• Market Cap
    $362.178B 0.70%
  • POW Market Cap
    $272.414B -0.09%
  • POS Market Cap
    $19.707B 2.27%
  • Masternodes Market Cap
    $1.158B -0.26%

Proof of Stake vs Masternodes. Two major solutions for developing passive income in crypto

By Inkarias - 2020-06-17

In their early days, blockchains only worked thanks to a Proof-of-Work, or more commonly named POW consensus system. This one, although extremely secure, quickly showed certain limits for daily use, both on its ability to manage numerous transactions and on its supposed energy consumption once widely used in a big network. To address this issue, the developers have brainstormed new consensus models such as the Proof of Stake to solve the different drawbacks brought with original blockchain visions. Although we oppose both the POS / Proof-of-Stake system in this article, it is still important to remember that the two solutions are linked since the masternodes are based on the POS system itself, even if there are certain improvements and differences. Many projects have also implemented a hybrid POS/MN system as base consensus to bring all the advantages of these different technologies.

Differences between standard POS system and Masternodes

Proof-of-Stake

To participate in securing the network of a PoS blockchain, it is mandatory to have accumulated a sufficient quantity of cryptocurrency tokens exchanged on the network, with a minimum often set by the project specifications directly and varies from network to network. The more a person has tokens from a cryptocurrency, the more it will be considered that network security is an important issue for them. This is the reason why we speak of “proof of stake”: when a participant is able to prove that the security of the blockchain represents a real stake for him, this one will have all the more chances to be chosen produce blocks and obtain a reward at the same time. Thus, the more a staker has a significant amount of the cryptocurrency of the network, the more it will be able to forge blocks and obtain rewards.

The operation of a Proof of Stake protocol is much easier to understand than that of Proof of Work. A proof of stake algorithm implies that different network users deposit part of their holdings in cryptocurrency to become minters. The algorithm is then based on the head of the blockchain to randomly select a minter and offer it the right to create the next block. If the latter does not create the block within a given time interval, the algorithm will automatically select a second validator in its place. In Proof of Stake, the longest chain is the one considered by default as valid. To enjoy the benefits of POS, users can either keep the corresponding wallet open ( leading to extra energy consumption from computer by leaving the wallet open all the time) 24/24, or delegate it to third-party services or exchanges offering the ability to stake freely or with small fees.

Masternodes

As we explained above, masternodes are part of the Proof of Stake consensus family. Therefore, they work by staking a given amount of cryptocurrencies acting as collateral to operate. For example, to operate a DASH masternode it will be necessary to gather 1000 DASH. Once the tokens have been purchased, the user will have to deposit the funds on the cryptocurrency wallet of which he wishes to operate a masternode. Masternode owners can either setup their own server at home or directly externalize this task to different third-party entities/companies offering their service to build and manage the VPS directly. Once the node is online on the network, whether the user has hosted it himself or whether it has passed through a third-party service, the latter will participate in the validation of the transactions which occur the network. To reward him, the network will assign him the newly created tokens for each block, whose transactions he has validated, this reward being commonly called reward. Indeed, Masternodes are computer servers whose mission is to ensure the proper functioning of a blockchain using the proof-of-stake based consensus. The latter will store a copy of the entire blockchain as well as validate the new transactions that run through the network. In exchange, the actors who operate these nodes are rewarded with the new pieces created for each block.

Advantages and Drawbacks of POS and Masternodes

Advantages of POS

The main advantage of Proof of Stake is that it does not require large amounts of electricity to secure a blockchain. In the long term, Proof of Stake projects have more sustainable growth and are generally more scalable. This is all the more the case that the currencies generated in proof of work often require to be created in large quantities in order to be able to offer significant rewards to miners in order to enable them to recover their material investment.

In PoS, on the other hand, cryptocurrencies are less likely to be inflationary because it is not necessary to create new tokens in large quantities to continue to motivate validators: whatever happens, they will always be profitable in contributing to network security. Compared to Proof of Work, Proof of Stake also reduces the risk of centralization, since it does not achieve the same economies of scale as an investment in a large amount of mining equipment. Thus, while it is possible for over-equipped mining farms to successfully outperform particular miners, such a disproportionate benefit is less likely to occur with consensus in PoS. This is one of the reasons why individuals today prefer to turn to staking or investing in a masternode rather than mining with a costly hardware equipment. The Proof of Stake also has the advantage of making forms of attack 51% much more expensive to perform than on proof of work networks.

Drawbacks of POS

The first drawback often associated with POS systems is that they tend to be less secure than more widely used POW blockchains. One of the main problems with proof of stake is also the "Nothing at Stake" issue. The attack on "Nothing at Stake" becomes possible if the blockchain undergoes a fork and then splits into two branches. In the event of fork of a Proof of Stake Blockchain, a validator has more interest in continuing to forge on the two chains rather than choosing only one, because this allows him to multiply his holdings. This is not the case in PoW, where the miner instead has an interest in concentrating his efforts and his computing power on the chain where he is most likely to mine a block.

