What is a Proof-of-Work Chain?
What is a Proof-of-Work Chain?

Since the launch of the first widely-used blockchain protocol in 2009, many cryptocurrencies have successfully processed billions of transactions without relying on centralized third-party coordination.

Decentralized networks, including well-known examples like Zcash, Ethereum, and Bitcoin rely on rules & mechanisms designed to ensure that every participant or “node” in the network recognizes the same ledger.

While cryptocurrencies can use any governing set of rules, Proof-of-work (PoW) is currently the dominant method for coordinating payments or other processes and securing the integrity of common blockchain networks.

What exactly is Proof-of-Work?

PoW is a consensus mechanism that employs a mathematical, cryptographic puzzle to validate each transaction in a blockchain. Due to their nature as systems relying on computers to solve these mathematical problems (as explained in more detail below), PoW systems often require the expenditure of lots of processing power  before  additional transactions are accepted into the network’s global ledger.

How do Proof-of-Work blockchains operate?

Please keep in mind that what follows is not meant to be a fullsome or accurate description of how every PoW system works .

At the backbone of some PoW systems are “miners” racing to validate every incoming transaction. Under a common model of PoW, every broadcasted transaction in a blockchain first enters a virtual pool with other unconfirmed entries. In this model, miners are free to grab any collection of pending entries to confirm whether each transaction contains a valid signature from the sender along with a sufficient balance.

After confirming a full block of transactions in such a system, miners must then input the entire text of their block along with a randomly generated guess—referred to as “Nonce” for Number Only Used Once—into a cryptographic hash function.

Before any miner can broadcast their proposed transaction block to the network, the output of their hash function must have a minimum of a certain number of leading zeroes. For instance, if a protocol required that the output of the hash function must contain 4 leading zeroes in order for its corresponding block of transactions to be considered eligible for addition to the existing blockchain, then any hash function output with four or less leading zeroes would not satisfy the condition. An example of a satisfactory output in such a system could be “0000073920484030334.” Bitcoin’s SHA-256 (a type of hash function) is capable of producing1.1 *1077 possible outcomes – a number that dwarfs all the grains of sand on Earth. While a single computer could spend thousands of years re-adjusting the Nonce to crack this code, a network of many computers is capable of consistently solving this puzzle on the Bitcoin protocol about every ten minutes.

After hitting the target and the successful minder broadcasts its block, every node in the network must verify that the corresponding transactions align with consensus rules and that the miner correctly solved the cryptographic puzzle. If either condition is not met, the network is free to ignore the proposal. If the network accepts the block, the miner is rewarded by “mining” new coins or simply writing an entry in the public ledger paying themselves according to the protocol rules.

If two miners broadcast proposals at the same time or provide conflicting information, the network is often designed to wait and see onto which prior proposed block the next block is added. In many blockchain protocols, the network only recognizes the longest known chain, and in PoW, the longest chain represents the largest energy expenditure.

How does Proof-of-Work Ensure Coordination and Security?

Many proponents of PoW protocols state that PoW protocols are difficult, costly, and time-consuming by design. These characteristics are designed to make network attacks more costly, thus improving security of the network..

Cryptographic functions used in PoW systems are designed to be challenging to solve and easy to verify. Anyone looking to add entries to PoW blockchains must contend with the time, energy, and resources needed to compete in creating the next block, with no guarantee of producing that block. These features of many PoW systems are designed, to some extent, to reduce the likelihood of attacks on the network by forcing any actor trying to corrupt the blockchain to obtain sufficient resources to outperform all other actors on the network combined, such that the corrupting actor will have a chance to corrupt the blockchain and successfully mine blocks to permanently include such corruption (like a false transaction) in the public ledger

FAQs

Which blockchains use Proof-of-Work?

Proof-of-work is widely held to have been popularized by Satoshi Nakamoto, the pseudonymous identity of the creator of Bitcoin. Since the launch of Bitcoin, many other cryptocurrencies have employed their own version of PoW.

Some PoW protocols operate on the same SHA256 algorithm employed by Bitcoin , but others have embraced their own cryptographic puzzle to alter the details of their protocols, like the time and energy expenditure needed to mine a new transaction block.

What are the alternatives to Proof-of-Work?

As the crypto market continues to experiment and innovate, alternatives to Proof-of-work have emerged as security measures for decentralized networks. Proof of stake – a model first employed in a cryptocurrency by Peercoin to reduce time and energy expenditures – has become a well-known alternative to PoW. Other measures, like proof of space, are similar to Proof-of-work, but require computer storage rather than computation to  secure the network.

