Investing Archives | Page 205 of 222

Oct

2021

DAOs and How They Work

By Matthew Zeitlin | Growing Wealth, invest, Investing | Comments Off

One of the strongest trends in technology has long been decentralization — from the creation of the internet connecting academics across the world, to the world wide web providing a platform for strangers to connect with one another. The advent of cryptocurrency has spurred another round of decentralization, the decentralized autonomous organization, or DAO.

What Is a DAO?

Decentralized autonomous organizations (DOAs) are innovative and potentially promising models for bringing blockchain technology to new areas of organization, beyond issuing and transferring value across the blockchain (aka currency). For example, DAOs could be used to develop blockchain in insurance or blockchain in real estate.

The goal of DAOs is to remove expensive and time-consuming processes and democratize how organizations are conceived and run, by doing everything in code. DAO stands for:

• Decentralized: This means no one person or group is in charge of the organization by virtue of a title. Instead, decisions are made by the members of an organization by virtue of how big a stake they have in it.

• Autonomous: The DAO is run entirely according to its smart contracts and the decisions of its members.

• Organization: DAOs can still act as a single entity, producing things and acting on behalf of all its members.

While DAO typically refers to projects using Ethereum (aka Ethereum DAOs), some scholars have suggested that Bitcoin itself is a DAO.

It’s important when discussing Ethereum DAOs or DAOs in general not to get them confused with “The DAO,” a group that raised money to invest in cryptocurrency projects. The organization was hacked and more than $50 million of about $160 million worth of Ethereum raised was stolen.

How Do DAOs Work?

While there have been procedures for more open and democratic organizations for as long as people have been gathering to make decisions, DAOs are an innovation that specifically hinges on blockchain technology.

DAOs are typically built on top of the Ethereum blockchain, which supports the second-most popular and valuable cryptocurrency in the world and is designed specifically to support “smart contracts” or agreements that execute automatically and don’t require third parties to enforce.

Imagine a traditional organization as a bundle of contracts and agreements between the members: an employment agreement specifies what an employee is supposed to do in exchange for pay, contracts with suppliers, loan terms with banks, and so on. These contracts all need to be specified on paper and their execution can be up to third parties and legal systems to oversee. For the DAOs, these are problems to be solved with code.

How Are DAOs Funded?

Typically DAO contracts are also set up for the sale of a token, as a way of raising money for the DAO and for establishing who gets to be involved in the decision-making. Token holders vote based on a process specified and executed in the smart contracts themselves. The idea is that token holders will want to maximize the value of their tokens, thus ensuring the DAO does not work to the advantage of any one employee or group, but instead to the token holders as a whole.

DAOs: Pros and Cons

Pros	Cons
Change always happens by vote	Can be hard to turn around in a crisis
Transparency through open-source	Organizational discretion is difficult
Smart contracts avoid after-the-fact tinkering with agreements	If contracts and code are poorly written, can be hard to change without consensus
Organizational roles specified in code	Makes taking on responsibilities beyond what’s specified in code difficult
Decentralization means everyone in the organization is responsible for the organization’s decisions	Lack of accountability for any one individual, like a central leader or chief executive
Open source means more eyes on critical functions and the best ideas rise to the top	Legal ambiguity could make decision-making difficult or force DAOs to engage in more centralized, traditional behavior
Everyone involved in decision-making has a stake	Token-based decision-making can make consideration of other stakeholders’ interests more difficult

Examples of DAOs

There are a variety of DAOs in operation right now. These are some of the well known ones.

MakerDAO

MakerDAO is one of the most prominent uses of the DAO structure and one of the most popular DeFi (or decentralized finance) projects that could serve as an example of how to use blockchain in the finance industry. MakerDAO produces a token, known as Dai, that has a steady $1 U.S. value and is used for financial products like loans. There’s also the MKR token, which is for governance of the overall project. This means that holders of MKR can “vote on changes to the protocol, like the addition of new collateral assets and protocol updates.”

