I have a feeling that I am going to be writing a lot on this topic in general for the foreseeable future, but the philosophical and existential crisis currently confronting the Bitcoin space over what constitutes “spam” is starting to have massive second order effects and consequences in all of the different Bitcoin communities.

I want to specifically focus on the reaction to this debate spilling over into what charitably can be construed as debating with Core developers, but in reality in most cases has taken the form of what can only be called harassment. This can be a very nuanced and subtle aspect of how Bitcoin works, as the relationship between “customers” that actually utilize Bitcoin and the developers that work to maintain, improve, and optimize the protocol and tools built on top of it is not a clear cut category separation. Many people who use Bitcoin are developers, and many developers are users of Bitcoin. There is no hard line distinguishing between the two, and someone who is one or the other can over time become both. In the same regard people who fall into both categories could cease to do so, and simply become solely a developer or solely a user. That is the first thing to understand, the line between users and developers is totally arbitrary, with constant overlap and the potential for that overlap to grow and shrink at any time.

That said, what about the users who are not developers? What is their relationship with the people actually writing and maintaining the software? There is no real black and white clear answer, but I can tell you what the relationship is not: an employer/employee relationship.

Developers do not work for us. Full stop. They are not our employees. We do not pay their bills, we do not fund their work, they do not have any contractual or legal obligations to us whatsoever. We are not product managers, we do not provide them with a project roadmap and dictate what pieces they work on, how they work on them, in what order, or what those pieces should even be or how they should function.

Disabuse yourself of any notion that this ecosystem functions in any way remotely like that. It does not. Developers freely choose to contribute their time to an open source protocol completely on their own terms. They decide how much time to spend, what to spend it on, and the way they actually implement what they chose to work on. Full stop. They have complete and unfettered autonomy in every way regarding how they interact with Bitcoin as a project.

Now turn that around to look at users. Users of Bitcoin are under no obligation whatsoever to adopt a change or tool that developers produce. Nothing is forcing users to change the software they run, or adopt a new tool developers build on top of Bitcoin. Having a Netflix subscription does not obligate you to watch a single piece of content they produce, it does not obligate you to consume any specific volume of content. You can watch as much or as little as you choose to, you can even cancel your subscription if you want. Netflix has literally no control over how you interact with it whatsoever except purely through the power of voluntary persuasion.

This is how Bitcoin works. Harassing developers on GitHub will not change that. It will not magically turn your relationship with developers into one of an employee/employer. Not only will crying on GitHub accomplish nothing whatsoever to create or bring about that power dynamic that many Bitcoiners seem to want to bring into existence, but it accomplishes nothing productive whatsoever. I say that as someone who has personally debated numerous issues with developers over the years, asserted numerous times that developers are incorrect about some issue or plan of action they think is the most appropriate one to take.

GitHub is not the place for arguing what the existential purpose or reason for Bitcoin existing is. It’s a place for narrow concept and implementation debate and criticism, for the express purpose of improving whatever technical proposal is being made. Whether that leads to a proposal being incorporated into Bitcoin, or rejected from Bitcoin, should be entirely up to the outcome of purely rational and logical discussion.

Even in the case where you do have a truly rational argument or piece of input, are you going to actually stick around and contribute or participate in the development process consistently? Or are you just essentially doing a drive by review or input on a specific issue to bikeshed it? Yes? Then even with a rational argument in hand, GitHub is not the appropriate place for those discussions. We have Twitter, we have Reddit, we have Spaces, we have numerous other places to debate and work towards consensus on things without actively interjecting nonsense and philosophical debates about semantics into the development process.

And I reiterate that I am a person who has spent a massive amount of time in this space making arguments about why a specific direction of development is or isn’t a good idea, bolstering those arguments with actual reasoning and logical rationale. I probably never will in any meaningful and consistent way contribute to the development of Bitcoin, so I do not attempt to inject my arguments, opinions, and ideas directly into that development process itself.

I make those arguments to the wider community, or when making them to developers, in other forums or mediums besides GitHub or platforms whose specific purpose and function is for developers to coordinate the development process. If my arguments actually hold merit, they will convince users. They will convince developers out of band from places like GitHub. Eventually, an argument with merit will grow and create consensus around it to the point that it presents a meaningful public signal that developers can choose, if they want, to incorporate into their own reasoning around Bitcoin and what they choose to spend their time and efforts doing to improve it.

Ultimately it doesn’t matter whether you look at these issues and this dynamic from the lens of developers or the lens of users: you have no power or influence whatsoever except the power of persuasion.

If developers produce something that the overwhelming majority of users do not want or find no value in, they can simply ignore it. If developers find an overwhelming majority of users demanding something that is completely irrational in terms of incentive alignment, engineering realities, or anything of that nature, they can simply ignore them.

Bitcoin is a self regulating system. Bad tools produced by developers will not be adopted. Users demanding incoherent or damaging things cannot make developers build that for them, but they can step up and build it themselves if they really want that thing. No one works for anyone else here in this dynamic, it is a completely voluntary process regulated by market forces. So either step up and actually try to be persuasive, do it yourself, or cry harder. You are not going to succeed in trying to force anyone to do something they don’t want to do. 

You can find the fork button in the top right corner right here. 

