t currently have many functioning Proof-of-Stake blockchains. Perhaps, Dash can be thought of as one, with its hybrid Proof-of-Work/ Proof-of-Stake or Service model. Ethereum is planning to switch to Proof-of-Stake at some point, but it’s far from clear that this upgrade will work as advertised.

TL;DR; I am willing to issue a conditional prediction:

In the event that Vitalik Buterin, Vlad Zamfir and the rest of Ethereum team can get their shit together and pull off a successful POS upgrade, in the long run Ethereum and other competing POS chains will take over and supplant POW currencies both as stores of value and as payment networks / ledgers.

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