Augur

Augur is an Ethereum-based prediction market, meaning it allows people to place bets on events in the future. The platform is a bundle of smart contracts and OracleDAO was created to assist with its development.

Uniswap

Uniswap is a decentralized cryptocurrency exchange specifically for “ERC-20” tokens with a governance token called UNI. ERC-20 is a standard on the Ethereum blockchain that is used for applications and services built on top of Ethereum. In the ongoing dispute between centralized vs decentralized exchanges, Uniswap is decidedly on the side of the latter.

💡 Recommended: What Is a Governance Token?

How to Invest in a DAO

Investing in a DAO isn’t that different from buying any other form of cryptocurrency. Here are the simple steps to do it.

1. Have a wallet. A crypto wallet is a software program or hardware and software system that allows an investor to safely and effectively store and trade cryptocurrencies including tokens issued by DAOs.

2. Do your research. There are new crypto projects starting every day. It’s important to have a detailed understanding of what the developers of the one you’re interested in are attempting to do, and that you are well aware of whatever rights you gain by investing in a DAO and purchasing a governance token.

3. Find an exchange. Some exchanges host tokens, including MKR, which can be bought and sold using their tools. Uniswap, for example, hosts token exchange.

4. Be an active participant. Study how governance works in the DAO you’ve invested in and be a conscientious and energetic participant.

The Takeaway

DAO stands for decentralized autonomous organization. In such organizations, there is no one person or small group of executives making decisions — instead, anyone holding tokens issued by that DAO has a say in policy and other organizational matters.

Photo credit: iStock/Pekic

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOIN0421180

Oct

2021

Crypto Technical Analysis: What it is & How to Do One

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

Crypto technical analysis involves using mathematical indicators based on previous price action data to try to predict future trends. The basic idea is that markets behave according to certain patterns and that once established, trends heading in a certain direction often continue along the same course for some time.

Broadly speaking, investors want to buy when markets are low so they can sell higher at some point in the future, and thus make a profit. Conducting technical analysis before entering a position is one way to try to identify price levels that might be considered low.

There’s no single, all-encompassing method for crypto technical analysis. Each trader will prefer to use different indicators and will likely interpret them slightly differently. It should also be noted that crypto technical analysis, similar to the technical analysis applied to stocks and other securities, is not a crystal ball; it’s not an guaranteed predictor of performance.

Crypto Technical Analysis: The Basics

There’s a long list of different technical indicators and chart patterns that can be used to conduct crypto technical analysis. Entire books have been written and courses created on the subject.

Here are just a few common technical indicators that traders can use when learning technical analysis.

Candlestick Charts

Traders often prefer candlestick charts for their high level of detail. Rather than condensing data into one point for each time interval, candlesticks display four different price levels for each interval. These include (in order of top to bottom, visually):

• High price

• Opening price

• Closing price

• Low price

Candlesticks show this information in the form of a bar and two wicks. The peak of the top wick is the high price and the tip of the bottom wick is the low price.

The body of the candlestick can appear either green or red. Red indicates that prices ended the day lower than they opened; green indicates that prices ended the day higher.

On green candlesticks, the top indicates the closing price and the bottom the opening price. For red candlesticks, the top indicates the opening price and the bottom the closing price.

Each candlestick is read in the context of surrounding data points, and offers a detailed look at how investors are buying and selling crypto during a certain period of time.

Recommended: Important Candlestick Patterns to Know

Support and Resistance Levels

The terms support and resistance refer to levels where prices tend to bottom or peak, respectively. Traders might identify these levels and then use them to try and make informed trading decisions.

How are support and resistance determined? There are many possible ways. Sometimes it could be as simple as looking at a chart and pointing out where prices have repeatedly pulled back (in the case of resistance) or bottomed out (in the case of support).

Once identified, traders might use these price levels to inform their trading strategy. For example, stop-loss orders might be placed at support, while sell orders to take profits might be placed at or above resistance.