To overcome this problem, penalty mechanisms such as the slashing solution have been thought and implemented quickly to dissuade the behavior of "Nothing at Stake". Finally, even if it is more decentralized than a Proof of Work network, a network based on a Proof of Stake protocol can nevertheless recall the functioning of a plutocracy, where the wealthiest have the greatest power. Owning a large percentage of the number of tokens put into circulation remains possible, and although the 51% attack remains unlikely, PoS cannot be considered as a 100% decentralized consensus.

Advantages of Masternodes

From a technical point of view, a masternode is a complete node that has a full copy of the blockchain. It performs, validates and transmits transactions over the network. Lower-level nodes only have a partial copy of the blockchain, and take turns checking transactions, using a random selection system. The main interest of setting up a node is the fact that this structure generates a passive income over time. Users just have to lock a certain number of coins of the crypto asset in question to be able to embark on this path. People will pass their transactions through masternodes and the network with these devices will validate these transactions. Owners will then earn commissions, which will be shared with the people who contributed to the validation of the transactions.

By doing so, users will automatically gain crypto assets without any effort, if not the initial effort which is to build up the node in the system. In addition, if the cryptocurrency is interesting, investors will also greatly benefit with the valuation of the token over time. The incentive also varies from one network to another, but most of them include two things, voting/governance rights and a financial reward, bringing investors to support a network and a project by setting up new nodes with a long-term vision.

Drawbacks of Masternodes

However, setting up a masternode is not necessarily accessible to everyone and not quite easy to manage. Investors must have a minimum number of coins for this to happen. So that means they will have to invest a lot of money if the project is quite popular in the cryptosphere. In addition, there must be sufficient equipment, a good Internet connection, and time to invest in keeping the equipment in good condition; because masternodes must be permanently available to ensure the proper functioning of the network. Obviously, it is still possible to use the services of a third-party supplier to rent a server, but it is never free. Owners need to have quite a bit of technical knowledge as well, as the process can be complex. Apart from the knowledge itself, there is also a certain criteria that they must meet. By far, the most common characteristic of most masternode setups is the need to lock away big amounts of the network's native cryptocurrency. This is necessary due to the way masternodes normally function. They usually work as PoS consensus mechanism. However, while locking up tokens is a necessity in order to create a masternode, this is an independent mechanism of the one used by the network itself.

What is the greater solution to build a passive income?

After comparing these different possibilities, we can ask the question of which is the most interesting to more easily earn cryptocurrencies whether it is short or long term. Several points of view are possible according to the desires of each and the different projects present on the market:

In 2017, the trend was leaning strongly for the newly arrived masternodes, benefiting from a significant media craze within the crypto sphere. Despite numerous projects based on this model having failed, a vast majority still managed to gain a place on the market to offer innovative solutions. We can cite projects such as Dash or Energi for example. In addition, the large number of thefts and frauds which took place in the past also cooled the new investors and largely discredited this method. Today in 2020, projects based on masternodes are becoming increasingly rare compared to POS solutions arriving daily on the market. The trend is now much more oriented towards POS solutions which offer less risk compared to projects with masternodes. This radical change is also due to the functioning of the market.

Masternode projects are often hyper-evaluated when they are put on the market and during the first exchanges, very often causing a rapid price crash. This decrease is linked to the recovery of the initial investment from owners of masternodes. In the short term, masternodes are a risky solution but very largely profitable depending on the project, vision, technology as well as the associated return on investment (very often high at launch with a linear decline as and when new masternodes join the network). There are many examples of both innovative projects bringing a lot to the cryptosphere but also a good number of projects without real impact on the world and without long-term vision allowing them to establish themselves solidly.

In contrast, projects based on pure POS tend to be projects aimed at achieving long-term goals. The rate of return on investment is very often low and stable even at the launch of the project. It is therefore an investment which is less profitable in the very short term, but which pays off in the long term. It is the preferred solution for investors since it provides a certain level of security for a financial investment.

With the rise of Proof of Stake and masternodes solutions, more and more investors are turning to masternodes at the expense of traditional mining. One of the advantages is the liquidity of these solutions. Indeed, in the context of the cessation of a mining activity it is necessary to resell the equipment and this stage often proves to be tedious and costly in time and money. Despite the great advantages brought by both POS and masternodes networks, many alternatives exist to move towards more comprehensive consensus mechanisms. New generation blockchains are increasingly tending to adopt a Delegated Proof of Stake protocol, often considered to be one of the most balanced protocols between network security, decentralization and scalability.