How to Spot Common Crypto Scams

Please note that this article is not designed to provide a complete overview of scams present in the crypto space. It is also not designed to provide advice regarding avoiding scams or otherwise. We hope that this provides some context to this area and as a basis for more research.

While there are opportunities in the world of cryptocurrencies, there are just as many opportunists looking to profit off newcomers and experienced users alike . Because all transactions on blockchains are final, users should prioritize understanding the landscape, and common scams before fully diving into the space.

Types of Scams

Unfortunately, fraudsters are creative with their scamming tactics. While the approach often changes, the strategy typically falls within a handful of “go-to” schemes meant to prey on naivety and emotion.

Anyone getting into crypto should be cautious of giveaways, tech support impersonations, and investment scams that plague the community.

Giveaway Scams

Giveaway scams are prominent on the internet as fraudsters dupe unsuspecting individuals with the promise of free money. These scams request for cryptocurrency payments with the promise of returning double or triple the original amount later . Unfortunately, the ease of crypto transfer allows for the scammers to get away without having to wait for things like ACH clearance, or wire transfers.

While anyone is capable of launching a giveaway scam, scammers find successby impersonating trusted individuals and celebrities to increase their reach and influence. Scammers will go the extra mile to secure or hack a verified Twitter account to feign legitimacy. Adversely, others will carefully craft profiles that are near identical to the original account. YouTube scammers will even repurpose footage of celebrities as a livestream and promote their giveaway scam in the description.

What is a Proof-of-Work Chain?
Figure 1 - Twitter accounts looking to impersonate will create an identity nearly indistinguishable from the original

With so many bad actors posing as legitimate figures, the best way to avoid giveaway scams is to remember – If it’s too good to be true, it probably is . You automatically forfeit all rights to your cryptocurrency the moment it leaves your wallet, so avoid sending funds to any strangers, especially if they are promising you future value in return. If you happen to spot a giveaway scam, do the right thing, and take a moment to report the fake account in-app in order to prevent others from being deceived.

Technical Support Scams

In addition to impersonating celebrities, fraudsters also work to masquerade as a customer support team and claim their computer/account has been compromised. After inciting fear, scammers will then offer to fix the non-existent problem after you verify your account information with your username and password. These scams are particularly dangerous for victims since their entire account balance becomes vulnerable.

Technical support schemes are often conducted as part of a phishing campaign, so malicious actors will seek to actively replicate the services of your normal services. Protecting yourself against this fraud requires a proper cybersecurity mindset.

  • Verify every digital correspondence to ensure the sender isn’t fraudulent
  • Never give remote access of your PC to any individual
  • Always use 2FA (2-Factor Authentication) when setting up your account, and never share these codes with any individual
  • Never give out personal account details in any digital correspondence

If you ever receive an email claiming any issue to your account, check your service’s social media and even personally reach out to confirm whether the cause for concern is legitimate.

Get Rich Quick Scams

Similar to giveaway scams, get rich quick schemes steal from honest people by preying on hope and greed. Unfortunately, between pyramid schemes, Ponzi schemes, and investment fraud, there are numerous approaches to this form of fraud that have been tested and refined in traditional finance before entering the crypto space.

Ponzi schemes and pyramid schemes in crypto operate no differently than they do in traditional markets – scammers promise immense returns on investment and then use the next round of investments at a higher valuation to pay off the previous set of investors. Unfortunately, crypto investors are eager to pile into a space where 100x returns within a few years aren’t uncommon. If anyone claims to offer such returns, you should do your own research.

Investment scams through Initial Coin Offerings (ICOs) are also difficult to identify since the market is built on providing early-stage capital to blockchain projects. Every promise of 10, 20, or 100x gains should be met with immediate skepticism – nobody knows where a coin will be valued in even 24 hours. Anyone looking to participate early in a coin offering should research the founders, company history, and feasibility of the project before putting any money in. Even if the price of a project increases dramatically in a short period of time, be wary of a pump-and-dump (where the cryptocurrency in question is artificially inflated and then sold off enmasse while retail buyers are still engaged in the chase upward movement).



What is DeFi?

After entering the crypto ecosystem in 2014, DeFi – short for decentralized finance – has been a rapidly growing popular alternative to traditional financial services. Cryptocurrencies like Bitcoin became infamous after producing truly decentralized money and monetary transfer.

DeFi takes this idea of monetary coordination a step further by decentralizing all the activities and services traditionally done with money. As a movement, DeFi aims to bring services like loaning, saving, and exchanging money from their brick-and-mortar institutions into the peer-to-peer cyberspace.

How does DeFi Work?