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Introduction

Defining Fiat Money

Fiat money is tender not backed by a tangible asset or commodity like gold or silver. It’s usually mandated by governments, but this isn’t always the case. The currencies we use for everyday transactions in the modern era are all examples of fiat money, such as the U.S. dollar (USD), the euro (EUR), the pound (GBP) or the Chinese Yuan (CNY).

The term “fiat” is a Latin word that means “by decree” or “let it be done,” representing an arbitrary order that reflects the issuance of money as a government enactment. Fiat is one form of money, along with representative and commodity money. While fiat money comes in various forms — physical banknotes, coins or digital units — representative money merely “represents” an intent to pay, like a cheque. Commodity money has an intrinsic value derived from the commodity it is made of; for example, precious metals, food and even cigarettes.

How Fiat Money Works

The currency itself has no intrinsic value but derives its worth from trust in the government that issues it; it is not representative of another asset like gold, silver or any other financial instrument.

Government Decree: Fiat money is declared by the government to be the official currency of a country and is typically designated as legal tender. This means that banks and financial institutions must adjust their systems to allow the currency to be accepted as a form of payment for goods, services and debts within a given country. There are some exceptions to this rule, with Scotland being the prime example.

Legal Status: Whereby the new money is given the status of legal tender, meaning it must be accepted as payment within the country. Laws and regulations are established to ensure the proper functioning of fiat money. These regulations cover issues such as counterfeiting, fraud and the overall stability of the financial system.

Acceptance and Trust: The value of fiat money is based on the belief and trust that it can be exchanged for goods and services and the illusion that it will retain its value over time. The general acceptance of fiat money by the public and its use in everyday transactions are crucial for its functioning. Should the majority recognize the power of compounding inflation, they may begin to lose confidence in the government’s money.

Central Bank Control: Central banks are responsible for maintaining the stability and integrity of the currency. They control and monitor the supply of base money and adjust it based on economic conditions and monetary policy goals. By managing the money supply, central banks aim to maintain price stability and promote economic growth.

Central banks have the authority to influence the value of fiat money through monetary policy tools. They do so by adjusting interest rates, adjusting lending conditions and through new money creation.

In extreme circumstances, central banks need to issue money to ensure that there is an adequate flow of coins and notes to allow the economy to function properly. In addition to this, cash, which in reality represents a small part of the total amount of money circulating in an economy, a second layer of money issued by commercial banks is injected into the economy in the form of bank deposits that are available at any moment.

When the government creates new money and increases the money supply, inflationary pressure arises, which is a typical state of fiat systems. Although rare, extreme conditions known as “hyperinflation” may also emerge, resulting in the currency losing value or becoming worthless.

How is Fiat Money Created?

Governments and central banks have several methods for creating new money and inflating the current supply. The most common methods employed are:

Fractional Reserve Banking: Commercial banks are required to maintain only a fraction of the deposits they receive as reserves. This reserve requirement enables banks to create new money by lending out a portion of the deposits. For example, if the reserve requirement is 10%, a bank can lend out 90% of the deposited amount. Once the loaned out money becomes deposits for other banks which, in turn, hold back 10% and lend out the other 81%; new money is created.

Open Market Operations: Central banks, such as the Federal Reserve in the United States, can create money through open market operations. They purchase securities, such as government bonds, from banks and financial institutions. When the central bank buys these bonds, it pays for them by crediting the accounts of the sellers with new money. As a result, the money supply increases.

Quantitative Easing (QE): Quantitative Easing and Open Market Operations are technically the same thing. The difference being that QE began in 2008 and is much larger in scale than regular OMOs and have specific macroeconomic targets to do with growth, activity and lending.

QE is therefore typically used in times of economic crisis or when interest rates are already low. In this approach, the central bank creates new money electronically and uses it to purchase government bonds or other financial assets from the market.

Direct Government Spending: Governments can also release new money by simply spending it into the economy. When the government spends on public projects, infrastructure or social programs, it effectively injects new money into circulation.

Characteristics Of Fiat Money

In such a context, three main characteristics are recognized as specific to fiat money, and they are the following:

• Lack of intrinsic value because it is not backed by a commodity or any other type of financial instrument.

• Establishment by government decree, and the government also controls the currency supply.

• Trust and confidence as the basis of value. Individuals and businesses must trust that fiat money maintains its value and acceptability as a medium of exchange.

Historical Context and Evolution

7th Century — China

The Chinese Song dynasty was the first to issue paper money, the Jiaozi, around the 10th century C.E., although the very first banknote-type instrument was used in the 7th century, during the Tang dynasty (618-907). During this era, merchants would issue some form of receipt of deposit to wholesalers to avoid using the heavy bulk of copper coinage in large commercial transactions.

During the Yuan dynasty in the 13th century, paper currency started being used as a predominant medium of exchange, as was also mentioned by Marco Polo in “The Travels of Marco Polo.”

17th Century — New France

In the Canadian colony of New France, the official beaver pelt started to be replaced as a medium of exchange by French coins in the 17th century. These coins soon became scarce as France reduced its circulation in the colonies. When local authorities began having a severe shortage of money, they had to become creative to pay military expedition soldiers, who had to be remunerated to avoid the risks of mutiny.

Playing cards started being used as paper money to represent gold and silver. They became widely accepted by merchants in the colonies until they were recognized as an official medium of exchange. People did not redeem them and instead used them for payments while gold and silver were hoarded. Therefore gold and silver were valued for their store of value properties while playing cards utility centered around convenience and risk minimization, an example of the Nakamoto-Gresham’s Law in action. When rapid inflation occurred due to the high costs of the Seven Years’ War, paper money lost nearly all its value in an event that could be considered the first-ever recorded hyperinflation.