There are many different ways to use support and resistance, because these levels can either be used to try to predict price reversals or, if prices continue beyond them, indicate that a new trend has emerged. If prices keep rising above resistance, this might indicate sustained momentum to the upside. Likewise, if prices continue falling beneath support, they might continue falling even more.

Relative Strength Index (RSI)

The Relative Strength Index is a favorite among veteran and novice traders alike. This indicator presents itself as a simple line graph below a price chart.

The line oscillates between the values of 0 and 100, with 50 being neutral. A higher value is thought to indicate overbought conditions, while a lower value is thought to indicate oversold conditions.

Like many technical analysis tools, the RSI is best used in conjunction with other indicators. For example, if prices for a cryptocurrency were approaching a well-established support level at the same time that the RSI was giving a low reading of 20, then the odds of an upcoming price rally could be higher than usual.

Average Directional Index (ADX)

The average directional index is a short-term indicator used to help investors determine how strong a trend is. The higher the ADX, the more momentum there might be behind current trends.

ADX is simply the average of the values of directional movement lines over a particular period. These lines are calculated with current low and high prices. Similar to the RSI, ADX can have a value between 0 and 100.

But unlike many other indicators, the ADX rarely rises above 60. Chart analysts generally believe that an ADX of 25 and up indicates trend strength and a reading below 20 means there is no trend. Between 20 and 25 is considered neutral, or no trend.

When the ADX line is rising, it’s a sign that the current trend is growing stronger.

Moving Averages (MAs)

While the ADX helps investors determine the strength of a trend, moving averages can be used as a tool to help determine the direction of a trend. A moving average summarizes data points of a cryptocurrency over a set period and divides the total by the number of data points to create an average. The term “moving” average is used because the number is constantly updated using the latest price data.

Long-term moving averages are thought to be stronger indicators, as they contain more data. But MAs can also be tracked in the short term.

There are different types of moving averages, different time lengths for them, and different ways they can be used to provide clues to the direction of a trend.

One famous bullish setup based on MAs is referred to as the “golden cross.” This occurs when a short-term moving average moves above a long-term moving average, most commonly the 50-day MA above the 200-day MA.

Recommended: 5 Bullish Trend Indicators

Trend Lines

Trends lines are just what they sound like — lines that illustrate potential trends. These can take many forms and sometimes multiple trend lines can be drawn on the same chart to show more complex patterns.

In their simplest form, trend lines are single lines connecting multiple high or low price points. The more points that connect on the same line, the stronger the trend might be.

Trend lines can be drawn to show a variety of different crypto technical analysis setups.

Cup and Handle Pattern

The cup-and-handle pattern is a famous bullish set-up. It consists of a price chart over which a cup (the bottom half of a circle) and a handle (a downward-slanting line at about a 45-degree angle) can be drawn.

For this to happen, prices generally must fall, briefly trade sideways, rise for about the same length of time as they originally fell for, and then have a steep but brief drop. The final drop creates the handle, at which point the pattern is thought to be confirmed, and prices could rise.

The inverse of this pattern can also happen and is thought to be bearish. If an upside-down cup and handle happens, watch out, as prices could fall.

The Takeaway

Crypto technical analysis is just one of many things investors might want to know before investing in crypto. That said, technical analysis of cryptocurrency can be highly subjective even though the indicators themselves are based on mathematics.

It should be noted that no technical indicator is correct 100% of the time. Even when multiple indicators converge on the same conclusion, prices could still react differently than expected. The best a trader can hope for is an increased chance of making a decision they feel good about, based on available information.

Photo credit: iStock/SDI Productions

First Trade Amount		Bonus Payout
Low	High	Bonus Payout
$50	$99.99	$10
$100	$499.99	$15
$500	$4,999.99	$50
$5,000+		$100

SOIN0421185

Oct

2021

How Many Dogecoins Are There in Circulation?

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

It’s hard to say exactly how many Dogecoins are in circulation, as many have likely disappeared due to issues like lost wallets or people sending coins to the wrong address. But according to CoinMarketCap data, there were about 131.6 billion DOGE in existence at press time.