All DeFi applications execute on top of existing decentralized blockchains. Instead of relying on a central authority to execute financial services, DeFi maintains coordination through self-executing code called smart contracts. These programmable contracts automatically move capital between parties on the blockchain after pre-defined conditions are met. With its developer-friendly scripting language, malleable protocol, and growing network effect, most DeFi coins and applications are built on top of Ethereum .

Why use DeFi?

Until the arrival of DeFi, those holding cryptocurrencies as a form of money were presented with limited use cases for their digital assets. After purchasing a coin, users only had two options – sell their coin or hold their coin… to sell later. Decentralized finance birthed a world of possibilities for digital assets. Holders of cryptocurrencies can now access traditional investment vehicles with their coins and further operate as their own bank, money market, or margin trader.

Examples of DeFi Applications

In a short period of time, DeFi has amassed over $100 billion in assets locked up in smart contracts. While the amount of capital in this space grows and applications continue to evolve, several use cases for DeFi have remained cornerstone throughout its short history.

Decentralized Exchanges

Decentralized exchanges (DEX) like Uniswap, Kyber, and Bancor enable holders of various cryptocurrencies to exchange their coins peer-to-peer without the need of an intermediary to clear transactions. DEXs allow for individuals to fill orders by automatically transferring ownership of different coins from one wallet on the blockchain to another address.

Lending and Borrowing

Holders of digital assets are also able to place their coins into DeFi lending platforms like AAVE or Compound in order to earn passive interest. Borrowers can access the liquidity on these platforms by offering their own coins as collateral. Since price fluctuations in the crypto are sudden, these loans are often overcollateralized to protect the lender.

Derivatives

For active crypto traders, DeFi unlocks the potential for easier hedging and speculation through more advanced trading instruments. Conditional programming on smart contracts is capable of mirroring sophisticated trading instruments like options, swaps, and futures, but features cryptocurrencies as the underlying asset providing value. Since no broker is required, DeFi derivative platforms like Synthetix, have enabled traders to engage in the same trading behavior as their Wall Street counterparts.

Advantages of DeFi Applications

Permissionless

In addition to leveraging the decentralized infrastructure of blockchain, DeFi also borrows the ethos that finance can be conducted in a permissionless, decentralized manner. For instance, decentralized exchanges allow for two owners of any coin to engage in a trade without worry about whether the exchange has approved support of their coins. DEXs also limit counterparty risk by enabling both sides of the trade to hold their private keys and retain ownership of their assets until the final moment of transfer.

Inclusivity

Since every participant in DeFi is at liberty to remain anonymous, accessing capital or securing a loan in DeFi removes the barriers of entry in legacy finance – background checks, credit scores, paystubs, W-2, and even photo IDs are not required in DeFi. As long as a borrower satisfies the requirements of the contract, they are fully capable of acquiring a loan.

Speed

Crypto is a world that doesn’t sleep yet moves at hyper speed. The blockchain technology underpinning these platforms are capable of moving any amount of digital value from one end of the planet to another within minutes. This means that anyone in the world can access any DeFi platform 24/7/365 without fear of bank closures, holiday hours, or weekends.

Yield

Of course, the most attractive feature of DeFi is the amount of yield versus traditional vehicles. Instead of being complacent with sub-1% interest rates set by most banks, DeFi savers can enjoy more lucrative interest rates set by the market itself.

Risks of DeFi

Finality

Like all activities in crypto, DeFi is a user-beware ecosystem where “permissionless” is synonymous with “unregulated”. Unlike traditional vehicles, DeFi networks do not have customer service representatives to contact for questions, refunds, or advice – just ask Mark Cuban . Since all transactions are considered final, users must review all conditions of a smart contract before locking their capital within a smart contract.

Volatility

While DeFi products are able to multiply the gains from rapid crypto price appreciation, the losses in this space are just as susceptible to crypto’s notorious rapid price drops. Overcollateralized loans can quickly hit liquidation due to the volatility of the underlying asset. The time-lock on many DeFi contracts also prevents users from accessing and selling their coins when market conditions abruptly change.

Technical Risk

Although third-parties are absent in DeFi, the faith and regulation in this space is placed on the code which always works as written, not intended. Hackers are continually looking to exploit bugs and backdoors in order to walk away with more capital at the expense of honest players. In addition to reviewing all conditions of a smart contract, users should also examine the underlying code to ensure that they’re capital is technically sound.

Introduction to Blockchain Technology

Diving into the world of cryptocurrencies can be a dizzying experience. New terms and concepts like Proof-of-Work and DeFi require patience to understand and have varying applications based on the cryptocurrency. Despite their differences, all cryptocurrencies universally rely on blockchain technology as the bedrock for the protocol.

