Security

Typically, these systems have used Proof of Work both for distribution, as discussed above, and to ‘secure’ the network. When people say ‘secure’ the network, they really just mean that Proof of Work is being used as the consensus mechanism to determine WHO is allowed to add data to the ledger (blockchain.) It is important that this remains consistent so that there are no deep reorganizations of the ledger; it is bad if a large section of the end of the ledger changes and this can happen a lot (hackers can do that) if there is not good, consistent consensus.

In order to keep consensus consistent, Proof of Work blockchains incentivise a LOT of people to mine and add blocks, because it is assumed that the vast majority of people are ‘good’ and do not purposefully try to reorganize the end of the ledger for evil (hacking.) To do this, they automatically reward block producers with 1) newly minted coins (inflation) and 2) transaction fees. Historically, transaction fees on these chains have been notoriously low, contributing close to 5% of the overall rewards. This is because they compete with lots of other blockchains transaction spaces. Therefore, inflation must remain very high on Proof of Work chains, up to $700m per day or more, in order to keep the network secure. This is paid directly from the pockets of anyone who is holding the currency; inflation is tax. This inflation is required to effectively pay for the energy that the miners are using, to keep them incentivized to mine to prevent re-organization attacks of the ledger which would compromise transactability and trust in the network, especially for centralized endpoints like exchanges. If the inflation were to fall (like due to a Halvening) then the security of the network will be deeply compromised, assuming transaction fees remain constant, as expected.

Based on that realization, many distributed ledgers have been researching Proof of Stake in order to maintain security and safely lower the inflation of the currency lower than 3%, something that has never been done. In my point of view, there is an even easier and more straight forward way to achieve this, you just have to split apart the Distribution and the Security mechanisms into two totally separate mechanisms. For example, you can use a second order cryptocurrency like a token.

Second Order Cryptocurrency

Now that we have blockchain virtual machines (like the Ethereum EVM) it is possible to build Second Order Cryptocurrency, or one that literally exists inside of the virtual machine of another cryptocurrency blockchain. In this way, it does not have to inflate, or even meet a transaction fee quota, to secure itself. Instead, the base layer (Ethereum) has a currency (Ether) which will inflate inorder to secure the network, allowing the second order asset (any ERC20 token) to exist with zero inflation and merely pay small fees whenever sent. This is why a second order currency is the ideal structure for a store of value: because it can exist with zero inflation and zero transaction fees, perfectly securely. Some of you may be distraught because unlike traditional cryptocurrency, most ERC20 tokens (secondary assets) are not ‘free, open and fair’ and were instead unfair; all of the tokens being given to one central party and sold in a centralized ICO. That sucks! However, not all second order currency is centralized like that, nor depends on a centralized project or company. For example, 0xb6ed7644c69416d67b522e20bc294a9a9b405b31 is a contract, and a cryptocurrency, that shows us that pure mined currency can be a second order cryptocurrency too. Philosphically, I believe that this is the ideal technology for a store of value long term; it is pure mined using SHA3 hashing Proof of Work so it acts exactly like a metal, digitally, but it does not have to pay anything to secure itself. That is to say, its holders do not have to pay anything for inflation or in transaction fees for it to continue to work forever.