Meritocracy, Blockchain and Consensus Mechanism Decentralization

Meritocracy

Imagine a world where our monetary system and its rewards is driven by merit; those rewarded with power and economic goods are those who are talented and hardworking instead of those that are wealthy or in a high social class. My version of a meritocracy does not mean a system that is driven by a sense of competition where losers receive nothing, but rather a system creating an improved world where people are yielded an equal opportunity to succeed irrespective of background. Over the past fifty years – as markets increasingly have become more efficient – the economic pie has grown larger. I believe, the pie will continue growing larger more rapidly if society follows transparent, fair and meritocratic rules. However, in addition to a growing pie, the pie must also be split in a just fashion by eliminating baseless hierarchies and corruption, which are core pillars of a compassionate fair society. Limiting dangers means holding large institutions or so called gatekeepers accountable by using meritocracy to call out wrongs and thus keeping centralized parties from attaining excessive power. Access to internet and the freedom of speech is therefore so important to decentralize the narrative spread by governments, banks and news organizations. Just like internet decentralizes the information narrative, cryptography decentralizes the value of money. While internet lessened gatekeepers’ like newspapers and governments power of information, blockchain technology will lessen banks’ and governments’ power over our monetary infrastructure by providing a transparent alternative. If governments and central banks across the world engage in moral hazard behavior – like bailing out insolvent banks, printing money and widening wealth inequality – cryptographic based digital currencies through consensus could provide a financial infrastructure alternative. My view is that centralized and decentralized systems can live in symbiosis in order to create the best world possible.

Centralized vs Decentralized Networks

Cryptographic Money, Market Cap and BTC

I wonder if David Chaum knew when he created the first blind signature in 1983 that his cryptographic invention was the start of a monetary revolution. The blind signature was the foundation of a new type of money that securely connects users monetarily through a blockchain network, perhaps similarly to how internet connects a network of people informationally. By utilizing cryptographic proofs, money transactions and record keeping is made possible with a high degree of security at super low costs without – if necessary – revealing the identity of counterparties. Just 15 years ago, the market capitalization for the entire cryptocurrency market was 0 and as of 2021, the total market cap topped 2 trillion dollars. That type of exponential growth has only been seen in connection with the internet. The market capitalization can increase so quickly because of network effects. If only one person uses the internet, then information sharing on the internet is useless, but each additional user makes the network more valuable at an exponential growth rate. Before the boom in crypto currencies, the original crypto currency was bitcoin, which was founded by Satoshi Nakamoto; his/her/their true identity remains a secret. The current purpose of bitcoin is debated heavily by the blockchain community. Like normal money, bitcoin’s original objective – per its white paper – was to function as a medium of exchange, unit of account and store of value. In addition to fiat money, BTC eliminates the need for trusted third parties like banks to validate transactions; the last part is what makes bitcoin an alternative to fiat currencies. However, as BTC has now been around for around 10 years and with the rise of alternative crypto currencies, BTC has now established itself more as a pure play alternative to gold. Just like gold, BTC is a scarce asset with only 21 million in total existence. Compared to gold, bitcoin is more portable and divisible so many experts argue that BTC will replace gold as an inflation hedge by a large margin. In terms exploring the crypto world, BTC has most likely grandfathered most of us into the cryptography community, which leads us to blockchain.

Market Cap of 15 Largest Cryptos as of 2021

Blockchain

For most centralized databases, there is an administrator that is responsible for validating that the records are accurate in the database. For example, in social media and banking, the administrator could be Facebook and Bank of America respectively. The point is that the administrator is basically a central authority holding ultimate power of all record keeping. In many cases, the central authority can in error or maliciously change someone’s medical records without anyone else knowing. However, in a transparent decentralized database based on cryptography, the administrator is replaced by a network of validators and would therefore be unable to change records without consensus. In addition to following a consensus mechanism, a functioning decentralized network also needs to be secure. The technology that secures bitcoin and other cryptocurrency transactions is also part of the blockchain to protect against malicious attacks. The bitcoin blockchain is ultimately a distributed self-governing ledger controlled through consensus used to keep track of how much bitcoin people hold. Essentially consensus means that everyone participating in the blockchain are on the same page by agreeing upon the network state. Through unique logins – public and private keys - all participants therefore have access to the exact same database. The control of the network – the distributed ledger – is divided between thousands of users, which replaces trusted third parties for updating, maintaining, deleting and approving transactions on the blockchain. Basically, what consensus does is that it makes sure transactions on the blockchain are fair, reliable, in real time, efficient and transparent.

The Crypto Trilemma

Consensus Mechanism

For cryptos like BTC, it is proof of work (PoW) that is the consensus mechanism making sure that all network participants have the same ledger. Launched in 2009 for BTC, PoW is an algorithm or system that uses a significant amount of effort to prevent fake uses of computing power like double spending. Blockchain networks are comprised of blocks and each block is a list of transactions within a certain time period. The blockchain for bitcoin is immutable because PoW consensus prevents bad actors from changing anything in the blocks. The word chain comes from the fact that new blocks are attached to the previous blocks. These new blocks are created by miners using their computers to add new blocks through executing PoW. It takes around 10 minutes on the bitcoin network for miners to find the accurate PoW hash function to validate transactions. Basically, PoW involves a ton of computer nodes around the world engaging in guesswork to solve a puzzle. Guessing involves a hash function, which is basically the password to a block. As reward for finding the correct password for a block in the bitcoin blockchain, miners are rewarded with bitcoin. The transactions are then validated on the blockchain with everyone receiving the updated record on the new block. Projects that use PoW includes Litecoin, Z-cash and Minero.

