Blockchain: Proof of Work (PoW) versus Point of Stake (PoS)
Ashutosh K.
Ex banker, Now self-employed, MD &CEO of Kumar Group of companies, Author of many books.
?Proof Of Stake in cryptocurrency or blockchain
INTRODUCTION
As software and computer technologies are developing, a new lexicon is emerging. There are so many unique terms that exist in Blockchain and its back Cryptocurrency. These technologies serve as the gateway between the digital blockchain and human society. Cryptocurrency is taxed as per 2022 and 2023 IRS Rules, this guide will explain everything we need to know about taxes on crypto trading and income. The next Cryptocurrency to explode in 2023, there is no certainty, but we have a line on eight possibilities. There are several definitions that appear to explain in different ways but almost mean the same except for words. Proof of stake is a consensus mechanism used to verify new cryptocurrency transactions. Since blockchains lack any centralized governing authorities, proof of stake is a method to guarantee that data saved on the network is valid. Decentralization is at the heart of?blockchain?technology and?cryptocurrency. There’s no central encoded or encrypted lock to security and safety to manage a blockchain’s record of transactions and data. Instead, the network relies on an army of participants to validate incoming transactions and add them as new blocks on the chain.
?The definition of Staking
Staking is when people agree to lock up an amount of cryptocurrency in exchange for the chance to validate new blocks of data to be added to a blockchain. These validators, or “stakers,” put their crypto into a smart contract that’s held on the blockchain.
Staking cryptocurrency is a process that involves committing your crypto assets to support a blockchain network and confirm transactions. “The simple way to look at staking is like interest income that requires you to complete a task to earn the interest—checking blockchain transactions,” says Doug Schwenk, chief executive officer of Digital Asset Research. “If I validate only good transactions, I earn interest on my assets. If I include bad transactions, then I’ll be assessed penalties and lose some of my assets.”
WHAT IS PROOF OF STAKE (POS)?
DEFINITION
(1) Proof of stake is the consensus mechanism that helps choose which participants get to handle this lucrative task—lucrative because the chosen ones are rewarded with new crypto if they accurately validate the new data and don’t cheat the system.
(2) ??Proof of stake is a type of consensus mechanism used to validate cryptocurrency transactions. With this system, owners of the?cryptocurrency?can stake their coins, which gives them the right to check new blocks of transactions and add them to the?blockchain.
(3) This proof of stake (PoS) method of verifying blockchain transactions could solve crypto's environmental impact.
(4) ??Proof-of-stake?(PoS) protocols are a class of?consensus mechanisms?for?blockchains?that work by selecting validators in proportion to their quantity of holdings in the associated cryptocurrency
(5) ??The proof-of-stake model allows owners of a cryptocurrency to stake coins and create their own validator nodes.?Staking?is when we pledge our coins to be used for verifying transactions. Our coins are locked up while we stake them, but we can unstake them if you want to trade them.
(6) ?Proof-of-stake?(PoS) protocols are a class of?consensus mechanisms?for?blockchains?that work by selecting validators in proportion to their quantity of holdings in the associated cryptocurrency. This is done to avoid the computational cost of?proof-of-work?schemes. The first functioning use of PoS for cryptocurrency was?Peercoin?in 2012.
(7) ??Proof-of-stake is a cryptocurrency consensus mechanism for processing transactions and creating new blocks in a blockchain. A consensus mechanism is a method for validating entries into a distributed database and keeping the database secure. In the case of cryptocurrency, the database is called a blockchain—so the consensus mechanism secures the blockchain. “When blockchain participants verify that a transaction is legitimate and add it to the blockchain, we say that participants have achieved consensus,” says Marius Smith, head of business development at digital asset custodian Fiona.
The first?cryptocurrency?to adopt the PoS method was?Peercoin. It was followed by Nxt, Blackcoin, and ShadowCoin soon after. PoS has gained more popularity than PoW as a consensus mechanism in the cryptocurrency world. There are currently about 80 different cryptocurrencies that use PoS as the consensus mechanism. Some of the most popular coins using proof of stake include:\Cardano (ADA), Tron (TRX), EOS (EOS), Cosmos (ATOM), Tezos (XTC), Solana, Terra, and Cardanoare are among the biggest cryptocurrencies that use proof of stake.?
