This post describes Ercoin story and sketches its place in the cryptocurrency ecosystem. For more pracical information, see the announcement of version 1.0.0 beta and the announcement of Initial Burn Offering.

At the beginning there was Bitcoin. The first cryptocurrency. We can’t however name Bitcoin the first decentralized money. Originally all money had been decentralized. Salt, sugar, gold, silver etc. — all of them are commodities for which there exists no institution that accounts who owns how many units. So why do we need those institutions in case of virtual currencies?

The problem with virtual currencies is that they‘re not tangible. If I spend a bar of gold, then I don’t have that bar anymore. But if I own a virtual currency, then it is just an entry in some database. This database cannot be modified freely: if I want to make a transfer from my account, I need to sign that transfer with my private key, proving that I am the owner. This protects from unauthorized access, but it does not protect from double spending. That is, I can create a transfer that sends all my funds to merchant A and also create a transfer that sends all my funds to merchant B. Then I can present the former to merchant A and the latter to merchant B. Two competing transactions (transaction histories) arise. How to determine which one is “right”? In an ordinary, centralized system we could make arbitrary rules that say, for example, that the transaction that arrived at the bank first is valid and the second one is discarded. But what to do in a decentralized environment, where no entity is privileged?

That’s where Satoshi’s innovation comes in place: we may consider as valid the chain that has most work (computations) performed to “authenticate” it. This is how Bitcoin works. And this is also how it distributes newly created coins: the more work you perform, the more coins you get. But it is wasteful in a sense: large computations are performed not to actually compute anything, but to perform non-arbitrary decisions. Instead of expensive, CO₂-emitting computations being used as voting power (proof of work), capital ownership can be used (proof of stake). Sunny King implemented this in Peercoin, creating a hybrid (proof of work + proof stake) cryptocurrency. Pavel Vasin created BlackCoin, the first 100% proof of stake cryptocurrency with fair distribution (no entity privileged).

The idea of proof of stake can be considered a final step of one of the cryptocurrency evolution paths in terms of reducing energy needed to maintain the network, but implementing a proof of stake cryptocurrency does not mean that there is no room for improvement. BlackCoin is a descendant of Bitcoin’s codebase and shares some of its shortcomings (see for example my article “Dynamic minimum transaction fees and negative transaction fees”). There are many cryptocurrencies which are not Bitcoin-descendant, often with ambitious features like Turing-complete computations. Often they are ICO-funded and have big development budgets. The goal of Ercoin is not to create a more feature-rich, more sophisticated cryptocurrency. Instead, it aims to fulfill a basic cryptocurrency function: providing a payment system, in a way that is simple and economically sound. Money is a simple idea, so it shouldn’t need a complicated implementation, right? I won’t go into details here; for these, see the whitepaper. I will however write a few words about distribution.

Proof of stake is a great way to reduce costs and make the network more secure. Instead of gaining credibility by expending electricity, you gain credibility by capital ownership, which does not involve wasting any real-world resources. Also if one decides to attack the network in proof of stake, he will undermine the value of his own coins, needed to perform a 51% attack. On the contrary, in Bitcoin a 51% attack can be performed by an external entity, owning virtually no coins.

Proof of stake in its direct form cannot however be used for initial distribution of coins, as there is no existing capital yet. Therefore you need to leverage some existing resource to perform distribution. BlackCoin had had an initial proof of work phase just for this purpose. Another method to obtain initial distributions is to perform a snapshot of balances of another cryptocurrency — this is what some hard forks have done (see for example Bitcoin Cash) and it can be considered a proof of stake distribution. Ercoin uses yet another method: you need to destroy (“burn”) blackcoins to obtain initial ercoins (and the more blackcoins you destroy, the more ercoins you get). This is distribution by proof of burn or, facetiously speaking, Initial Burn Offering (IBO). It has the advantage that users can decide how to split their funds between the original currency and the newly created one, whereas in the proof of stake distribution they need to achieve their preferred partition after launch, by trading. Snapshots are also not always feasible due to technical incompatibilities. By the way, proof of burn can also be used to secure the network, as it is done in Slimcoin.

When performing an ICO, invested money flows to a selected entity, making it a driving development force. This is not the case for IBOs and it affects impetus of marketing and development. Besides technical and economical features, one can think of Ercoin as an experiment in how far we can get in creating an oldschool cryptocurrency: community-funded, with unprivileged distribution. Fortunately, there are some factors in favor of making this work in case of Ercoin. First, the business logic is simple; in particular, we don’t aim to create a virtual machine or a scripting language. Second, we use Tendermint as a consensus engine which takes care of many difficult and generic parts. Third, we all know about the success of Bitcoin, developed without premine and without ICO, which still dominates the market with bigger capitalization than all of its more than two thousand competitors combined (even including those with price artificially pumped by supply manipulation). Peercoin and BlackCoin at their peaks also had very high market share.

Will this model, when applied to Ercoin, still give good results? Time will tell. People will tell. Code development can be done alone, eliminating many problems with human management and decision making, though the feeling of programming loneliness doesn’t give much motivation and fun, not to mention scaling constraints. However for market adoption it is crucial to gain people’s recognition. So it is not only the product, its technical and economical features that contribute to success, but also marketing — the truth that prevails in business in general, but is probably even more important in the fiduciary area of cryptocurrencies.