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Michael J. Casey is the chairman of the CoinDesk advisory panel and a senior blockchain research consultant at MIT's Digital Currency Initiative.
The following article originally appeared in CoinDesk Weekly, a personalized newsletter that was delivered every Sunday exclusively to our subscribers.
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With last week's delay in Constantinople offering a reminder that ethereum faces challenges in its long roadmap to migrate from a job verification algorithm (POW) to proof-of-stake (POS), it is easy to lose the fact that elsewhere in crypto-land, the POS is already a thing.
A little discussed issue is that POS will create new commercial and financial models for cryptocurrencies, which will in turn give rise to new regulatory and security challenges.
Seen through the prism of traditional finance, a consensus model in which cryptocurrency owners earn block premiums when they put, or deposit, their holdings to "vote" on the validation of a ledger begins to seem a little 39; as a function of interest. And when third parties, like those who are starting to provide "picketing as a service", do this on behalf of the coin holders who trust them to provide custody and exchange functions, it starts to look like banking.
This evaluation would rightly alarm the cryptic traditionalists. And it is one of the reasons why some warn against these attempts to improve the POW model on which bitcoin is founded, arguing that the POS will reduce security and encourage centralization.
But although the Lightning network and other "Layer 2" solutions can help bitcoins and other POW coins solve problems of scalability and costs, the test of work must face real challenges both in terms of computational efficiency and in its public perception as an environmental threat.
As such, it is difficult to imagine that there will not be a continuous and growing support for the chains using the stake test and its cousin, the delegate test of the stake (DPoS), which draws on the notions of representative democracy to increase efficiency. at the cost of a certain centralization.
Already from 19 of the major blockchain projects reviewed on Crypto-Economics Explorer by CoinDesk, three – Cardano, Dash and Qtum – are using the game test and three more – EOS, Lisk and Tron – use DPOS. Four of these six are among the top 15 classified cryptocurrencies cited by CoinMarketCap.com, which collectively represent $ 6 billion in monetary value starting Friday afternoon.
If we added ethereum to that group, along with Tezos, another major blockchain project that used a change in POS, the total market capitalization of these major POS chains would have been $ 18.8 billion.
This is still less than a third of the total valuation of $ 64 billion bitcoins. However, this universe of future and current POS chains can not be ignored. We must reflect on what POS means for the evolution of a financial system based on cryptography.
A business waiting to happen
I had not thought about it until I read one excellent thread conductor Twitter of Israeli blockchain entrepreneur Maya Zehavi in which he assessed aspects of a new report by the European Securities and Markets Authority (ESMA) on the regulation of cryptographic activities.
Zehavi took stock whereas while ESMA recommends that cryptographic exchanges now employ segregated account systems, in the future there will also be a need for 'exchanges to explicitly inform customers if their funds are used for stakeout purposes' and for' obtaining a consensus specific".
It made me think of how unavoidable the appealing-as-a-service is for all trades that handle people trading in POS coins. There are no clear signs that someone is doing it with encrypted tokens in their custody – and if that happens is happens without user consent, must stop. But the idea of helping their clients earn revenue on their otherwise dormant currencies, and charging a commission to do so, is certainly appealing to both parties.
A bitcoin utopia in which "everyone is their own bank", with complete control over their private keys, could be desirable from the point of view of decentralization and security. But millions have proven to be happy to have an insured third party that manages custody for them rather than having exclusive control over their assets. The success of Coinbase and other similar handbags and wallets managers tells us about this.
Now, add that the prospect of having an exchange or a dedicated custodian manages cash rewards on behalf of the people and it is easy to see many people doing it.
There is a fiat equivalent: most of the world savings in dollars, euros, yen and all other traditional currencies are in interest bearing bank accounts or are grouped in funds whose portfolios are managed by third parties. People find it convenient and more effective to pool their monetary power with others and make a stranger invest them for them.
Back to the Future
But wait a second. Are we not simply recreating the old banking world with all its connected systems and counterparty risks? Maybe yes.
As Viktor Bunin of Token Foundry points out, if we can imagine that the service of staking-as-a-service becomes so popular that virtually all currencies permanently reside with the most trusted of these keepers, always earning rewards, then we can even imagine those entities that issue transferable and interest-bearing deposit certificates based on the coins held with them.
Given that it is unlikely that all users' currencies will be withdrawn simultaneously by that institution, these revenues would be traded at par, which could mean that they are treated as a unit of exchange equivalent to the value of the underlying deposited coins, allowing essentially for the creation of off-currency money.
"Congratulations!", Writes Bunin, "We're back to the starting point to reinvent the fractional banking system! Now you have a good and a financial instrument that's a credit for that good."
Anyone who has studied the history of the banking sector, particularly banking, systemic risk and all the panic that have led to repeated crises in our financial system, and who has also looked at how governments have entered the crypted space in the name of the consumer protection, will know that this scenario will inevitably invite another level of regulation. And for a number of reasons, including maintaining the cost of entry for innovative startups, it can be problematic.
Now it's time to try and move on. As with many other ideas that try to fight security risks away from regulatory authorities and put them in the hands of users through blockchain-inspired governance, the way forward could lie in innovators developing decentralized solutions.
Not unlike the work done in decentralized exchanges and atomic swaps that protect users from counterparty risks with centralized exchanges, developers can also look to decentralized systems to pool resources used in stakeout services.
One way to think about it is illustrated by a proposal to create pools of block producers managed by their decentralized applications, so that smaller players can participate in the lucrative EOS reward system for producers of delegated blocks.
Another way to add security to the system could be to enforce multi-sig custody agreements in the betting service agreements, so that customers maintain final control while service providers still have the power to run blocked votes.
As the investor Arianna Simpson has documented, the staking is already taking off, with the first players earning steep margins. It takes note of a natural trajectory through which the new competitors will enter the market and restrict the diffusion, making this more attractive for the wider market.
The moment to understand what this means for the encrypted financial system is now.
Image of Ethereum through the CoinDesk archives.
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