That number is constantly going up, since a new block gets processed on the DOGE network every minute, and each block reward contains 10,000 new DOGE. That means 10,000 new Dogecoins appear every minute.

Does Dogecoin Have a Limit?

There is no limit to how many new Dogecoins miners can create, although its creators had an initial goal of keeping about 100 billion coins in circulation at a time.

The idea was that by keeping the supply inflationary, people would have an incentive to spend Dogecoins. Since items in high demand with a scarce supply tend to rise in value, while anything with low demand and high supply tends to fall in value.

For a brief period in 2021, sparked by headlines and word of mouth, investor demand for DOGE exceeded the supply, driving prices up. As the climate shifted, however, that trend came to an end and the price of DOGE dropped (a typical pattern in the volatile world of crypto).

Recommended: Will Dogecoin Ever Be Capped?

Here are four things to consider when thinking about the supply of Dogecoin and other altcoins.

Dogecoin Has an Unlimited Supply.

Since there’s no cap on the supply of new DOGE, the price has a ceiling on it. There will always be new coins being dumped onto the market, and unlike Bitcoin, that new supply will never decrease.

For DOGE to maintain its value, then, there has to be new money coming in that at least matches the new coins being created. This can only be sustained for so long. The general tendency for the price of Dogecoin will be to go down, due to these supply and demand dynamics. That makes crypto traders more likely to spend DOGE than to HODL it.

Of course there can be exceptions to the rule. As noted above, crypto prices can be volatile in response to current events and other market conditions. For example, DOGE prices collapsed by about 70% in just two months following the May 2021 high of $0.69, bottoming out at $0.17 before bouncing back slightly.

Recommended: How Many Bitcoins Are Left?

DOGE is Easier to Mine Than Most Cryptocurrencies

Miners receive block rewards for DOGE every minute. That’s compared to once every ten minutes on the Bitcoin network.

This means that solo miners have ten times the odds of finding a block on their own when mining DOGE as opposed to mining Bitcoin or any other coin with 10-minute blocks. DOGE mining pools also wind up with greater rewards, can potentially charge miners lower fees, and have lower transaction costs.

DOGE network mining also tends to be easier than many other proof-of-work coins. Currently, the DOGE network has a hash rate of 207 Terahash per second (TH/s).

By comparison, Bitcoin has a hash rate of 124 Exahash per second (EH/s).

A terahash equals one trillion hashes per second, while an exahash equals one quintillion hashes per second. In other words, the current hash rate of the Bitcoin network is more than 500,000 times higher than that of the Dogecoin network.

Recommended: What is a Good Hashrate?

This makes the barrier to entry for mining DOGE much lower than mining Bitcoin. Whenever DOGE rises in price, more people are likely to mine it, and eventually dump their new coins on the market. Without a constant supply of new money piling into DOGE, the price will fall.

Doge Has Little Technical Development

For much of its history, Dogecoin development has stagnated. Between the years of 2015 and 2018, the cryptocurrency had zero development updates. By comparison, Bitcoin’s code is updated almost every day.

In 2015, Dogecoin co-founder Jackson Palmer stepped away from the project, calling the crypto industry “toxic.” Since then, not much has been done with the code that underlies Dogecoin.

The most recent update was Dogecoin Core 1.14.3, released in February 2021. Before that, November 2019 was the last major upgrade. All in all, there have only been two significant updates to Dogecoin in the last six years.

The Supply of DOGE is Highly Centralized

A huge portion of existing Dogecoins are held by a small group of crypto wallets. One address holds about 27% of all available DOGE. The top 20 addresses hold more than 50% of the entire supply. It’s possible some of the large wallets could belong to Dogecoin mining pools or crypto exchanges, but no one knows for sure.

The Takeaway

There are more than 130 billion DOGE at the time of writing. That number will continue to rise at a rate of 10,000 per minute. Dogecoin’s creators decided to let the currency be an inflationary one to encourage DOGE “tipping” and other transaction-based uses.

