Proof-of-stake was the first mechanism used by a Bitcoin-based monetary system, and it was Peercoin. The proof-of-stake model used by Peercoin, however, is not without criticism. These objections are discussed in this article along with a related system that has been altered to address them.
Each node can use a portion of its balance as a stake in a condensed version of Peercoin’s proof-of-stake architecture, enabling it to chain blocks. This node has a greater chance of growing the block chain the higher the stake. Chaining blocks earns you 1% of your used stake per year in newly minted coins. On the other hand, carrying out transactions necessitates paying a fee that devalues 0.01 coins per transaction. One transaction is made by Bob, for instance, after he chains a block using one coin at stake. The 0.01 coins he earned as compensation for chaining that block are then obliterated by the fee he must pay to complete this transaction.
Here are five objections to this proof-of-stake model:
- It makes the wealth gap more pronounced. Let’s say Peercoin is Bob and Alice’s sole source of funding. Bob makes 200 coins a month, but 80% of that amount is spent on expenses. Alice makes 800 coins a month, but 50% of that amount is spent on expenses. Assuming for the sake of simplicity that neither Bob nor Alice have any savings—which Alice is more likely to have—Bob and Alice will be able to reserve 40 and 400 coins as block-chaining stakes, respectively. Then, despite the fact that her income is only 300% greater than Bob’s, Alice’s block-chaining reward will be 900% greater than his.
- Money supply instability results from it. Inflation now varies inversely with transaction fee payments but directly with successful block-chaining rewards. The exchange value of goods and the velocity of money circulation are already fairly inevitable sources of price instability, but this variable inflation unnecessarily adds another source, decreasing price predictability and transparency. Like Bitcoin will have after the year 2140, Peercoin’s money supply ought to be steady.
- Every time the total cost of paid transaction fees is less than the total cost of successful block-chaining rewards, all inactive or unsuccessful block-chaining nodes will, through inflation, pay a fee to all successful ones. The cost of using the system is concealed by this implicit value transfer.
- The (currently 0.01 coins) transaction fee will eventually become excessively valuable as coin values rise, necessitating that Peercoin developers reduce it. However, selecting its new nominal value is a political issue because it is an economic choice rather than a technological one.
- System integrity relies on extrinsic incentives: both the block-chaining reward and its compensating transaction fee require arbitrary adjustment, which once again requires an economic choice and results in a political issue.
Transaction Rights Instead of Money
The extrinsic, financial nature of blockchain incentives—the blockchain reward minus its compensating transaction fee—is the source of all five of these criticisms. Therefore, only a block-chaining system that is fundamentally nonmonetary can address all of them. But is that system actually feasible?
Yes, if the benefit of chaining blocks is the ability to conduct transactions rather than newly created or even old coins. This means that the reward does not have to be equal to the stake. For instance, Alice does not simply need to own twice as much money as Bob to conduct twice as many transactions as he did. However, how can a stakeholder in a blockchain estimate the volume of transactions required? Is there a way to determine that volume objectively?
Yes, even though it’s just one that’s generic: the system’s actual transaction volume. Then, chaining a block will not yield a monetary reward, but rather future transaction rights equal to the total size of all transactions in the block. To allow for future transaction volume growth, if necessary, this reward must be larger than it is. For instance, a block-chaining reward — in Peercoin, a stake output — could allow its winner to make a future volume of transactions 1% larger than the sum of the sizes of all the transactions in its containing block, as opposed to annually minting 1% of its used stake.
Here is how to implement such a nonmonetary block-chaining model:
- Each transaction must be signed with the private key corresponding to the block chaining reward.
- The combined size of all transactions that the same private key can still sign is calculated by subtracting the size of each transaction signed by the private key signing a block-chaining reward from the maximum transaction volume permitted by that reward.
This design addresses all those initial five objections:
- It cannot widen the wealth gap because neither its transaction fee nor its block chaining reward have any monetary value.
- Since neither its block-chaining reward nor its transaction fee creates or destroys money, it is unable to cause instability in the money supply.
- Because its money supply is unaffected, it cannot force all inactive or unsuccessful block chaining nodes to pay a fee to all successful ones through inflation.
- Since there is no monetary value, it cannot be required to adjust the nominal transaction fee that chains blocks in response to changes in its own invariable.
- For its block chaining, which is a prerequisite for carrying out transactions, it cannot demand extrinsic incentives.
In actuality, block chaining essentially collects transactions rather than money; transactions, not the creation of money, are what depend on chaining blocks. Therefore, even though they are still indistinguishable from actual transactions, the blockchaining reward is always represented by transaction rights. Additionally, rewarding each block with the right to make a future volume of transactions exceeding that of all transactions in this block by a limited margin has the following two advantages:
- Monopolizing transaction rights becomes as improbable or fleeting as chaining together consecutive blocks.
- Monopolizing transaction rights becomes just as unlikely or fleeting as unilaterally increasing transaction volume.
Monetary Tier
What happens, though, if a node is unable to acquire the required transaction rights as soon as possible, if at all? For instance, if Bob has just received his first set of coins and needs to make transactions before potentially chaining the right to do so, how can he do so? Fortunately, nothing mandates that the private keys that signed a transaction-right reward and its enabled transaction inputs belong to the same owner. For instance, Alice can use the same private keys to sign Bob’s transactions as she did to sign her own unused, excessive reward if she has enough unused, excessive transaction rights.
However, those who use their earned transaction rights to facilitate transactions from others should receive additional compensation. As a result, since they must be exchanged for those rights, the reward can no longer be any of those things; it can only be money. For instance, Alice could charge Bob a fee to use her private keys, which are still capable of signing transactions.
To the then-underlying, otherwise nonmonetary block chaining system, this transaction-right pricing adds a second, more monetary tier: a market for resolving inequalities in the distribution of transaction-rights. However, this transaction-right market is a real market, unlike the relationship between Bitcoin miners and those paying them fees to transact. Transaction rights, a necessary byproduct of the block-chaining process, are already something its block chainers can sell for those fees. Bitcoin miners can only charge for those rights in the future. The block-chaining business itself is currently their only marketable good outside of bitcoins, which unlike these are not priced in transaction fees. Otherwise, they are limited to charging for the chaining of blocks, a still privately controlled public service, just like their government.
On the other hand, those who charge to allow transactions in the commercial tier of a non-monetary block chaining system are not always, or even frequently, the same ones who include those transactions in a block. The relative independence of transaction rights as a marketable byproduct of block chaining prevents their monopolization and subsequent price gouging, but on the other hand, it also maintains the decentralization of block chaining.
Feedback Loop
However, determining the rate at which transaction volume can grow is still a matter for the economy, which poses a political conundrum. Exist any unbiased indicators of how much more transaction rights must be used?
Yes, although only two:
- the volume of paid transactions per block as a percentage.
- relative price change for this volume compared to the previous block.
The two tiers of this transaction-right chaining system form a feedback loop when additional transaction rights are determined using the average of those two relations. For instance, if a block has 4% of paid transaction volume and pays for that volume 1% less than the previous block would have done, it can allow for transactions that are at most 4% less than its contained ones, or 1.5% more in total size. As a result, the transaction rights gained by chaining block B will be smaller than the total size of the transactions it contains if the relative price drop of the paid transaction volume since the previous block exceeds the proportion of this paid volume in B.
In fact, the only objective indicator of people’s unmet transaction-volume needs is the price they pay for a given volume of transaction rights. The minimum size of a single transaction must be the minimum limit on the total number of transaction rights earned by chaining a single block, or else they would not have become transaction rights, which must enable actual transactions.