Cryptocurrencies work on top of blockchain technology. This underlying technology helps to settle transactions in real-time and also guarantee security. The public ledger maintains a record of all transactions that have occurred between the members in the network.
Members of the network who keep a local copy of the ledger are called as nodes. These nodes could be either full nodes or light nodes. A few cryptocurrencies use a second tier to increase security and also provide additional functionality. These are called masternodes.
Nodes are responsible for mining, which creates new currency on that network whereas masternodes perform specialized transactions that miners cannot accomplish. A masternode is a complete node which hosts the entire copy of a blockchain in real-time. Hosting a masternode can be considered to be a good option for passive income. However, it is required that masternodes stake a fixed amount of digital currencies before they can be accepted as such.
A detailed understanding of a Masternode
A blockchain works on a set of defined rules which have been mutually agreed. These mutually agreed set of terms are called consensus mechanism. Proof of Work and Proof of Stake are some examples of types of consensus mechanisms.
The oldest digital currency Bitcoin works on the Proof of Work consensus mechanism where miners verify and add newer transactions the mainchain. Mining is a computation-intensive process and the miner is rewarded in digital currencies for his work.
Nowadays, Bitcoin is the largest blockchain network in the market. However, running Bitcoin consumes large amounts of energy. Most of the Bitcoin miners are currently located in China. This is also one of the main critics received by Bitcoin.
Proof of Work systems are energy-intensive and hence being replaced by a more efficient mechanism called Proof of Stake. Proof of Stake attributes mining power to the proportion of coins held by the miner. Masternodes are partly based on the Proof of Stake consensus mechanism.
The first cryptocurrency to implement masternodes was Dash. Dash uses a Proof of Service mechanism which contains two tiers of networks. The first one consists of the network of miners to achieve distributed consensus on the blockchain. The second tier is made up of masternodes which provide special functionality such as InstaSend or voting on budget funding.
These operators work under a collateral-based system to ensure their integrity. They are rewarded for processing transactions on the network in real-time.
How does a Masternode Work?
Establishing a masternode requires holding a substantial amount of that particular cryptocurrency. 1000 Dash are required for running a Dash masternode. This amount is then staked to create a masternode. The core wallet of the native cryptocurrency is required. The wallet integrates your computer as one of the nodes that support the blockchain.
Masternodes enable a variety of features such as instant or anonymous payments. It also allows masternode operators to vote on important developments occurring on the blockchain. Masternode operators usually earn an equal 45 percent of a block reward along with miners. The remaining 10 percent goes to a blockchain fund and operators are required to vote on how these funds should be used to improve the network.
Each cryptocurrency has its own set of rules or conditions on establishing and maintaining a masternode. If these conditions are violated the masternode will cease to be operational. Take into consideration that there are different blockchain networks in the market. Dash is the most popular one but you can find a wide range of coins with this characteristic.
Benefits of Masternode
Establishing a masternode could be a capital intensive procedure depending on the cryptocurrency. Most of the costs include the upfront payment required to buy the digital currency which needs to be staked and for setting up the necessary infrastructure.
This cost of operation also helps in keeping the network decentralized as no one person or entity can acquire a monopoly on the network. The rewards offered also help in motivating masternode operators to properly maintain their nodes without any malicious intent.
Dash originally established the masternode system to provide support for additional features. One of these features is InstaSend, a way to implement instantaneous transactions. PrivateSend is another feature which allows users to send and receive instantaneous transactions. Dash also allow operators to vote on financial and technological developments for the blockchain.
Running a Masternode
Most cryptocurrencies that support masternodes require a node owner to hold a certain amount of coins. This is to ensure that they have a vested interest in the network. It also safeguards against node owners trying to sabotage the network for their personal gain. Each currency has its own set of guidelines to set up a masternode which can be found on their official website.
The basic procedure to set up a masternode remains common to all currencies. The first step is to purchase the required amount of coins on an exchange and transfer them to your desktop wallet on your computer. The next step is to synchronize the blockchain with your computer.
A node address needs to be created. The coins are then transferred to that address. This allows you to obtain the private key and transaction data required to set up the node. The final step involves setting up a server. This can be your own personal server or a private virtual server. A private server is more preferable since most cryptocurrencies require the node to be online 24 hours a day. Once the server has been built and configured, it can be started using the desktop wallet.
At this point, the masternode is fully operational and will now synchronize with the blockchain. The rewards you obtain will be based on the regulations of the selected cryptocurrency. Some digital currencies also require masternodes to have a separate VPN network as well as an IP address.
Most masternodes require a high initial investment which might not be feasible for everybody. Another way to invest in a these blockchains is to purchase a share instead of a complete masternode from a holder. The reward earned will be based on the percentage of the share purchased.
Crypto Assets that Support Masternodes
Following the example of Dash, various cryptocurrencies like Block, Crown, PIVX and many others implement this solution on their blockchain. Block Net will use masternodes to support its decentralized exchange. Syscoin uses this implementation for its decentralized marketplace. BOScoin has integrated masternodes for its smart contracts and its Congress Network. This gives masternode operators voting privileges on code and policy modifications and also on revenue allocation.
In the future, there might be a larger number of these blockchain networks. Nonetheless, these kinds of blockchains have been very rare. It is very important to understand why these networks couldn’t continue expanding. Proof-of-Stake and Proof-of-Work networks became the standard.
Bitcoin, Ethereum and Litecoin are all PoW networks. However, ETH could soon transition to PoS. This is going to take some time, though. Despite that, we haven’t seen new projects moving to this novel way of running decentralized networks. But why?
Earning from These Blockchain Networks
Earning money from masternodes depends on various different factors. Selecting the appropriate cryptocurrency is the most important factor. If the selected currency does not have a use case it should be avoided. The masternode space has also been affected by scammers similar to the rest of the crypto market.
Cryptocurrencies that offer very high-interest rates should be scrutinized. The guidelines regarding the establishment of the masternode of that currency are the next factor to be considered. The returns from the selected coin should be good enough to cover the operation costs and also provide good profits. The value of the selected coin should ideally be worth significantly more in the future to be able to cover the initial investment.
Take into consideration that there are also many risks. For example, the coin in which you invested could eventually stop existing. Moreover, a hack could occur and your funds would be lost. This is why it is always important to never invest more than what you are able to lose.
Applications involving these networks are quite flexible. It provides a balance between Proof of Work and Proof of Stake. Masternodes compensate for the limitations of Proof of Work and offers the best of Proof of Stake. This helps to avoid the centralized mining pools and consumes less energy than Proof of Work consensus mechanism. Furthermore, this could also be a partial solution to large energy consumption.
Masternodes offer increased stability and network loyalty as high initial investments and large dividends make it less probable that operators will leave their position on the network. It can also be used to keep miners in check. The Dash model gives complete authority to operators to reject or orphan a block if a miner or pool tries to manipulate the network.
These networks have immense potential to further democratize decisions within a blockchain network. But of course, there are many challenges ahead. This is why it is definitely important for developers to continue working on these solutions. Improving the Proof of Stake and Proof of Work consensus algorithms is also one of the main issues of the industry.
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