Photo credit: iStock/Irina Vaneeva

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

²Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount		Bonus Payout
Low	High	Bonus Payout
$50	$99.99	$10
$100	$499.99	$15
$500	$4,999.99	$50
$5,000+		$100

SOIN0821329

Oct

2021

How to Buy Dogecoin (DOGE)

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

Dogecoin may have started as a joke cryptocurrency, but it’s evolved into a very real digital asset. Like all cryptocurrencies, there are multiple ways that traders or investors can purchase DOGE.

There are two basic ways to buy DOGE: Through a cryptocurrency exchange, or through an online stock trading platform or application.

How to Buy Dogecoin in 4 Steps

Buying Dogecoin is a fairly simple process — it’s more or less the same process you would follow if you were trying to purchase Bitcoin or any other altcoins.

While this may seem complicated for crypto beginners, it’s a fairly straightforward process, whether you’re buying crypto to keep for the long-term or to spend right now.

Here’s a detailed walkthrough of each step:

1. Choose Where You Want to Buy Dogecoin

If you understand the basics of Dogecoin and are interested in buying DOGE, you’ll need to decide whether you’d like to use either a cryptocurrency exchange or an online trading platform. No matter which route you go, you’ll need to establish an account with the platform or exchange (if you don’t have one). That may require banking information (account numbers, etc.), addresses, phone numbers, email addresses, and in some cases, your Social Security number.

Crypto Exchanges

Crypto exchanges are platforms that allow interested parties to buy, sell, or trade different cryptocurrencies. They’re not all the same — some cryptos are available on some platforms, but not on others, for instance — and they tend to work like stock markets.

That is, traders and investors are exchanging cryptos, much like they would with stocks or bonds on the stock market. There are different types of exchanges, too, including centralized, decentralized, and hybrid exchanges.

A quick Google search will reveal plenty of them, if you’re interested in going this route.

Exchanges tend to have a large variety of crypto choices, are generally simple to use, and make it pretty easy to trade. However, some of them may have high fees for trading, and may not grant users complete control over their storage options. While nearly all exchanges will let you buy or sell crypto, some may support more advanced orders such as limit orders or margin trading.

Online Stock Trading Platforms

Aside from crypto exchanges, which can be used to buy Dogecoin, there are also stock trading apps — of which there are also many choices. And, again, a simple Google search will yield plenty of results, if you want to find a few options to start trading.

These trading apps generally work similarly to exchanges for end users. Essentially, it’s a matter of opening and funding an account, and executing the trade. But the apps and platforms in question are generally known for trading stocks, bonds, and ETFs rather than cryptocurrencies, as opposed to crypto exchanges.

They act as brokerages, in other words, and may charge a markup or fee for executing a trade.

That said, many of these apps have opened themselves up to crypto trading as demand has grown. And, for the most part, trading crypto on these platforms is a similar (if not the same) process as trading stocks.

As for the pros and cons of using these apps, it’ll depend on the specific platform. Some may require minimum deposits to open an account, for example. Others will charge fees of varying degrees (or none at all), and some will be less user-friendly than others. On some brokerage platforms, you can’t withdraw your crypto directly from the account, instead, you’d need to sell your assets to be able to withdraw the balance to other accounts.

It’ll take a little research and experimentation to find one that you like, if you choose to use one of these apps to buy Dogecoin or other cryptos.

2. Setup a Payment Method

Once you’ve decided where you want to buy Dogecoin, it’s time to get down to brass tacks: Laying the lines to execute a transaction. That means setting up a method to pay for your new Dogecoin holdings.

Depending on whether you choose an exchange or a trading app, the specifics of this step will vary. But in general terms, it’s connecting a way to make a payment to the exchange or brokerage — usually by connecting a credit or debit card, or a bank account — to your account, so that you can make purchases or trades.

3. Purchase Dogecoin

At this point, it’s simply a matter of executing the transaction to buy Dogecoin. This process will vary depending on the exchange or app you’re using. But it’s usually as simple as inputting the amount of Dogecoin you want to buy, and hitting the “purchase” button to initiate the purchase.