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PROOF OF WORK
1.?????Proof of work requires miners to compete to solve complex mathematical problems.
2.??????Proof of work has earned a bad reputation for the?massive amounts?of computational power—and electricity—it consumes. Given the heightened concern about the environmental impacts of blockchains that use proof of work, like Bitcoin, proof of stake offers potentially better outcomes for the environment.
?Ethereum, the second-largest crypto by market capitalization after?Bitcoin, is in the midst of a transition from proof of work to proof of stake.
THE NEED FOR SEARCHING FOR ALTERNATIVES PROOF OF OWNER REPLACED BY POINT OF SALE
?Comprehending PoS is very vital for those investing in cryptocurrency. Proof of stake (PoS) method is an alternative to proof of work, the first consensus mechanism developed for cryptocurrencies. Since PoS is the best energy-efficient, because of this property, it has become more acceptable as attention has turned to how?crypto mining?affects the planet. The PoS model allows owners of a cryptocurrency to stake coins and create their own validator nodes.?Staking?is when we pledge our coins to be used for verifying transactions. Our coins are locked up while we stake them, but we can unstake them if we want to trade them. When a block of transactions is ready to be processed, the cryptocurrency's proof-of-stake protocol will choose a validator node to review the block. The validator checks if the transactions in the block are accurate. If so, they add the block to the?blockchain?and receive crypto rewards for their contribution. However, if a validator proposes adding a block with inaccurate information, they lose some of their staked holdings as a penalty.
To become a validator, a coin owner must "stake" a specific number of coins. For instance,?Ethereum?requires 32 ETH to be staked before a user can become a validator.?Blocks are validated by more than one validator, and when a specific number of validators verify that the block is accurate, it is finalized and closed. To activate your own validator, you'll need to stake 32 ETH; however, you don't need to stake that much ETH to participate in validation. You can join validation pools using "liquid staking" which uses an ERC-20 token that represents your ETH. Different proof-of-stake mechanisms may use various methods to reach a consensus. For example, when Ethereum introduces sharding, a validator will verify the transactions and add them to a shard block, which requires at least 128 validators on a committee.?Once shards are validated and a block created, two-thirds of the validators must agree that the transaction is valid, then the block is closed.
The two most commonly used methods are?Random block selection?and?Coin age selection:
· Random block selection:?Validators are selected by looking for the nodes with the lowest hash value combined with the largest stake.
· Coin age selection:?Nodes are chosen based on the time that their tokens have been held as shares. Coin age is calculated by multiplying the number of days the coins are held as stakes by the number of those coins. PoS also gives validators and node operators a greater opportunity to enter into a consensus. Entry and exit require holding a specific amount of tokens. This is attracting users who do not want to spend the cost of expensive hardware to mine Bitcoin.
The method used to PoS in a Cryptocracy Cardano
We illustrate with an example by taking Cardano, a major cryptocurrency that uses PoS. The owner of Cardano?can stake it and put their own validator node. The time Cardano requires to certify blocks of transactions, its Ouroboros protocol selects a validator. The validator verifies the block, joins it, and gets more Cardano for their effort. The blockchain algorithm selects validators to detect each new block of data based on how much crypto they have staked. The more we stake, the better our chance of being chosen to do the work. When the data that’s been cleared by the validator is added to the blockchain, they get a newly minted crypto as a reward.
PoS Benefits
Proof of work (PoW) has created heightened concerns about its working which makes the?massive amounts?of computational power but consumes massive electricity causing negative environmental impacts on blockchains that use PoW, like Bitcoin, PoS offers immensely better outcomes for the environment. On a global scale, PoW is the most profitable where energy can be had for the lowest cost. This exacts crypto mining in a few regions where electricity costs are the lowest. According to Smith, proof of stake’s modest energy consumption addresses this problem and widely distributes infrastructure, possibly making a blockchain system stronger. PoS unlocks the door to more people partaking in blockchain systems as validators. Therefore, the need to buy costly computing systems and consumption of massive units of electricity to stake crypto. All you need are coins.