Some PoW coins like LTC, Minero and BTC.

PoW and Layers

PoW was the first consensus algorithm that ingeniously created a secure blockchain by providing validators with bitcoin rewards in exchange for computer powered security provision. Like most things in life there are some weaknesses with PoW, which opens up for competing cryptographic consensus mechanisms to take over the pole position for blockchain validation. All blockchain based consensus mechanisms must balance the holy trinity of security, scalability and decentralization. Bitcoin and Ethereum are level 1 protocols meaning that they are foundational base layers. In terms of scalability, both ETH and BTC are slow meaning that they cannot process a high number of transactions per second, but in return, they are secure and decentralized. Blockchain decentralization refers to the meaningful distribution of computing power and consensus throughout a network, while security reflects a blockchain protocol’s defenses against malicious actors and network attacks. Bitcoin, for example, has not been hacked since its inception in 2009, which is an incredible feat by itself! In a perfect world, all three pillars of the holy trinity offer 100% security, scalability and decentralization at the first layer. However, to solve the scalability problem, ETH have many level 2 protocols that intends to increase transaction speed, while lowering gas fees. There are four main approaches for forming layer 2 contracts on Ethereum including channels, sidechains, plasmas and roll ups. These different approaches all have strengths and weaknesses and it will be up to the market to decide which approach is the most efficient. Sadly, achieving more scalability – faster transactions – on a blockchain means sacrificing decentralization and security. There are also other layer 1 projects like Solana and Algorand that attempt to scale faster than Ethereum, but these protocols are less secure and decentralized. In the end, the market determines the optimal balance between these three pillars, which is the reason for why there are so many different tokens that can be traded in the crypto world. The other leading consensus mechanism is proof of stake (PoS).

Ethereum 2.0 switch will happen and that will move ETH from PoW to PoS

Proof of Stake

If PoW is the original and largest consensus mechanism for cryptos, then PoS is the largest competitor. PoW is number one because both BTC and ETH still use PoW. However, the plan is for ETH to migrate over to PoS to limit energy usage when verifying blocks on the blockchain. In a PoS world, miners use the underlying token for staking rather than computing power and in return earns a reward. To prevent powerful miners from attaining too much power there is often an inverse relationship between staking and return. If a miner stakes a lot of coins, then the return is lower, which disincentivizes centralization. Other than a lower environmental impact and perhaps a greater amount of decentralization, PoS also removes some of the other main issues with PoW. A great analogy for comparing PoW and PoS is done by the educational YouTube channel, Whiteboard Crypto.

Imagine that there are 8 people running a 100m race. Some participants are athletic and others are fat. For participants running the PoW race, the goal is to reach the finish line first to get a reward; there is no second place or participation trophy. The person who wins the first race is most likely to win the next race so in the PoW system the people who are most athletic earns all rewards. However, it might be the case that 7 participants in the race gets sick so sometimes the person who is the least athletic might win the race. In reality, the runners in PoW are miners competing to solve a computational puzzle. With a strong computer the miners are more likely to solve the puzzle and earn the mining rewards. Worth noting is that more participants means a more difficult the puzzle to make sure that blocks are not solved to quickly or slowly; in fact, it always takes 10 min to solve for a block in the BTC blockchain. In PoS, there are still 8 runners, but only one runner gets picked to finish the race. However, in order to be on that starting line all 8 runners must have staked something – putting up collateral like a mortgage – so if they get picked and don’t finish the race they will lose some of their stake as a punishment; this is called slashing.

PoS algorithms have different factors that in combination chooses who becomes the validator validating the block. Some PoS algorithms give a higher likelihood of being a validator to those participants who have staked more coins. Other PoS models considers the amount of time participants have staked their coins. Finally, almost all PoS models also take randomness into consideration. To figure out a factor combination, reading the white paper for each blockchain token using PoS is a must.

PoS vs PoW

Conclusion

Blockchain makes it possible to create a more meritocratic world through consensus mechanisms rather than easily corrupted central authorities. The crypto revolution started with David Chaum in the 1980s and since then the total market cap of all cryptos have now surpassed 2 trillion dollars. All cryptocurrencies must solve the holy trilemma of scalability, security and decentralization. Ultimately, the market will decide the optimal blockchain. The two main consensus mechanisms are PoW and PoS. A big difference between PoW and PoS is that the “race” in PoS is much shorter. In fact, the PoS race is so easy that one modern smart phone can solve the problem. Many coins start with PoW and when the network grows large, the coin moves too PoS. That is because with a larger network there is more decentralization, which makes it more difficult for participants to collude and cheat the system. The main issue with PoW is that it takes a lot of energy to solve the puzzles, which is bad for climate change. There should however be a switch to renewable energy, but that will only be done by miners if there is an incentive/cheaper to do. What did happen as well with PoW is that ETH and BTC miners could earn so much that its incentivized growth in faster computing and hardware. In PoS, the miners invest in the native coins so that they can stake more and have a higher chance of solving the block puzzle. That means switching too PoS should increase the price of coins as demand increases. Finally, if you do not want to be a validator under PoS, you can use your voting power to delegate it to someone that is a validator. In this case, no special equipment or knowledge is needed.

//Stay Adaptive