4. Safely Store Your Dogecoin

Securely storing your cryptocurrencies isn’t quite as simple as holding a stock or ETF. Both exchanges and crypto wallets have become targets for hackers, so it’s important to make security a priority after you’ve purchased crypto.

Depending on whether you’ve used an exchange or an online trading platform to buy Dogecoin, your storage options vary. Crypto storage is a deep topic all on its own, but what you need to know is that specific exchanges and platforms may store your coins differently.

Platforms may store your Dogecoin in either “hot” or “cold” wallets. The essential difference is that “cold” storage is offline — making it more difficult for hackers, or other bad actors, to access. Conversely, coins held in “hot” storage remain online, and can be accessed quickly to facilitate trades.

Some platforms use a combination of hot and cold storage. Again, it depends on the specific platform you choose.

You can also transfer your Dogecoin to your own digital wallet, of which there are many to choose from with varying degrees of security and features. You can also choose from DOGE-specific wallets or those that allow you to store multiple types of cryptocurrency.

The Takeaway

The process of purchasing DOGE is similar to that of buying other cryptocurrencies. Once you’ve decided whether you want to go through a crypto exchange or a brokerage platform, you simply need to create an account and execute the purchase. Keep in mind that like all cryptocurrencies, DOGE is a risky investment with extreme price volatility.

Photo credit: iStock/StockRocket

Oct

2021

What is Proof of Work? Definition & Guide

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Cryptocurrencies are known for their high level of security — and in many cases, that security is made possible by a proof-of-work (PoW) algorithm. The proof-of-work consensus algorithm is currently used by Bitcoin, Ethereum, Dogecoin, Litecoin, and many other cryptos (although the Ethereum network is transitioning to a different algorithm known as proof-of-stake).

Proof of work largely serves to prevent double spending, which is when the same coins are spent more than once. Digital currencies are prone to double spending since they don’t have any material exchange — it can seem easy and tempting to forge transactions that are just numbers on a screen.

Proof of work and the blockchain keep track of every transaction to prevent this from happening. The algorithm is extremely secure and complicated, making it nearly impossible to double-spend Bitcoin and other PoW cryptocurrencies.

The concept of proof of work was originally developed to prevent denial of service attacks (DDoS) and spam emails, but in 2004 Hal Finney adapted it for use in blockchain digital currency networks. Bitcoin was the first cryptocurrency to put the idea to use.

How Proof of Work (PoW) Works

Proof of work is basically what it sounds like: proof that work has been done. The “work” is the conversion of electrical energy into “weight” on the Bitcoin blockchain through the use of computing power and a complicated mathematical calculation. Overall, this work makes forging transactions on the blockchain prohibitively expensive and difficult.

The mathematical calculation involves a hash function, which in turn generates a long string of unique numbers. This helps validate transactions and create the next block on the blockchain. Each block contains information about a specific Bitcoin transaction. As the transactions are validated and recorded on the chain, this ensures that double spending hasn’t occurred. Once information has been stored on the blockchain, it cannot be changed or deleted. This helps to keep the private keys of Bitcoin owners secure and anonymous.

Miners’ Role in Proof of Work

Bitcoin miners (nodes) run specialized machinery that works to solve the equation as quickly as possible, and they are rewarded with new bitcoins depending on how much computing power, or hash power, they contribute to keeping the network running.

The objective of PoW is to extend the blockchain. The miner that creates the longest chain gets the reward as well as the transaction fees contained in the block. The best way to solve the calculation is through trial and error, so the more computing power a miner can put into doing as many trials as possible as quickly as possible, the more likely they are to win the block reward.

Why Proof of Work is Needed

Proof of work ensures that double spending doesn’t occur in digital asset networks. It provides security and a record of transactions as well as an incentive for miners to keep the network running.

