second draft
Proof of Stake ScalabilityWhat is the problem?Proof of stake systems are off to a great start. From our current vantage point these new ways of validating the blockchain implemented in currencies like Peercoin and Nxt, seem to adequately secure their respective blockchains while simultaneously promising to create a fraction of the carbon footprint that their Proof of Work based predecessors do. It has long been known that without increased transactions fees Proof of Work systems will eventually no longer be able to provide enough incentive to motivate a sufficient variety of miners to still call the network decentralized.
At smaller scales the effect of validation cost goes unnoticed. When you're only conducting a small fraction of the number of possible transactions, it doesn't cost that much to validate them, leaving all the attention on how decentralized the network is, and what is the cost per transaction.
With relatively few transactions in a market that has not yet gone mainstream it makes sense that validation cost has yet to become a serious matter in any as validation can be done with much less computer power. Already we see that in Peercoin and Nxt that to make gains from running a node, one must have a substantial amount of currency up for stake.
You can see this coming if you've ever tried to mint Peercoin with only a hundred coins to your name, or forge Nxt with only a thousand. It just doesn't happen in a timely manner, and that means you have to keep your node running for a longer amount of time to mint a given amount, and the longer a node runs the more resources it consumes. At this early stage, that extra time running a node is pretty much negligible because the electricity and computing resources to do so won't constitute much at this stage of the game, without very many people making transactions. Given more popularity, and thus more transactions that need validating, this problem will increase in time, given more general usage.
This problem can be mitigated with transaction fees but at a certain point, in order to remain profitable, transaction fees would have to increase to the point that spending the currency would become discouraging and people wouldn't use the currency for it's intended purpose so that's a non-option. This is less of a problem with Peercoin because it's designed to be leaner, and more oriented towards savings and larger transactions anyway, but Nxt is supposed to be more of a bread buying currency and this could lead to issues later.
Let's take a look at Nxt. Based on the number of transactions as of the time of this writing, information found
here by Empirical1, the network is likely to bring in less than about $8000 worth of transaction fees a month. That's given their current number of transactions which is averaging about 0.8 transactions a minute, or 0.01 transactions a second. Increasing that rate to 10 transactions per second means 1000 times more transaction fees, or 80,000 a month from securing the network. Running a node for one person is going to cost on average about a hundred dollars a month for electricity costs. This means in a completely decentralized Nxt network that doesn't use leased forging, only those with 1/800 of all Nxt or more would be able to forge profitably at ten transactions per second. The costs for hardware go up even more as the number of transactions increase.
At 2000 transactions a second this means the network (assuming the transaction fee isn't altered) would bring in about 16,000,000 a month. However to cost to secure a network with that many users is going to increase exponentially as well. At this point a server capable of handling that many transactions is going to cost along the lines of $5000 a month. The end result is that only those with balances more than 1/3,200 (at this level that will be many millions of dollars) of the network would be able to forge profitably given complete decentralization. This seems like a reasonable number until you consider that to create that many transactions, the network will consist of billions of users.
The situation is similar with Peercoin, only the fixed transaction fee spreads the cost of running those nodes more evenly to each shareholder.
Then you have proof of work systems, which retain the same hardware costs as running a PoS node but also add artificial hardware resource costs to help facilitate distribution of currency. This already costly effect is amplified in Ethereum's proof of chain model which requires the entire blockchain to be downloaded to mine. Ultimately the primary difference in this model is that distribution is based on who has the most powerful hardware rather than who has the most stake, but as we've seen, even attempts to base it on who has the most stake eventually result in hardware costs exceeding profitability for but those who have the most wealth.
The only option is some degree of centralization, which occurs naturally in all of these schemes over time.
How to balance centralization with scalability?It seems an inevitability that no matter how you spin it one of two scenarios will play out in the current systems left unchecked, either centralization will take hold, or transaction fees will get unwieldy. So how should we mitigate this? The most recently posed solution to this is
Decentralized Proof of Stake. In a DPOS system centralization is anticipated, and introduced by design but voted on in a decentralized manner using a system similar to reddit's upvoting to determine delegates tasked with the duty of signing nodes and preventing the blockchain from forking. Delegates can be voted on automatically based on the systems own analysis of how it's performing, or in cases where it may be necessary, they can also be voted on manually. A vote happens with each transaction so it's like a continuously ongoing election.
In DPOS those delegates chosen to secure the system, unhindered by any process designed to enforce decentralization, are incentivised by transaction fees and the prospect of being re-elected, to do their job correctly. The difference here is that the number of delegates are limited, and the amount of stake one holds or amount of computing resources one owns is seperated from their ability to secure the network. This results in a much more financially efficient scheme for validating transactions while still achieving a measured amount of decentralization to keep the network from being taken over by a few small parties.
This extra efficiency could be used to benefit the network as a whole. In DPOS, assuming an operating cost of about a hundred dollars a month, this works out to a need for $10,100 per month necessary to compensate delegates. Assuming one transaction per second this necessitates a fee of $0.004 per second, but as the number of transactions per second grows, this the amount that must be charged goes down until improved hardware becomes a factor. Setting the fees to a competitive $0.05 or $0.10 per transactions would provide extra income for delegates to promote or market the infrastructure as a whole, and profit shareholders. As more and more people pile onto the network it becomes more possible to continue lowering fees and give more back to shareholders.