As a fan of cryptocurrency, you’ve probably heard the terms “Proof of Work,” “Proof of Stake,” and maybe even “Proof of Burn” before, but what do they really mean, and what is a “proof,” anyway? Without getting into too much technical detail, we will explain each concept one at a time, so you can have a better understanding of what they refer to the next time you see it in a potential investment. This week we explore an interesting take on a consensus algorithm for the blockchain known as Proof of Burn.

Review of the Importance of the Consensus Algorithm

Without consensus algorithms, a distributed ledger like a blockchain would be difficult to implement. In order to function, all nodes within a cryptocurrency network must agree on the current state of the blockchain or it risks facing problems like double-spending. When a new block is formed, the transactions within that block are checked and then it is added to the blockchain. The miner responsible for creating a block who receives the corresponding reward is determined by the consensus algorithm.

In the Proof of Work (PoW) mining, those who find the solution to a highly complex arithmetic problem first receive the reward most quickly. The probability of finding the right solution, of course, is greater the more hash power the miner is directing toward the network and the better the mining equipment they are using. With Proof of Stake (PoS) mining, coins are rewarded to stakers based on random selection and the amount of coins being staked by an address, and the probability of receiving a reward increases proportionally with the amount of coins being staked.

Both of these methods insure that the miner has invested something of value into a cryptocurrency network, so they will have something to lose if they attempt to manipulate or break the system. In the case of PoW, the miner has invested time into the mining process and money into their mining rigs. In the case of PoS, the miner has invested time into the maturation of their stakes and money into the size of their stakes. Both of these components, time and money, are what help give any cryptocurrency its inherent value upon its creation. Without them, there would be nothing special inherently found inside of a digital form of money, perhaps making it less trustworthy or harder for people to feel truly “invested” in it.

The developers of Counterparty (XCP), one of the first coins to employ a third type of consensus algorithm called Proof of Burn (PoB), summed up the problem of having nothing at stake in the success or failure of a digital currency:

“Imagine Satoshi had suddenly appeared out of nowhere with his great idea and a pile of bitcoins for sale at, say, a dollar each. Would he have won the backing of the countless people who have since invested their money, time and resources to build the infrastructure that is making Bitcoin successful? Or would people have instantly suspected some kind of pump-and-dump currency scam and steered well clear?”

Proof of Burn

Proof of Burn (PoB), otherwise known as “coin burning,” is often referred to as an energy saving variation of Proof of Work. As with the PoW or PoS, a PoB coin miner receives a reward proportional to the amount of money they “invest” into their coin mining. The Proof of Burn concept was first proposed and developed by Iain Stewart, who described “burnt” coins as “being the same as mining rigs.” As the name Proof of Burn suggests, this particular consensus algorithm “burns” coins by sending them to addresses to which the private keys are unknown and can never be known (in all statistical probability). Burned coins are therefore irrevocably removed from their network of origin, taken out of circulation, and will never be accessible by any person. The basic idea behind this seemingly radical action is that the miner is demonstrating their willingness to take a short term loss in order to make a long term profit, proving their dedication to and belief in the success of the project.

Iain Stewart’s original post announcing his idea of Proof of Burn. Source: bitcointalk.org

By sending coins of a given value to an unusable cryptocurrency address, the sender is expending resources the same way a PoW or PoS miner expends resources to create more coins using those consensus algorithms. Thus, the value of the coins burned can be seen as being transferred to the value of the new coins. The biggest PoB cryptocurrency network are “piggybacked” off of existing blockchains and use the native blockchain of the coins being burned in order to process their transactions. This means that they actually rely upon the consensus algorithm of a pre-existing blockchain and that PoB does not perform any special set of math equations to help secure transactions of the coins in its network.

Pros and Cons of Proof of Burn

Being a philosophically new take on what it means to offer a cryptographic proof for the creation of a new cryptocurrency, the Proof of Burn algorithm is a much discussed topic within the crypto community. Let’s review the points in favor of the PoB consensus algorithm and the points against it:

Advantages:

  • It is well-suited for the introduction and distribution of new cryptocurrencies.
  • It consumes less energy than Proof of Work and is more environmentally friendly.
  • Coins created cannot be monopolized by mining pools or ASIC miners and thus distribution is fairer than Proof of Work.
  • The process of burning promotes an investor’s long-term commitment to the project.