Crypto exchanges?like Coinbase, Binance, Kraken, ICON, Shitcoin, Coinbase, Robinhood, eToro, Gemini, etc., offer staking as a feature on their platforms. There are even committed staking platforms, like Everstake. Depending on the blockchain, crypto owners can earn yields of 5% to even 14% on their holdings by staking. One additional benefit of proof-of-stake blockchains offers potential for the future: they may be more scalable than their proof-of-work counterparts. Smith says that PoS blockchains can, in theory, assist more simultaneous transactions without compromising security or decentralization. This is where a great deal of innovation is happening today, and indeed a challenge that blockchains will have to overcome if they are ever to become widely used on a global scale.
PoS Drawbacks
According to Amaury Sechet, founder of eCash, PoS isn’t without cons. PoS is not as extensively vetted as PoW, which has secured billion-dollar blockchains for over a decade now. Certain executions of PoS could leave blockchains more vulnerable to different kinds of attacks than PoW, such as low-cost bribe attacks. Susceptibility to attacks mitigates the overall security of the blockchain. Validators who hold huge amounts of a blockchain’s token or cryptocurrency may have an extra-large amount of influence on a PoS system. Migrating a cryptocurrency from PoW to PoS is a complex and highly thoughtful process. Any crypto that wants to change consensus mechanisms will have to go through a difficult planning process to ensure the blockchain’s integrity from start to finish and beyond.
PoS
It necessitates validators to hold some of the blockchain’s tokens or cryptocurrency. It doesn’t require significant computing power for transaction validation. It’s a newer approach than proof of work, with less adoption as a consensus mechanism. Cryptos that use proof of stake might be more attractive for an?ESG portfolio?because of the lower environmental impact.
PoW
It has a long-proven history of use as a blockchain consensus mechanism. Miners don’t need to hold any of the blockchain’s assets, and only need computing power to validate a transaction. It may use a very significant amount of electricity. Cryptos using proof of work are often excluded from ESG portfolios because of the energy demands.
PoS versus PoW
There are two consensus mechanisms that are generally used in cryptocurrency and?defi?applications: PoS and?PoW. Whereas the former employs staking, PoW needs miners to resolve intricate math riddles in order to decide which network participants get to validate transactions and expand the blockchain. The biggest difference between PoS and PoW is their energy usage. PoW requires miners to compete to solve complex mathematical problems. The first miner to solve the problem gets to add a block of transactions and earn rewards. This results in mining devices around the world computing the same problems and using substantial energy. Since PoS doesn't require validators to solve complex equations, it's a much more eco-friendlier way to verify transactions.
?MINING POWER IN PoS
Mining power in proof of stake hinges on the number of coins a validator is staking. Participants who stake more coins are more likely to be chosen to add new blocks. Each PoS protocol works differently in how it chooses validators. There's usually an element of randomization involved, and the selection process can also depend on other factors such as how long validators have been staking their coins. Although anyone staking crypto could be chosen as a validator, the odds are very low if you're staking a comparatively small amount. If our coins make up 0.001% of the total amount that has been staked, then our likelihood of being chosen as a validator would be about 0.001%. That's why most participants join staking pools. The staking pool's owner sets up the validator node, and a group of people pools their coins together for a better chance of winning new blocks. Rewards are split among the pool's participants. The pool owner may also take a small fee.
The followings are the pros and cons of the proof-of-stake model:
PROS: Energy-efficient, provides fast and inexpensive transaction processing, doesn’t require special equipment to participate
CONS: Not as proven in terms of security as proof of work, Validators with large holdings can have excessive influence on transaction verification, some proof-of-stake cryptocurrencies require locking up staked coins for a minimum amount of time
Here are examples of major cryptocurrencies that use proof of stake:
Cardano is a research-driven blockchain platform that prioritizes security and sustainability. Tezos?is a programmable blockchain designed with an on-chain upgrade mechanism for adaptability. Algorand uses a two-tier blockchain structure to offer processing speeds of 1,000 transactions per second. Because of how it works, proof of stake benefits both the cryptocurrencies that use it and their investors. Cryptocurrencies that use proof of stake are able to process transactions quickly and at a low cost, which is key for scalability. Investors can stake their crypto to earn rewards, providing a form of?passive income. And the fact that PoS is environmentally friendly means it will likely continue to grow more popular as a consensus mechanism.