18th Century — France

During the French Revolution, facing incumbent national bankruptcy, the Constituent Assembly issued a paper currency called “assignats,” backed by the value of the properties confiscated from the crown and the Catholic Church.

By 1790, assignats were declared legal tender and went through phases of new issuance with the idea that they would be burned at the same rate that the lands securing them were sold. Lower denominations were produced in large numbers in order to ensure wide circulation. However, while such measures were meant to stimulate the economy, they also increased inflationary pressures and led the assignats to continuously lose value.

By 1793, the political situation had precipitated with the outbreak of the war and the fall of the monarchy. The Law of Maximum — that had set price limits and punished price gouging to ensure continuous food supply to Paris — was lifted which caused assignats to lose almost all value (hyperinflate) in the following months.

In the aftermath Napoleon opposed the implementation of any other form of fiat currency and the assignats became memorabilia.

18th to 20th century

The transition from commodity to fiat money could be established over these two centuries. WWI, the interwar period and WWII marked profound turbulence and economic crisis worldwide, with many countries facing high debt levels and widespread unemployment. During World War I, the British government issued war bonds to finance its war efforts.

These were essentially loans taken from the public, with the promise of repayment with interest after the war. Such war bonds were only one-third subscribed, which led to the creation of “unbacked” money. Many other nations followed suit and applied the same measures to finance their own war efforts.

The Bretton Woods monetary system agreed upon in 1944 was established to provide stability in international financial transactions and promote economic growth. The U.S. dollar was denominated as the global reserve currency and linked other major currencies to the dollar through fixed exchange rates. The International Monetary Fund and the World Bank were also founded to facilitate international monetary cooperation and provide financial assistance to member countries.

In 1971, U.S. President Richard Nixon announced a series of economic measures that became known as the Nixon shock. The most impactful of these measures was the cancellation of the direct convertibility of the U.S. dollar to gold, which effectively ended the Bretton Woods system.

The Nixon shock marked a shift towards a floating exchange rate system, where currencies fluctuate freely based on supply and demand. It had significant implications for global currency markets, the international monetary system and the price of all goods and services. (Some of these distortions can be viewed on the website wtfhappenedin1971.com.)

The Transition From The Gold Standard To Fiat Money

The gold standard was the monetary system prior to WWI, where a country’s currency was backed by gold. Governments held significant gold reserves to back their currencies, and individuals could exchange their paper money for gold at a fixed rate. This system provided stability and confidence in the currency’s value, as it was directly linked to a tangible asset.

From the start of WWI there was gradually a transition from the gold standard to fiat money, where currencies were no longer backed by a specific quantity of gold but instead derived their value from government regulation and public trust.

Various factors led to the shift in the monetary system, including the need for a more flexible monetary policy to address economic challenges effectively. The gold standard limited governments’ ability to control the money supply, interest rates and exchange rates, as they were tied to fixed gold convertibility. Furthermore, the initially decentralized commodity was difficult to transport, store and secure, so it became centralized by goldsmiths and later banks, leaving its fate subject to the whims of governments.

By the late 20th century, most countries had fully adopted fiat monetary systems. Governments and central banks took responsibility for managing the money supply, setting interest rates and attempting to stabilize their respective economies, although a long-term economic security could never be guaranteed.

Fiat Money In The Global Economy

The Role Of Central Banks

In the global fiat monetary system, the role of central banks is crucial in the implementation of monetary policy. They use various tools — such as setting interest rates — to influence economic conditions, stabilize prices and promote economic growth.

They are generally responsible for issuing and managing the national currency, regulating the money supply, ensuring the availability of an adequate quantity of currency and maintaining its integrity and stability. However, through manipulating rates and the money supply, central banks have profound influences on people and business, making it hard to plan for the future.

Central banks often have the authority to supervise and regulate commercial banks and other financial institutions within their jurisdiction. They set prudential regulations, conduct bank examinations and oversee the stability and safety of the banking system to help maintain financial stability and protect depositors and consumers.

They also act as lenders of last resort to provide liquidity and emergency funding to banks and financial institutions that may face financial distress or liquidity shortages.

Impact On International Trade And Exchange Rates

As a national currency, the fiat dollar significantly impacts international trade and exchange rates, being the most widely accepted medium of exchange that facilitates the buying and selling of goods and services between countries. Its ease of use simplifies transactions and promotes economic integration across borders.

Furthermore, exchange rates reflect the value of one currency relative to another and are influenced by a range of factors, including interest rates, inflation rates, economic conditions and market forces. Changes in exchange rates impact the competitiveness of exports and imports, influencing trade flows and the balance of payments.

Fiat Money And Economic Crises

Fiat money systems are susceptible to economic crises due to excessive money creation, poor fiscal management or financial market imbalances. Unsustainable policies can lead to inflation, currency devaluation and asset bubbles, resulting in economic downturns and crises.

To face such consequences, central banks take measures such as lowering interest rates and increasing the money supply to stimulate economic growth during a downturn. While these measures can boost economic activity and asset prices, they can also lead to speculative bubbles and unsustainable expansion. When these bubbles burst, they can trigger recessions and sometimes depressions.