What is blockchain?

A “blockchain” is simply a chronological record of information sequenced into units called “blocks”. The idea was first practically implemented by Satoshi Nakamoto and the first Bitcoin developers in 2008 and 2009, but the concept of a blockchain was first theorized in the early 80s by David Chaum and reimagined in the 90’s by Stuart Haber and W Scott Stornetta. Blockchain was borne from the need to write information into a database without any possibility of altering or sacrificing any earlier entries.

The immutability of the blockchain ensures that the integrity of the information is never compromised regardless of the number of entries or passage of time.

How do blockchains work to secure data?

All blockchains place cryptographic hashes (or digital fingerprints) at the top of each block. These hashes act as unique identifiers for each entry in the chain, and can dramatically change if any detail of the block is altered. As new blocks are added to the record, the previous hash is inscribed below the new hash. Effectively, any alteration to one portion of the blockchain would require recalculating the hash for every subsequent block. This feature of a blockchain allows every participant to follow along and verify the validity of every proposed block as the blockchain grows.

Since modern computers are capable of incredibly high computational throughput, blockchains were only practical in theory until the original bitcoin whitepaper surfaced on bitcoin.org. In order to limit the ability for a single supercomputer to alter the blockchain and strongly hold the creation of each subsequent block, Satoshi Nakamoto utilized a blockchain design that purposely slowed down the creation of each new block to ~10 minutes. This design principle, known as “Proof-of-Work” is implemented by requiring an immense amount of energy expenditure for any new proposal to the blockchain.

The purposefully managed block space and block time ensures that any low-cost computer is capable of hosting a copy of the ledger and auditing every entry to ensure its validity. By preventing a single actor from amassing enough energy and computational force to brute force the system, Proof-of-Work enables network coordination without any intermediary dictating the validity of the record.

Uses cases for blockchain

Blockchains inherently trade efficiency for record security and immutability. While any form of data can be recorded into a blockchain, the technology is only practical for storing information that is highly valuable and transparent to a large group. Thus, modern-day applications of blockchain use the technology as a ledger for recording the transfer of property ownership without the need of a trusted third party.

What is a Proof-of-Work Chain?
Figure 1 - Google search interest for the term "blockchain" skyrocketed in 2014 as individuals began using the technology for their own cryptocurrencies

Bitcoin first applied blockchain ledger technology to spawn the world’s first peer-to-peer electronic cash and payments system, but since 2014, individuals and companies have adopted and innovated on Nakamoto’s breakthrough to create their own use cases for blockchain. In addition to digital money, blockchain projects have been used to secure ownership of real estate titles, music royalties, and digital art. Large corporations have also started implementing blockchain technology to track supply chain data and prove to auditors that their records haven’t been tampered.

Since blockchain is merely a system for writing and recording information, the number of use cases continues to grow as more entrepreneurs and innovators find their own personal applications for the technology.

Types of blockchain networks

Public blockchain networks

In a public blockchain, anyone is capable of entering the network and requesting an addition to the ledger. Nearly all cryptocurrencies available today use this approach. While anyone has the power to submit a transaction, only the miners have the computing power to cement the proposals in a block. Public blockchains are perfect for large-scale decentralization, but since every user has access to the ledger, they provide little to no privacy for transactions.

Private blockchain networks

Private blockchains also operate in a decentralized peer-to-peer network, but in these networks, one organization or group of decision-makers decide who is able to participate in the network and maintain a copy of the shared ledger. Private blockchains are useful for parties who wish to secure trust and confidence between themselves.

Permissioned blockchain networks

A permissioned blockchain network is a form of private blockchain where limitations are placed on the participants within the network. In addition to obtaining an invitation before joining, permissioned blockchains restrict the transaction capabilities of the participants to fit within guidelines.

Consortium blockchains

Consortium blockchains are private networks run by multiple stakeholders who share the responsibility of maintaining the blockchain. Members of the consortium are typically pre-selected and do not change throughout as the blockchain progresses.

Basics to Crypto Trading

On top of creating an entirely new internet format, cryptocurrencies have ushered in an entirely new way of making money in the 21st century. Like a stock, cryptocurrencies can be bought, held, and sold for profit. Some individuals have made supplemental income or even an entire living out of trading cryptocurrencies.

While the world of crypto trading may seem complex, we’re here to help you navigate your first steps into crypto trading.

Trading vs. Investing

Before buying your first cryptocurrency, we recommend outlining your goals and expectations for the purchase. As yourself a few questions :

  • What price do you expect this coin to reach?
  • How long will it take for the coin to hit that target?
  • Are you planning on selling any coins before reaching that price target?