Where to invest $1,000 right now. When our award-winning analyst team?has a stock tip, it can pay to listen. After all, the newsletter they?have run for over a decade,?Motley Fool Stock Advisor, has?nearly tripled the market. Lyle Daly?has positions in Bitcoin and Cardano. The Motley Fool has positions in and recommends Bitcoin and Cardano. The Motley Fool has a?disclosure policy. For a blockchain transaction to be recognized, it must be appended to the blockchain. In the proof of stake blockchain the appending entities are named?minters?or?validators?(in the?PoW?blockchains this task is carried out by the?miners);?in most protocols, the validators receive a reward for doing so. For the blockchain to remain secure, it must have a mechanism to prevent a malicious user or group from taking over a majority of validation. PoS finishes this by requiring that validators have some quantity of blockchain tokens, requiring potential attackers to acquire a large fraction of the tokens on the blockchain to mount an attack.
PoW, another commonly used consensus mechanism, uses a validation of computational prowess to verify transactions, requiring a potential attacker to acquire a large fraction of the computational power of the validator network.?This incentivizes consuming huge quantities of energy. PoS is more energy-efficient. Early PoS implementations were plagued by a number of new attacks that exploited the unique vulnerabilities of the PoS protocols. Eventually, two dominant designs emerged: so, called?Byzantine Fault Tolerance-based?and?Chain-based?approaches.
Attacks
The additional vulnerabilities of the PoS schemes are directly related to their advantage, a relatively low amount of calculations to be performed while constructing a blockchain.
Long-range attacks
The low amount of computing power involved allows a class of attacks that replace a non-negligible portion of the main blockchain with a hijacked version. These attacks are called in literature by different names,?Long-Range,?Alternative History,?Alternate History,?and History Revision, and are unfeasible in the PoW schemes due to the sheer volume of calculations required.?The early stages of a blockchain are much more malleable for rewriting, as they likely have a much smaller group of stakeholders involved, simplifying the collision. If the per-block and per-transaction rewards are offered, the malicious group can, for example, redo the entire history and collect these rewards. The classic "Short-Range" attack (bribery attack) that rewrites just a small tail portion of the chain is also possible.
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Nothing at stake
Since validators do not need to spend a considerable amount of computing power (and thus money) on the process, they are prone to the?Nothing-at-Stake?attack: participation in a successful validation increases the validator's earnings, so there is a built-in incentive for the validators to accept all chain forks submitted to them, thus increasing the chances of earning the validation fee. The PoS schemes enable the low-cost creation of blockchain alternatives starting at any point in history (costless simulation), submitting these forks to eager validators endangers the stability of the system.?If this situation persists, it can allow?double-spending, where a digital token can be spent more than once.?This can be mitigated by penalizing validators who validate conflicting chains?("economic finality") or by structuring the rewards so that there is no economic incentive to create conflicts.?Byzantine Fault Tolerance-based PoS are generally considered robust against this threat.
Bribery attack
Bribery attack, where the attackers financially induce some validators to approve their fork of blockchain, is enhanced in PoS, as rewriting a large portion of history might enable the collusion of once-rich stakeholders that no longer hold significant amounts at stake to claim a necessary majority at some point back in time, and grow the alternative blockchain from there, an operation made possible by the low computing cost of adding blocks in the PoS scheme.
Variants
Variations of stake definition
The exact definition of "stake" varies from implementation to implementation. For instance, some cryptocurrencies use the concept of "coin age", the product of the number of tokens with the amount of time that a single user has held them, rather than merely the number of tokens, to define a validator's stake.
Delegated proof of stake
Delegated proof of stake (DPoS) systems separate the roles of the stakeholders and validators, by allowing stakeholders to delegate the validation role.
IMPLEMENTATIONS
The first functioning implementation of a proof-of-stake cryptocurrency was?Peercoin, introduced in 2012. Other cryptocurrencies, such as Blackcoin,?Nxt,?Cardano, and?Algorand?followed.?However, as of 2017, PoS cryptocurrencies were still not as widely used as proof-of-work cryptocurrencies. In September 2022,?Ethereum, the world's second-largest cryptocurrency 2022, switched from proof of work to a proof of stake consensus mechanism system,?after several proposals[?and some delays.