Hyperinflations are rare, but they have occurred in some cases of fiscal mismanagement, political instability or severe economic disruptions — notable examples include Weimar Germany in the 1920s, Zimbabwe in the 2000s and more recently, Venezuela. Hyperinflation is a fiat phenomenon that occurs when prices increase by 50% within one month.

Throughout history, it has occurred “only” 65 times, according to the Hanke-Krus research; however, it should not be underestimated as its consequences have been catastrophic and have destroyed countries’ economies and societies in the past.

Properties Of Fiat Money

Fiat money is excellent for everyday transactions, but it’s a poor store of value compared to commodity money like gold. Whether fiat is better than gold is subjective, and in some respects, it is. However, it has introduced its drawbacks as it scores poorly against critical properties such as scarcity, which many would argue is a fatal flaw.

Pros Of Fiat Money

The implementation of fiat money has produced some advantages, especially in relation to gold, as highlighted here:

• Ease of use: Fiat money is more practical for everyday transactions due to its portability, divisibility and broader acceptance. It is convenient for a range of economic activities, from small purchases to large commercial transactions.
• Lower costs and risks: It eliminates the costs and risks associated with storing and securing physical commodities like gold. It reduces the need for acquiring and safeguarding large gold reserves.

Pros for Governments

• Greater flexibility in monetary policy: Governments and central banks can adjust the money supply, interest rates and exchange rates to respond to economic conditions and promote stability. This flexibility enables them to mitigate economic downturns, control inflation and manage currency fluctuations, which are notable features of the fiat system.
• Prevention of gold drain: Government measures to safeguard their gold reserves and prevent the outflow of gold from the country become unnecessary. Maintaining an adequate supply of gold was crucial for the currency’s stability under the gold standard.
• Sovereign control: Fiat money offers governments and central banks greater flexibility in managing monetary policy to address economic challenges and promote stability. They can adjust interest rates, control the money supply and handle exchange rates to respond to economic conditions and promote stability.

Cons Of Fiat Money

Even though fiat money has widespread drawbacks, it became the predominant form of money globally primarily due to advantages in terms of flexibility, convenience and adaptability to complex economic systems. However, maintaining effective monetary governance and ensuring trust and confidence in the currency are critical to mitigate the potential disadvantages associated with fiat money.

1. Inflationary and hyperinflationary risks: Fiat money systems are vulnerable to inflationary pressures and have been the cause of all hyperinflations in history. The prices of goods and services are forever increasing in fiat systems, but it’s due to the value of currency units decreasing.
2. Lack or loss of intrinsic value: Unlike commodity-based money like gold, fiat money does not have inherent or intrinsic value. Its value is derived solely from the trust and confidence placed in the issuing government and the stability of the monetary system. This reliance on trust can make fiat money susceptible to loss of confidence during economic or political uncertainty.
3. Centralized control, government dependence and manipulation: Fiat money systems are subject to centralized control by governments and central banks. Allowing flexibility in monetary policy opens the way for manipulation and mismanagement. Poor policy decisions, political interference and lack of transparency can lead to misallocation of resources, currency devaluation and financial instability. Centralized entities are also inclined to use censorship and confiscation.
4. Counterparty risk: Fiat money relies on the credibility and stability of the issuing government. In cases where governments face economic or political challenges, there is a risk of default or loss of confidence in the currency. This can lead to currency devaluation, capital departure or even currency crises.
5. Potential for abuse and corruption: Systems can be susceptible to abuse and corruption, mainly when there is a lack of transparency and accountability in monetary management. Unscrupulous practices, such as money laundering, illicit transactions or political manipulation of the money supply, can undermine the currency’s integrity and erode public trust. Such approaches may produce the Cantillon effect, where changes in an economy’s money supply cause the redistribution of purchasing power among people, altering the relative prices of goods and services which results in the misallocation of scarce resources.

Read More >> How Fiat Money Broke The World

The End Game

Limitations Of Fiat In The Modern Age

It could be argued that fiat once served a purpose as gold failed to meet the postwar world’s demands. Similarly, current conditions indicate that we are reaching another inflection point, whereby fiat is no longer equipped for the digital age.

Even though fiat has digitized financial transactions, the reliance on digital platforms and systems introduces cybersecurity risks. Hackers and cybercriminals tend to target digital infrastructure and government databases, attempting to breach security measures, steal sensitive information or carry out fraudulent activities. These risks threaten the integrity of digital fiat money systems and the trust placed in them.

Privacy constitutes another concern. Online fiat money transactions leave a digital trail, raising apprehension about privacy and surveillance. Collecting and using personal financial data can produce privacy risks and potentially misuse sensitive information.

Artificial Intelligence and bots present yet another challenge, which could be solved by introducing private keys and microtransaction fees. Without addressing such challenges, the fiat system will be left behind with new online publishing monetization opportunities that are moving beyond the traditional advertising model.

Furthermore, fiat cannot sustain the extreme efficiency that code-driven digital currencies can provide, including quick settlement. Centralized systems will always rely on intermediaries to approve transactions that must go through different layers of authorizations before being confirmed, sometimes taking days or weeks to resolve. Bitcoin transactions can take as little as 10 minutes to become irreversible.