Answering these questions will provide clarity on whether you’re pursuing an investing strategy or a trading strategy.

Often used interchangeably, investing and trading are two different frameworks for capturing price movements. Those with a long-term outlook for the value of a cryptocurrency – 1 year, 5 years, a decade –fall into the investment camp. Even though the price may fluctuate higher and lower (and they often do in crypto), you are convicted to “ride out” the volatility because you believe that the coin will appreciate over time.

Trading cryptocurrencies is much more active than investing. Instead of simply buying and holding for a period of time, traders buy and look for an exit at a specific price point. Since cryptocurrencies are highly volatile, traders have abundant opportunities to enter a trade. While long term investors may be content with annual returns of 10-15% a year, active traders look for these gains at least every month.

Defining a Trading Style

For those chasing active gains through trading, it is important to define your approach. Most traders find themselves in one-of-four buckets:

  • Position Trading: Position is held from months to years.
  • Swing Trading: Position is held from days to weeks.
  • Day Trading: Position is held throughout the day only with no overnight positions.
  • Scalp Trading: Position is held for seconds to minutes with no overnight positions.

While any style is capable of success, you should stick with a strategy that best fits your personality. For instance, scalp traders are typically more impatient yet dedicate a considerable number of hours towards watching price action; while day traders are typically more type B personalities who prefer to begin and end their trading windows within 24 hours.

Scalp and swing traders might be nervous about stepping away from the computer with an open trade, position and swing traders have the confidence to hold a position for an extended period. Regardless of approach, you should find a trading style that provides the most comfort for you.

Traditional Trading vs. Crypto Trading

Trading cryptocurrencies mirrors the experience of trading in any commodity, forex, or equity market – cryptocurrency traders even apply the same technical analyses used in traditional markets. Despite the similarities, there are a few differences between trading in crypto and trading in legacy finance.

Trading Hours

Most markets (besides forex) bind trading within normal business hours. For aspiring traders with part-time and full-time jobs, traditional trading windows occupy the same time as their responsibilities. Trading cryptocurrency is much different. The blockchain never sleeps. No matter the time or day, crypto traders are always able to open and close positions on the open market.

Ownership

In traditional trading, your brokerage typically assumes ownership of the assets you purchase and sell on your behalf. Crypto exchanges and brokers assume the same responsibility but allow for you to transfer any coin nearly instantly into or out of yourwallet. Some traders with low time preference might forgo this option, but position and swing traders might opt for personal ownership and added security.

Capital Flows

Since the blockchain is an open and decentralized ledger, all transactions and monetary transfers are open for anyone to see and analyze. A new field of analysis known as “on-chain” analysis enables traders to examine the economic data for a blockchain to identify price trends. Normally, this data is available after running a node on a network, but several companies like CoinMetrics and Glassnode aggregate this information for both the public and paying customers.

How to Trade Crypto

Now that you have an understanding of trading strategy, and the basics of crypto trading, it’s time to take the steps to make your first trade!

Step 1: Study the Market

Before making any trades, it’s important to study the market and piece together price patterns of the cryptos you plan on trading. Understanding the fundamentals around a blockchain, the use cases, user growth, hype cycles, etc. can provide valuable insight and ultimately influence your trading strategy.

Step 2: Create a cryptocurrency account with a brokerage or exchange

Opening an account with a crypto exchange like Binance will empower you to trade dozens of cryptocurrencies on the open market. After providing personal identification information and creating an account, you’ll have access to trading views for every available crypto and currency pair. Make sure to get familiar with the interface of your trading view. Check out Binance’s guide on trading views for a quick crash course.

Step 3: Fund your account

After setting up your account, you’ll need to supply a trading balance through a bank account, debit card, or wire transfer. If you already own cryptocurrencies, you can even transfer your existing coins to Binance, where your personal trading account will be credited.

Step 4: Make your first play

Now that you’re set up and have a strategy, feel free to test and make adjustments to your approach as you learn from successes and mistakes. Err on caution for your first few trades and never risk more than what you’re comfortable losing. Experience makes the best teacher!

Feel free to test your strategy and make adjustments as you start to understand the landscape. There is a treasure trove of trading strategies and analyses left over from traditional finance for your disposal. Learn how to manage risk and make sure that you only use what you are fine with losing.

**All information and data is provided “as is” for informational purposes only, and is not intended for trading purposes or financial, investment, tax, legal, accounting or other advice. Fees may apply for any activity conducted through the Binance.US exchange. View our Fee Structure to learn more.

What is a Proof-of-Work Chain?
DexStrats 16 September, 2021
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