Critics have argued that the proof of stake model is less secure compared to the proof of work model. Centralization This section?is missing information?about how this "token-rich" favor differs from a "miner-rich" favor in PoW — e.g., resistance to flash-loan attacks.?Critics have argued that the proof of stake will likely lead to cryptocurrency blockchains being more centralized in comparison to proof of work as the system favors users who have a large amount of cryptocurrency, which in turn could lead to users who have a large amount of cryptocurrency having a major influence on the management and direction for a crypto blockchain.
Energy consumption
In 2021 a study by the?University of London?found that in general, the?energy consumption?of the proof-of-work based?Bitcoin?was about a thousand times higher than that of the highest-consuming proof-of-stake system that was studied even under the most favorable conditions and that most proofs of stake systems cause less energy consumption in most configurations. The researchers also noted that the energy consumption of different proof-of-stake systems was divergent with permission systems that used fewer validators being more energy efficient than permission-less systems that don't. They also couldn't find the energy consumption of a proof-of-stake system on a large scale, as such a system did not exist at the time of the report. In January 2022 Vice-Chair of the?European Securities and Markets Authority?Erik Thedéen?called on the EU to ban the proof of work model in favor of the proof of stake model due to its lower energy consumption. On 15 September 2022,?Ethereum?transitioned its?consensus mechanism?from proof-of-work to proof-of-stake in an upgrade process known as "the Merge". This has cut Ethereum's energy usage by 99%.
Blockchain has a reputation—not necessarily deserved—for being complicated and impenetrable. This has a lot to do with the consensus mechanism, which is essentially the way users of a blockchain agree on transaction history, present, and future. Here, we demystify the consensus mechanism that seems poised to take over the world of cryptocurrency: proof of stake.
What is a blockchain?
Blockchain?is a technology that enables the secure sharing of information. Obviously, a database is where data is stored. A ledger is an account book where transactions are recorded. A blockchain is a type of?distributed?database or ledger—one of today’s?top tech trends—which means the power to update it is distributed between the nodes of a public or private computer network. This is known as distributed ledger technology or DLT. The network provides incentives for nodes to make updates to blockchains in the form of digital tokens or currency.
What is a consensus protocol?
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Cryptocurrencies, which have no physical note or coin exchange, are?decentralized systems. That means there’s no bank or other central authority to keep track of how much money is in each account and whether transactions are valid or fraudulent. Everyone participating in the network, or every node, needs another way to keep on top of ledgers and transactions. For the blockchain to work, every node needs access to the?same, continually updating the database. That’s why it’s important that all nodes on a blockchain come to a consensus on any changes to the record. When new data is added to the network, the majority of nodes must verify and confirm the legitimacy of the new data based on permissions or economic incentives; these are also called?consensus mechanisms. When a consensus is reached, a new block is created and attached to the chain. All nodes are then updated to reflect the blockchain ledger. There are many kinds of consensus protocols. Proof of work is the consensus mechanism that most cryptocurrencies have used until now; in September 2022 Ethereum-based cryptocurrencies transitioned to proof-of-stake protocols in a highly publicized event known as “The Merge.”
?A blockchain protocol provides traders with incentives?to validate transactions by rewarding them with cryptocurrency for every correct validation. As a safeguard against fraud,?proof-of-stake protocols require traders?to “stake” some of their cryptocurrency as collateral, which is then locked up in a deposit. If a trader adds a transaction to the blockchain that other validators deem to be invalid, they can lose a portion of what they staked. There’s usually a?lower limit?to how much validators can stake. After the limit is surpassed, validators can stake as much as they want. In fact, the more a trader stakes, the more likely they are to be chosen by the algorithm. Here’s a simple example to illustrate the point: let’s say there’s a new change to the blockchain that needs verification. Ten nodes volunteer to validate it, and they each stake one cryptocoin for the privilege. That means that they each have an equal 10 percent chance of being awarded the work.