The Rise Of Bitcoin

Besides its transaction finality, bitcoin offers several advantages over fiat in the digital age. Decentralization, SHA-256 encryption and the proof-of-work consensus mechanism combine to create an immutable ledger. Its limited supply makes it inflation-proof, the perfect store of value and medium of exchange, as it appreciates sufficiently to be adopted as a unit of account.

Bitcoin is smart money, programmable, not confiscatable and has all the properties that make it the ideal asset to save and an excellent medium of exchange for merchants who want quick settlements.

Moreover, being a digital currency, bitcoin possesses an optimal capability to leverage the efficiency of AI for tasks like fraud detection and risk assessments within its services. It encompasses the advantageous characteristics of gold, such as its limited supply, while also embodying the divisible and portable nature of fiat currency. Furthermore, it introduces novel properties tailored to suit the requirements of the digital era.

In the coming years the transition from fiat money to bitcoin will represent the next evolution of money. The two monetary systems will co-exist for the time necessary for the world’s population to adapt to the best money humanity has ever experienced. In the meantime, we will likely continue to spend our national currencies and store bitcoin, as bitcoin has the necessary properties to store value through time. This will continue until the value of Bitcoin far exceeds the value of national currencies, upon which time merchants will refuse to accept the inferior money.

Frequently Asked Questions

How Does Fiat Money Differ From Commodity Money?

Fiat money is based on trust in the government; commodity money is backed by a physical asset like gold.

What Currencies Are Not Fiat?

Currently, all currencies being used by governments are fiat currencies. El Salvador is the exception, as it has implemented a dual currency system of bitcoin and fiat.

What Factors Can Affect The Value Of Fiat Money?

Some examples include a lack of trust in the government that issues currency, uncontrolled money printing, unsustainable monetary policies set up by central banks and political (in)stability.

How Do Central Banks Regulate The Value Of Fiat Money?

Through interest rate adjustments, open market operations like buying or selling government securities (bonds) in the open market and reserve requirements for banks. Capital controls to manage currency volatility, maintain stability or prevent excessive inflows or outflows of funds could disrupt the domestic economy and impact the value of fiat money.

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Introduction

Bitcoin miners collect and broadcast transactions in a block and verify their validity. Then they apply a cryptographic hash function of the previous block’s header to the new block. Finally, they try to solve the proof-of-work problem. Satoshi Nakamoto adopted a proof-of-work (PoW) consensus mechanism to resolve the Byzantine Generals’ Problem, establishing a transparent and objective protocol.

What Is Proof Of Work (PoW)?

Proof of work is literally proof that work has been done to validate the network’s transactions and generate new bitcoin. It is the consensus mechanism and algorithm that uses computing power to verify transactions and add them to the Bitcoin blockchain. Such a mechanism allows the Bitcoin network to be trusted and remain decentralized.

PoW resolves the Byzantine generals’ problems, which may fail a distributed computer system for different reasons, not only of malicious nature, but perhaps a software defect, a hardware malfunction, or a well-coordinated attack by a bad actor. They can all be difficulties that prevent nodes from reaching consensus on distributed networks.

The Byzantine Generals’ Problem is only common to decentralized systems, where it’s more difficult to come to an agreement.

Bitcoin resolves the Byzantine Generals’ Problem by providing a way to communicate and transfer value safely without the need to trust one another through a network of nodes that agree on the truth before it is timestamped. Once one node has recorded a transaction, a copy is propagated to all other nodes in the network. PoW was created to achieve this objective.

Why Is Proof Of Work Important?

Proof of work is often misunderstood or underestimated, as many consider it a wasted effort on a poor system design; they claim that entering a transaction on any other digital ledger could be made instantly and with no effort. This is why proof of work is necessary for the ledger’s security and how it prevents any one party from compromising it. The effort is not wasted however, if it empowers a network to be an alternative to the current monetary system and its various flaws.

The significance of proof of work lies in its ability to serve as a tangible expense for generating bitcoin and safeguarding its credibility. It would be exorbitant to execute a 51% attack on the Bitcoin network with the intention of creating counterfeit coins or carrying out deceitful Bitcoin transactions. If any entity tries to compromise the Bitcoin network, it would have to redo all previous proof of work quickly enough to outpace the network’s continuous proof of work. For this reason, Bitcoin has unforgeable costliness characteristics and is immutable since it is nearly impossible to change confirmed transactions.

To maintain stability in the proof-of-work system, Nakamoto implemented a simple yet genius solution referred to as the difficulty adjustment algorithm, which regulates the difficulty level of discovering a new block every 10 minutes. This is crucial to prevent the discovery of new blocks from happening too quickly as more miners join the network. It also ensures that the mining process does not become too slow if the mining activity drops.

Proof Of Work Versus Proof Of Stake

We’ve seen how PoW is a good use of energy to secure Bitcoin while forcing everyone to adhere to the same fixed rules, including the interdiction to issue more bitcoin to increase the supply.

The security difference between the two consensus mechanisms holds great importance. Proof of work requires energy consumption to ensure that Bitcoin maintains its position as the most secure network worldwide, whereas proof of stake (PoS) does not resolve the problem of possible interference from malicious entities. Instead, PoS sacrifices security for scalability, making it a faster blockchain, albeit one that cannot be trusted. Bitcoin’s proof-of-work consensus mechanism is expensive, and motivates participants to only publish truthful information.

