Advice + Tax + Accounts for smart business owners.
April 23rd 2021

Cryptoassets: consensus, proof of work and proof of stake

Many cryptoasset networks are not controlled by a single body or person; often the network of users of a particular token play an important role in verifying transactions or making changes to the network.

This approach is often known as a "consensus" because a certain proportion of the network has to agree to a transaction or technological change, before it goes ahead. For example, if Fred wants to send Mary 100 tokens, the network must first agree that Fred does indeed hold 100 tokens; if it does so, the transaction can then be added to the Distributed Ledger (DL).

Proof of work

Proof of work is the best known consensus system, used by Bitcoin among others. Here, the right to add a new entry to the DL is only available to the first person to solve a randomly generated cryptographic puzzle. That person then creates the new entry, which is shared with all the holders of the DL. The time and energy required to solve the puzzle is the proof of work, and the right to add the entry to the DL is the primary reward. The person with that right will be entitled to any fees available for including transactions in that entry, and they will be allocated new tokens that are released into circulation. This process is known as "mining" and helps maintain the network.

Proof of stake

Proof of stake has developed as an alternative to proof of work because the latter typically requires significant energy and computing power. Under proof of stake, the ability to create a new entry is determined by the user's wealth in the cryptoasset (their "stake" in it), rather than their computing power and ability to solve a puzzle before anyone else does. Those verifying transactions under proof of stake are rewarded with fees for facilitating the transaction, instead of any new tokens.

If you think you might have a tax liability associated with your cryptoasset activities, contact us for help today.

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