?Direct answers to complex questions
Let’s say that one volunteer really wants to win the work. They could up the odds by staking three coins on the deal. If everyone else kept their stake at one coin, they would up their chance of winning the work to 25 percent, while everyone else’s chances would go down to 8.3 percent. In practice, it’s a lot more complicated than that. That’s because new transactions are grouped together in blocks, sometimes of several hundred or more. Then several blocks are chained together to create a record of all the transactions in order. Another complicating factor is that traders can enter staking pools, where groups of validators can together come up with a lower limit to become a validator. When a staking pool is awarded the work, the reward is split among the pool’s members, with a slightly larger share going to the pool’s owner.
What is a proof-of-work consensus protocol?
Currently, most blockchains arrive at consensus via proof of work (PoW). Here’s how it works: the first node, or participant, to verify a new data addition or transaction on the digital ledger receives a certain number of tokens as a reward. The verification process requires a participant—who might be called a “miner”—to solve a cryptographic question. The computer that completes the puzzle first is awarded the token. This?model provides incentives for miners?to act quickly, which increases the speed at which an operation is completed.
?Why is proof of stake seen as an upgrade from proof of work?
Many expect that a significant number of cryptocurrencies will migrate to proof of stake. In PoS systems, miners are scored based on the number of coins they have in their digital wallets and the length of time they have had them. The miner with the highest at stake has a greater chance to be chosen to validate a transaction and receive a reward. Directing the resources of high-powered computers to solve puzzles means?using more electricity. Cryptocurrencies that use proof-of-work consensus mechanisms have been?criticized for their electricity consumption.
Proof of stake is faster,?sidesteps the energy burn, and requires no special computing equipment. For these reasons and others, it’s the validation protocol for newer waves of cryptocurrencies and altcoins. For example, Ethereum 1.0 uses proof of work, but Ethereum 2.0 uses proof of stake. Others using proof-of-stake protocols include Tezos, Cardano, Solana, and Algorand. Users like it for its quick processing returns and the scalability made possible by the lower cost.
·???????Proof of Stake (PoS) is a type of algorithm that aims to achieve distributed consensus in a Blockchain. This way to achieve consensus was first suggested by Quantum Mechanic here and later Sunny King and his peer wrote a paper on it. This led to
·??????Proof-of-Stake (PoS)
KEY TAKEAWAYS
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Proof of Stake
Proof of Work
Block creators are called validators
Block creators are called miners
Participants must own coins or tokens to become a validator
Participants must buy equipment and energy to become a miner
Energy efficient
Not energy efficient
Security through community control
Robust security due to expensive upfront requirement
Validators receive transactions fees as rewards
Miners receive block rewards
?Proof-of-Stake Security
Long touted as a threat for cryptocurrency fans, the?51% attack?is a concern when PoS is used, but there is doubt it will occur. Under PoW, a 51% attack is when an entity controls more than 50% of the miners in a network and uses that majority to alter the blockchain. In PoS, a group or individual would have to own 51% of the staked cryptocurrency. It's very expensive to control 51% of staked cryptocurrency. Under Ethereum's PoS, if a 51% attack occurred, the honest validators in the network could vote to disregard the altered blockchain and burn the offender(s) staked ETH. This incentivizes validators to act in good faith to benefit the cryptocurrency and the network. Most other security features of PoS are not advertised, as this might create an opportunity to circumvent security measures. However, most PoS systems have extra security features in place that add to the inherent security behind blockchains and PoS mechanisms.
?Proof-of-stake is a consensus mechanism where cryptocurrency validators share the task of validating transactions. There are currently no certificates issued. It's possible that Bitcoin can change to proof-of-stake. However, it takes years to implement successfully, and the community would need to agree to the change.
CONCLUSION
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. The Ethereum Merge is the joining of Ethereum’s proof-of-stake (PoS) Beacon Chain with the Ethereum Mainnet. "Difficulty bomb" referred to the increasing difficulty and time needed to mine Ethereum blocks to discourage a fork after the blockchain transitioned to proof-of-stake. A 51% attack is an attack on a blockchain by a group of miners who control more than 50% of the network's mining hash rate, or computing power. Cardano is a blockchain and smart contract platform whose native token is called Ada. Find out how Cardano works and how to earn rewards. Algorand (ALGO) is a cryptocurrency and blockchain platform that can finalize transactions immediately. If tokens for a chance to be selected to validate the transaction blocks and be rewarded for doing so.
Based on all the above, it is beyond the imagination of common people. Their users are all very talented software professionals.