Proof of stake is the consensus mechanism for most altcoins, digital penny stocks, and other Ponzi schemes marketed as alternatives to bitcoin. Its consensus mechanism works through “staking,” which requires investors to lock the chosen protocol’s tokens into the system so that the token cannot be spent. However, the higher the number of tokens staked, the higher the chance of validating a block of transactions.

Considering that most altcoin tokens are issued to insiders and developers before they became publicly available, it’s easy to figure out how poorly decentralization is designed in proof-of-stake networks.

The primary differences between the two mechanisms are highlighted here:

Proof Of Work

• Validation is performed by a network of miners
• Competitive nature uses lots of energy and computational power to determine the probability of finding a new block
• Proof of work has a real-world physical cost to production, which insulates the network from attack
• There is an economic and environmental advantage to proof of work

Proof Of Stake

• Validation is done by participants who offer their tokens as collateral
• Less energy is used, but the amount of stake or number of coins determines the probability of validating a new block
• Proof of stake has no real-world cost of production, which leaves the network vulnerable to attack
• There is no environmental advantage to proof of stake

In proof of stake, it’s easy to acquire a 51% stake and then change the rules of the protocol to one’s benefit, and relatively straightforward to censor network participation and activity, such as declining a person or entity’s transactions by not including them.

How Proof Of Work Works

Proof of work was previously achievable using central processing units (CPUs) and graphic processing units (GPUs). However, due to the vast amount of electricity required, it can now only be performed using specialized computers operated by miners, known as application-specific integrated circuits (ASICs).These serve to input transaction data, information from the previous block header, and a nonce (random number) to guess the result of hash functions.

Hash functions are mathematical functions. In Bitcoin, SHA-256 is the hash function algorithm that transforms your input data — anything that can be represented in ones and zeros — into the output, a string of 64 characters, which will be unique and perfectly correlated to the input data.

From how it works, it is impossible to figure out a resulting output from a publicly visible input other than through expensive ASIC-generated rapid guessing.

On the other hand, miners want to optimize their work. To be profitable, they must increase the number of hashes (or guesses) per second that their devices can produce while using the cheapest and most reliable energy source.

Bitcoin’s difficulty adjustment makes mining an even more competitive industry. In simple terms, proof of work is similar to buying lottery tickets with a prize draw every 10 minutes. The more tickets you buy, the greater the statistical likelihood of winning the lottery. In ASIC terms, a Bitmain Antminer S19j Pro can operate at 104TH/s, which basically means 104 trillion guesses, or tickets, per second.

Due to the increased competition, it’s become harder for individual or solo miners to mine bitcoin since 2012, when ASICs became necessary. Yet, they can now join a mining pool to increase their chances of getting rewarded with bitcoin, though the funds would be split among the pool members.

Advantages And Disadvantages

Proof of work is necessary to keep Bitcoin secure, immutable, and always decentralized. Here are the primary benefits and drawbacks of Bitcoin’s consensus mechanism.

Advantages

• Decentralization, i.e., the real breakthrough of the technology
• Censorship resistant, as a result of decentralization
• Immutability, the blockchain is nearly impossible to reverse
• It’s a fair and objective system based on robust protocol rules and laws of physics
• High level of security: PoW economically incentivizes miners to protect the network
• Carbon and methane capture: Bitcoin exploits wasted energy to issue more coins and verify transactions
• By monetizing energy, PoW speeds up the rollout of renewable energy networks, and also improves load balancing on existing grids, making them more efficient and secure

Disadvantages

• Slower transaction speeds
• Mining expenses (OPEX & CAPEX) are very high but necessary for proof of work
• PoW consumes a lot of energy, but this has been proven to encourage innovation in renewables and wasted energy exploitation

Criticism Of Proof Of Work

Criticism of Bitcoin’s energy consumption is common. Since Bitcoin requires a substantial amount of energy to protect the network, proof of work is an easy attack vector by those whose interests are more aligned with the pre-existing fiat financial system.

However, the widespread narrative fails to acknowledge that Bitcoin is, in reality, driving innovation in the technology that generates clean energy and exploits wasted energy.

How? Bitcoin miners need to find the most cost-effective energy sources to be profitable. As a result, affordable energy for Bitcoin mining is increasingly coming from renewables, as well as from wasted and “stranded” energy sources, rather than relying on fossil fuels.

Renewables

Since renewables — primarily wind and solar — are among the cheapest energy sources, Bitcoin miners are incentivized to subsidize their innovation, to the benefit of everyone.

Many misunderstand that energy consumption doesn’t directly produce carbon dioxide emissions, but the source may. The effect on carbon emission comes from energy production, not consumption.

Wasted Energy

Flared natural gas is an example of wasted energy: To avoid the high costs of transporting natural gas from remote locations, oil companies that produce it are recommended to either release the gas into the atmosphere or literally “flare” it to limit environmental impact. However, flaring it safely also has a cost, and if gas drillers could use a gas generator to power Bitcoin miners, that wasted energy is turned into good usage — producing bitcoin!

Stranded Energy

As Bitcoin mining operations can be located anywhere in the world, they are increasingly attracted to “stranded” energy, which is often too remote for populated areas, like ocean currents or desert sun. Biogas is another such option, which produces reliable energy, but is oftentimes not connected to the grid.

Frequently Asked Questions

How is the difficulty level of the proof-of-work problem determined?

Depending on how many hashes per second are mining on the network, the hash function’s complexity will increase or decrease accordingly so that it takes miners an average of 10 minutes to find a new block across the global network.

