It’s no secret that merchants who immediately sell their Bitcoin for fiat currency create downward pressure on the Bitcoin price, but the merchants aren’t the only people to blame. The proof-of-work (POW) system used by Bitcoin and other cryptocurrencies fails to create an incentive for miners to hold onto their coins. That means that as much as 3,600 BTC may be sold per day to pay for electricity and rent, alone. The mined bitcoins alone has a value of more than 180 000 USD. Depending on the type of pool used, some miners sell their coins instantly after being awarded their coins. Others sell throughout the day, or at the end of the week or month. This constant selling causes constant downward pressure on the Bitcoin price.
Bitcoin is based on a POW (Proof of Work) system where the probability of mining a block is dependent on how much work is done by the miner. A proof-of-stake (POS) systems varies in that a person can “mine” depending on how many coins they hold. Simply put, a person owning 5% of a coin based of proof-of-stake can mine 5% of the blocks in the same way that a person owning 5% of the bitcoin mining network will theoretically mine 5% of the blocks.
There are fears that POW systems can lead to low network security, due to the Tragedy of the Commons, and this has led to some coins adopting a POS system.
A tragedy of the commons for Bitcoin means that as payouts becomes smaller and smaller for Bitcoin miners, there is less incentive to avoid a 51% attack. The POS systems makes any 51% attack more expensive. Someone trying to doublespend and destroy faith in the network would have to own a majority of the coins, and the attacker would suffer from his actions.
However, Proof-of-stake systems alone don’t work – without mining you can’t create a community around your coin. Most coins that adopt proof-of-stake use a mixed system with both POS and POW. This is because POS encourages hoarding that is great for speculation but not for currency, which is supposed to be used. According to Fred Wilson, a venture capitalist and self-proclaimed Bitcoin believer, due to the price volatility and speculation people are hoarding their coins. People fear that the hoarding of bitcoins will lead to a deflationary spiral causing the Bitcoin price to plummet and ultimately signal the death of the currency. By design, POS system could unintentionally exacerbate the hoarding problem.
Proof-of-stake systems are also not as safe as a simplified explanation of them might make them out to be. If there are 1,000 coins in circulation, but only 100 coins staked, an attacker would only need 101 staked coins to perform the attack. Now image if there were only 2 staked coins – Yikes!
So neither the POS or POW system is perfect, and that’s why many coins are experimenting with a mixed system. Coins using a mixed system create the community with miners, whom reduce hoarding and also provide reduced downward pressure on the coins price. Bitcoin experiences downward pressure from miners who sell their coins, but with a mixed system miners are rewarded for holding onto their coins and will likely choose to hold a percentage. With the volatility in the Bitcoin price, you’d think the developers would want to reduce any negative pressure, but Bitcoin remains a POW system and, by all accounts, will remain so.
Bitcoin isn’t the only coin that could benefit from switching to a mixed system. While miners who believe that the Bitcoin price will increase over time hold their bitcoins – almost all other altcoins that are mined are sold for fiat currency or bitcoins. Cryptocurrencies that are weaker than Bitcoin risk being quickly mined and dumped, destroying the coin altogether until someone else picks it for a pump and dump.
In the last few weeks, the price of Bitcoin has been struggling, and we know that miners aren’t helping. Merchants are putting downward pressure on the price, but that’s a necessary evil. Miners don’t have to be a part of the problem, and switching to a mixed system could help counter the downward pressure the Bitcoin price experiences due to merchants. Is it just me, or should all coins use a mixed system? It makes sense as a way to provide incentives for miners to hold their mined coin.
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Last modified: August 30, 2014 16:48 UTC