Proof of work is also needed because Bitcoin has no central authority (vs. a bank, for example). A central authority would keep track of transactions as well as issue new bitcoins to the network. Instead of this, the network of miners keeps track of the blockchain.

Proof of work also adds value to Bitcoin because it shows that people are willing to convert energy, a material resource, as well as fiat currency, into the production of the cryptocurrency. This provides more confidence for those who are interested in investing in Bitcoin.

Pros and Cons of Proof of Work

There are several reasons why PoW is used for Bitcoin and other popular cryptocurrencies, but there are arguments against it as well.

Pros of Proof of Work

• PoW helps keep the network secure

• It prevents double spending

• It adds value to the network through the use of energy

• It is an integral part of the decentralized authority system of the network

Cons of Proof of Work

• It requires computational power, which uses a significant amount of electricity

• PoW has low performance capacity for the execution of on-chain transactions

• Getting involved in mining requires a large upfront equipment cost and ongoing maintenance and electricity costs

• There is a risk that miners may group together to attack the network, undermining its decentralized nature

Which Cryptocurrencies Use Proof of Work?

Proof-of-work is the most commonly used algorithm for cryptocurrency networks. However, some cryptocurrencies use other algorithms, such as proof of stake. The following cryptocurrencies use proof of work:

• Bitcoin (BTC)

• Ethereum (ETH) (for now until it moves to proof-of-stake)

• Bitcoin Cash (BCH)

• Litecoin (LTC)

• Monero (XMR)

• Dogecoin (DOGE)

• Ethereum Classic (ETC)

• Bitcoin SV

• Decred

Proof of Work vs. Proof of Stake

Since PoW has some downsides, developers have been working on many other types of consensus algorithms for cryptocurrency networks. One of the most anticipated is proof of stake (PoS).

Rather than miners, PoS uses validators who are chosen to create blocks based on how many coins they hold, rather than having to compete to create the blocks. Proof of stake rewards validators that hold the most coins with the ability to mine blocks and validate transactions.

The benefit of PoS is that it uses a lot less electricity. However, PoS rewards nodes for holding tokens, resulting in hoarding rather than use of the crypto. PoS is also vulnerable to 51% attacks, where an individual crypto miner or group of miners gets control of more than 50% of a network’s blockchain.

The Takeaway

Proof of work is the original way to secure blockchains and protect cryptocurrency from being double-spent and potentially devalued. Bitcoin uses the PoW consensus algorithm, as do a number of other cryptocurrencies.

Photo credit: iStock/MesquitaFMS

DAOs and How They Work

What Is a DAO?

How Do DAOs Work?

How Are DAOs Funded?

DAOs: Pros and Cons

Examples of DAOs

MakerDAO

Augur

Uniswap

How to Invest in a DAO

The Takeaway

Crypto Technical Analysis: What it is & How to Do One

Crypto Technical Analysis: The Basics

Candlestick Charts

Support and Resistance Levels

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Relative Strength Index (RSI)

Average Directional Index (ADX)

Moving Averages (MAs)

Trend Lines

Cup and Handle Pattern

The Takeaway

How Many Dogecoins Are There in Circulation?

Does Dogecoin Have a Limit?

Dogecoin Has an Unlimited Supply.

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DOGE is Easier to Mine Than Most Cryptocurrencies

Doge Has Little Technical Development

The Supply of DOGE is Highly Centralized

The Takeaway

How to Buy Dogecoin (DOGE)

How to Buy Dogecoin in 4 Steps

1. Choose Where You Want to Buy Dogecoin

Crypto Exchanges

Online Stock Trading Platforms

2. Setup a Payment Method

3. Purchase Dogecoin

4. Safely Store Your Dogecoin

The Takeaway

What is Proof of Work? Definition & Guide

How Proof of Work (PoW) Works

Miners’ Role in Proof of Work

Why Proof of Work is Needed

Pros and Cons of Proof of Work

Pros of Proof of Work

Cons of Proof of Work

Which Cryptocurrencies Use Proof of Work?

Proof of Work vs. Proof of Stake

The Takeaway

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