Can brute force solve the proof-of-work problem?

The only way to resolve the proof-of-work problem is through brute force, a general problem-solving technique, and an algorithmic paradigm that searches all the possible solutions to a given problem before finding the most satisfactory one.

What happens to proof of work when all the bitcoin has been mined?

When all the bitcoin has been mined, proof of work will still be needed for validating transactions, for which miners will receive a fee.

Are there any viable alternatives to proof of work?

To produce a decentralized, immutable, censorship-resistant, secure cryptocurrency like bitcoin, there is no secure alternative to proof of work.

What happens if two miners solve the proof of work problem for the same block simultaneously?

The block that appears in the longest chain will be chosen, which is the one that has the “greatest combined difficulty” of the hashes used and took the most computational power to create it.

The Final Word

Purposely misleading politicians and organizations have an advantage in criticizing Bitcoin’s proof of work and financing projects to discredit Bitcoin for its energy consumption. The advantage is to keep the current system as it is, beneficial to them, under the disguise that Bitcoin is wrong and harmful to humanity and the Earth.

Bitcoin is disruptive; it’s the hope humanity needs and must be discovered and understood to be fully appreciated. Proof of work is necessary to empower the transition to a new monetary system and a different world, and the effort required to produce it makes it even more worthy.

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Introduction

In a blockchain network where participants remain anonymous, a dependable coordination mechanism is essential. The “proof” acts as confirmation that a participant has met the requirements to validate a block of transactions, signifying their good-faith participation. One such consensus algorithm employed to generate new blocks, distribute new cryptocurrency, and validate transactions is proof of stake (PoS).

This mechanism provides an alternative to the original consensus method, proof of work (PoW). Rather than the energy expenditure necessitated by PoW, PoS requires validators or miners to make contributions to the network from their own holdings of the blockchain’s native cryptocurrency, i.e., their “stake.”

To avoid losing their stake, validators are incentivized to operate honestly and reach a consensus on the order and validity of transactions. PoS miners are selected based on the amount of cryptocurrency they hold or “stake” in the network; therefore, the more cryptocurrency a validator stakes, the more likely they will be chosen to create the next block.

Read More >> Technical Guide To Proof Of Stake

Comparison With Proof Of Work

Instead of stakes, PoW requires considerable computational resources and energy consumption to validate transactions and create new blocks. For this reason, people assume proof of stake is more energy efficient and less resource intensive than PoW. Yet, we will learn later in this article that this is a somewhat false assumption.

Both consensus mechanisms aim at producing new blocks and validating transactions. They must also maintain the security and integrity of the blockchain network, but they do so in different ways.

In PoW, miners compete to solve the Byzantine Generals’ Problem faster and reach a consensus on the validity of transactions. The quickest miner to complete the target hash creates a new block and receives the block reward, the network’s token of value. By selecting the chain with the most work, the network overcomes any ambiguity, and double spending is prevented due to requiring at least 51% of the global hash power for a double spend block to catch up.

In Ethereum’s PoS, by means of comparison, the double-spending problem is solved using “checkpoint blocks” at various points in time, approved by a two-thirds majority vote through a stake to “assure” everyone in the network about the “truth” of the system.

Another significant difference between PoS and PoW is the incentives and the ethics behind them. In a PoS network, incentives hide a negative (penalty-based) connotation since validators may lose their stake if they act maliciously. This contrasts with PoW, where miners are only incentivized to behave honestly to be rewarded with cryptocurrency through a positive (reward-based) incentive system.

Bitcoin miners who attempt to break the rules by producing poorly formatted blocks or invalid transactions will find their blocks ignored by full nodes. As a result, they will incur substantial electricity costs. Moreover, they would need to command 51% of the hash power to build upon older blocks; otherwise, these chains will lag behind, leading to even more costly energy waste.

One of the most heated debates in consensus mechanisms is decentralization and the ability to maintain this decentralization. PoW decentralization is secured by an active network of full nodes, in addition to miners, a vital feature that isn’t reflected in PoS consensus mechanisms. The importance of nodes in PoW was marked in the blocksize war of 2017 when the small block supporters won the battle against big blockers by starting the user-activated soft fork (UASF) movement and voting for the BTC chain instead of Bitcoin Cash (BCH). That historic Bitcoin event emphasized how nodes could win against big corporations and that miners do not control the network, unlike PoS validators.

How Proof Of Stake Works

In a proof-of-stake network, participants can be miners or validators who verify and authenticate transactions and create new blocks based on the amount of the blockchain’s native cryptocurrency they hold or “stake” in the network.

Validators are randomly selected to add the following block based on their stake; the more cryptocurrency a validator has staked, the more likely they will be chosen to validate transactions and create new blocks.

When a validator is chosen to create a new block, they need to validate all the transactions in the block and add them to the blockchain. To validate the transactions, the validator must check that they are valid, are not “double spending,” and that the sender has enough cryptocurrency to make the transaction.

Once all transactions are validated in the block, a new block is created and added to the blockchain. At that point, the successful validator is rewarded with native tokens for their work.

In a proof-of-stake network, consensus is achieved when most validators agree on the state of the blockchain. If a validator creates a block that is not accepted by the majority of validators, the block is rejected, and the validator may lose their staked cryptocurrency.

