Whales and Proof-of-Stake

by Alexander Mueller

Proof-of-stake consensus algorithms are touted as the next big thing in blockchain and not for no reason - concerns about massive electricity usage in existing proof-of-work architecture have taken on macro-scale environmental relevance with the success of Bitcoin and others. Proof-of-stake does not require significant real world resources on the margin, so there are in fact much better prospects for limiting energy utilization. However, moving costs into the virtual sphere presents new dangers, particularly to the extent that this makes it easier for “whales” (big-time owners of huge amounts of cryptocurrency) to manipulate markets.

First, let’s rewind a bit: what is proof-of-stake and how does it differ from the original proof-of-work approach? What is commonly called mining is really participation in maintaining the shared, distributed ledger, and all cryptocurrencies work by creating formidable incentives to participate in this maintenance honestly. In the older proof-of-work model, reaping the rewards of mining requires solving a computationally difficult makework problem. An attempt to participate in mining maliciously might not work, but it would still require the expense of solving this makework problem. This system has worked well, but many have become justifiably uncomfortable directing so much energy to open makework.

Proof-of-stake, on the other hand, requires a “stake” of cryptocurrency rather than a solution to a makework problem. If you behave yourself, you get it back, while you lose it as punishment for bad behavior. It is obvious but important that this system is explicitly oriented towards those who already hold cryptocurrency.

There are concerns already that ownership in cryptocurrency is so concentrated - for example, 1,000 addresses control 40% of all Bitcoin, and many smaller currencies are even more dominated by these “whale” crypto one-percenters. (There is also reason to believe that single whales might control multiple addresses and thus more power than is apparent.) These big players have considerable ability to manipulate the price of these assets using the same techniques you would use to manipulate the value of of any other asset, and there is some evidence that they are willfully doing so. Unfortunately, there is potential for proof-of-stake to make this situation worse.

The key issue is the role played by transaction volume in evaluating the health and viability of a cryptocurrency. Networks that are processing lots of transactions, so the conventional wisdom goes, are really being put to work by someone out there and are thus likely to stick around. The danger here is that someone might find a way to submit a macro-scale volume of transactions to and from accounts they control. One can potentially create an appearance of traction and relevance that is not there, and typically this would mean an increase in price.

If I am both a big-time holder and a big-time miner, the fees attached to a transaction may be fees I end up paying to myself. Proof-of-work has an answer to this problem, as I am still on the hook for the electricity bill whether or not my manipulation scheme is successful. Proof-of-stake might not have an answer - the whole point is to eliminate real-world, physical costs, but these costs were also a principal barrier to manipulative self-dealing. Whale miners could very well find themselves in a position where they have every incentive to pay themselves to process transactions from themselves to themselves. On the outside, it looks like blossoming commerce, but the reality is that it is accounting manipulation on the books of a single large whale.

The environmental concerns attached to proof-of-work are real, but equally real are the concerns about how proof-of-stake might make a network more vulnerable to manipulation.