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So when running a network and exchanging information or currencies, you must
have a way to make it accessible and secure at the same time. Most places that
keep large amounts of data and records, such as the Department of Motor Vehicles
(DMV), use a centralized server. This means only one server is in charge of holding
and securing the information. In a way, this is easier to secure because it’s a private
server that has limited access. Also, companies can afford high-end computers that
are supposed to perform transactions very fast in large volumes. The downside is
that it is centralized, meaning that it is controlled by one of a few people. They are in
control of all the data and if had bad intent cause a lot of problems for a lot of people.
The other problem is that if there is a weak point in its security, hackers only have to
bypass that server's security to control all the data.
So, starting with POW, I will be using Bitcoin as an example. With Bitcoin, you are entrusting large numbers of people to manage large amounts of data, secure it, and agree on transactions. POW solves this problem. A simple analogy would be if you had one person randomly pick a color and asked you and your friends to make that color by combing different colors from a selection of 256 colors. You might need three colors mixed in or thirty, and you will have to get the ratio in the mix correct as well. To add more of a challenge, the last art class all of you had was in high school, so basically it is just a guessing game. It would take a lot of work, and you could not lie about making the correct color since a majority have to agree it is the correct color. Now if you want an advantage, you can hire some more help. This is why you see large computer setups mining Bitcoin. These high-end computers and server farms act as extra people, helping mix colors to try and get the correct color. POW has all the nodes performing complex problems that go through a hash to find the correct number. Once the correct sequence of numbers is found, the node is rewarded with being able to mint the next block. Due to the amount of time and power it takes to perform this function, nodes are awarded a set amount of Bitcoin as well to add as a reward. So, for someone to take control of the network, they would have to control 51% of all the computing power on that block that uses POW. With larger chains like Bitcoin, you can see why that is unlikely to happen with all the people who are trying to mine it in an honest way.
Using POS as a consensus algorithm is becoming one of the most common ways to secure a blockchain. I will be using Cardano as an example to help explain this topic. Just like POW, there has to be a way to allow information to flow through the network while being trustless and secure. POS does this by having nodes stake a certain amount of their tokens to have a chance at being rewarded as the one that places the next block. The node that is rewarded for the block is kind of random. It is random in the sense that it is not pre-determined who will win, but whoever has the largest stake has a better chance to win. POS is like wearing a blindfold and throwing a dart at a very large dartboard that is broken up into uneven sections. The more you stake, the larger your portion of the dartboard will be. Now some blockchains add in parameters such as the longer you stake, the larger the reward, and other long-term incentives, but for simplicity, we will not include that.
The reason for having someone stake a certain amount of tokens makes them have an investment to incentivize proper behavior. If the individual who is staking becomes a bad actor or is dropping off the network frequently, their rewards will be diminished and they could risk losing some of their staking tokens. Not everyone can run a node consistently, so Cardano and other POS blockchains, they have staking pools. This is where people can delegate their tokens to someone who will stake all of them at once. Even though the stake pool operator has tokens delegated to them, the tokens still belong to the delegators. When rewards are paid out to the staking pool the owner normally gets a set amount and the rest a divided amongst the participants in the pool. They are rewarded based on the percentage of the pool their tokens make up. A very well-known downfall of POS is that if someone or a group stakes the majority of the tokens, they will be able to control the network. Several POS blockchains will only allow staking pools to reach a set amount before they start lowering rewards. This will discourage over-saturated pools.
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