Valid Criticisms Of Proof Of Stake

Although proof of stake is often perceived as more energy efficient and less resource demanding when compared to proof of work, these assumptions can be easily refuted, showing that decentralization and security are compromised with proof of stake and that PoS is a mirror image of the current monetary system, which is known to be particularly energy inefficient, as well as unfair to the majority of participants.

One key argument against the perceived advantages of proof of stake is the concentration of wealth and power this can lead to. In a PoS system, validators with more stake (or wealth) have a higher probability of being chosen to validate transactions and create new blocks. This results in a rich-get-richer scenario, where the wealthiest validators gain even more control and influence over the network. The table below from Nansen Research provides a clear picture of the staking landscape within the Ethereum proof-of-stake system. 

This concentration of power contradicts the principles of decentralization, as a small number of validators can potentially dominate decision-making processes. Unlike proof of work, where miners have to invest in computational power, proof of stake allows validators to accumulate wealth and control the network based on their initial stake, rather than their ongoing contributions to the system.

Another valid criticism of proof of stake is the pre-mine configurations many cryptocurrencies, including ether (ETH), are based on. Mining tokens before their public launch means that founders, stakeholders, and developers may access a lot of wealth and have a considerable advantage over any other investors or validators who later join the network. While such a design could also apply to proof-of-work blockchains, it is more often used in the proof-of-stake ecosystems, because in such systems, it’s possible to have a greater share of the validation process, due to the absence of nodes.

Common critiques of the PoS consensus mechanism:

• Lack of decentralization: validators who hold a large amount of cryptocurrency have a higher chance of being selected to create new blocks, receive rewards, and they have more influence over the network, leading to a concentration of power in the hands of a few validators. This could lead to a situation where a small group of validators controls the network and its rules, potentially compromising its security and decentralization and reinforcing existing wealth inequalities.
• The validation process can be manipulated: since the network could be manipulated by owning 51% of the tokens in circulation, it is easier to influence the transaction validation than with a 51% attack on PoW, which requires controlling 51% of a network’s current computational power.
• Security: in PoS, the network’s safety depends on the amount of cryptocurrency held by validators, making it more vulnerable to attacks if a large number of validators were to collude.
• Complexity: there are various types of proof of stake, such as delegated PoS (DPOS), leased PoS (LPOS), pure PoS (PPOS), and other hybrid types. These are all variants of an overengineered system, which is difficult for anyone to truly explain and understand. The more complex a system is, the more likely it is to fail.
• Environmental impact: proof of stake (PoS) is often criticized for its environmental impact, mirroring the concerns associated with the existing monetary system. Unlike proof of work (PoW), which incentivizes the expenditure of energy, PoS systems are considered less energy intensive. However, the proliferation of blockchains relying on inefficient PoS mechanisms collectively exacerbates their environmental footprint.
• Nothing-at-stake problem: the nothing-at-stake problem is a theoretical weakness in PoS, where validators have little to lose by creating multiple versions of the blockchain. In a PoS network, validators could create multiple versions of the blockchain, hoping that one version will become the “correct” version. This could lead to a situation where the network is unable to reach a consensus, compromising its security.
• Difficulty in determining the right amount to stake: determining the optimal amount of cryptocurrency to stake in a PoS network is challenging. Validators must balance the desire for higher rewards with the risk of losing their stake.

Would Bitcoin Ever Move To Proof Of Stake?

Ethereum’s recent shift from PoW to PoS in September 2022 sparked ideas across the corporatized environmental world that Bitcoin should do the same and therefore abandon the “extreme energy consumption” required by its consensus mechanism.

Changing Ethereum to a PoS system won’t/didn’t reduce energy consumption by 99.95%, as it fails to take into account that expensive enterprise farms and corporations use enormous amounts of energy to subsidize the work necessary to complete PoS transactions globally.

The Greenpeace “Change the Code” campaign funded by Ripple Labs to discredit the energy usage of Bitcoin’s proof-of-work system is a typical example of how the corporate world does not encourage change and, instead, promotes the perpetration of an elitist system that is now fully mirrored in Ethereum’s consensus mechanism.

Besides proposing a new revolutionary and fair monetary system, PoW fosters renewable energy innovation and the use of stranded and wasted energy which will benefit the environment more than a supposedly energy-efficient PoS system in the long term. Proof of stake is merely better at concealing the energy purchases made by the corporations that enable its validating mechanism.

Thankfully, Bitcoin’s code is highly resistant to these types of attacks and was purposely developed this way. It is improbable that a proposal to change the code would even pass any initial stage of consideration by the developers, let alone the community.

Conclusion

In free markets, it is important to allow both proof-of-work (PoW) and proof-of-stake (PoS) mechanisms to coexist and evolve in ways that are profitable and beneficial to their respective supporters. Bitcoin, as an innovative monetary system, not only brings about technological advancements but also strives to have a positive impact on the environment. Educating individuals about the significance of PoW in this transformative process is a responsibility that Bitcoin enthusiasts understand and embrace.

If you’re concerned about wealth protection, financial inclusion, and fostering a better environment for all life on earth, the ideal choice is a currency that is borderless, permissionless and embodies pristine hard money and freedom technology.

This type of money, which is impervious to censorship and safe from confiscation, highlights the superiority of proof of work over proof of stake. In years to come, Bitcoin may likely be the only token of value, and the decision to support proof of work will be seen as obvious in hindsight.

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