Disadvantages:

  • Burning of coins can be considered a waste of previously-established value.
  • It has the similar problem of Proof of Stake, in that whoever owns more coins to be burned can earn more coins, and thus has better chances to earn more of the new coins.
  • There is no guarantee that PoB miners will be able to recover the value of the burned coins. Therefore, burning is also a risky investment.
  • In some PoB systems, anyone who has ever burned coins gets a lifelong right to be allowed to generate new blocks. This means that their probability of getting the reward for the next block increases with the number of coins they have been burned over time. This problem is also paralleled with the Proof of Stake consensus algorithm.

In the process of coin burning, coins (which can be either blockchain native or outside cryptocurrencies), they are sent to an “eater address.” The eater address is often a randomly chosen bitcoin address. Its private key is unknown, and since it cannot be calculated backwards from its address, it is impossible to ever spend the coins that go to an eater address. Each bitcoin address is between 26 and 34 characters in length, which are case sensitive and include numeral 1 through 9. This means that, after the initial address character (usually “1” but sometimes “3” in the case of multisignature addresses), there are 61 different options for each of the next 20 or more characters following it, with the last few characters limited in choice by the constraints of the address generation system.

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Counterparty

Counterparty

The first and most famous implementation of PoB is Counterparty (XCP), a protocol for token (“colored coin”) generation that piggybacks on the Bitcoin Network. Counterparty can basically be thought of as a giant DApp that uses the Bitcoin Network to process its transactions which involves the creation of tokens by adding special designations to tiny bits of bitcoin. Counterparty tokens can be moved back and forth from bitcoin wallet to wallet, but like bitcoin, their movement requires a transaction fee in order to incentivize miners to confirm the transaction in an incoming block. Counterparty was also unique at the time of its launch in that its platform contained the first built-in asset exchange, dedicated to the sole purpose of trading Counterparty tokens.

XCP “eater” address as displayed on blockchain.com

Counterparty was founded by Adam Krellenstein, Evan Wagner and Robby Dermody. In January 2014, the project was announced to the public, and everyone in possession of BTC was invited to take part in its burning period. Throughout the month, slightly over 2,100 bitcoins were burned, creating about 2.6 million XCP. Bitcoin was sent to this following address, the private keys of which are unknown to anybody and were never generated:

1CounterpartyXXXXXXXXXXXXXXXUWLpVr

Counterparty’s official platform wallet, named Counterwallet, was one of the first to readily enable multisignature transactions and also to rely heavily upon smart contracts for its wallet operations. The team gives the following rationale as to why they chose to implement the PoB method in order to give their coins value:

“By opting to distribute all XCP by proof-of-burn, the Counterparty developers eliminated any speculation that they planned to get rich quick or redistribute risk unequally. On the contrary, they put themselves in the same position as everyone else, backing their ideas with destroyed bitcoin to obtain XCP in the hope of eventually benefiting financially from their own project and hard work…

If burning bitcoins for XCP still sounds strange, consider that Bitcoin miners also destroy one resource to get another. Miners use electricity (which is ultimately burning fuel) and receive newly minted Bitcoins in return for processing transactions and keeping the Bitcoin network secure. Those who burnt bitcoin to get Counterparty XCP coins did the exact same thing, except the resource they destroyed was not more fuel, but bitcoins. The result achieved was establishing Counterparty’s legitimacy, as we have already discussed.

In a very real sense, the original energy used to create those bitcoins was repurposed and used to create XCP.”

At its peak in popularity, XCP managed to climb to about 25x its initial value of 0.0008 BTC / XCP (the average amount of BTC that needed to be “burned” in order to create 1 XCP). For a while it enjoyed media coverage thanks to the Rare Pepes phenomena of collectible cryptocurrencies and has always had a steady membership in its core community who help its ecosystem continue to thrive. Unfortunately for long-term supporters, the project never really managed to gain much traction or popularity after the crypto boom of 2017 and is now usually regarded more as an interesting experiment – a historically significant undertaking – rather than a practical idea that appeals to mass audiences. Nevertheless, Counterparty proved that PoB was indeed a viable option for the means of coin generation, paving the way for future PoB-oriented cryptocurrencies to follow.

A few other PoB coins include Slimcoin (SLM), Request Network (REQ) and Triggers (TRIG).

 

Do you have questions about Proof of Burn? Maybe feel like we missed something you feel is worth explaining? Feel free to let us know in the comment box below and we’ll be sure to get back to you as soon as we can.