When it comes to blockchain or cryptocurrencies, we’ve all heard of Bitcoin and Ethereum. These blockchain platforms employ a consensus mechanism such as Proof of Work (PoW) or Proof of Stake (PoS). The consensus algorithm, such as PoS or PoW, ensures that the transaction process to be added to the new block of the blockchain ledger is regulated and verified without involving any central authority.
Blockchain technology operates on a network, and each cryptocurrency adheres to specific protocols and regulations. A consensus mechanism or consensus algorithm is the rules or system on which a blockchain network operates and provides insurance against the outside world (hackers and cybercrime).
Ethereum uses the Proof of Stake (PoS) consensus mechanism, whereas Bitcoin uses the Proof of Work (PoW) consensus algorithm. Understanding the difference between PoS and PoW is critical for understanding each blockchain platform and cryptocurrency.
What exactly is Proof of Stake? (PoS)
Proof of Stake (PoS) is a consensus method used in the blockchain to process transactions and create new blocks. A consensus method validates entries in a distributed database while also protecting the database. In cryptocurrency, the database is referred to as a blockchain; thus, the consensus method secures the blockchain.
Understanding the Proof of Stake Mechanism (PoS)
PoS reduces the time and effort required to solve complex computational problems for transactions and blocks, thus improving the security of the blockchain network.
Users holding native tokens perform verification under the Proof of Stake (PoS) protocol. Those users offer their tokens in exchange for the opportunity to validate the blocks. Users who have staked their native tokens are eligible to become “Validators.”
The PoS mechanism selects validators at random to validate the block, whereas the Proof of Work (PoW) mechanism employs a competition-based selection process.
There is a minimum requirement that the user must meet in order to become a validator. For example, if we take Ethereum, the user must stake 32 ETH on the blockchain before becoming a validator.
Multiple validators validate blocks, but when one validator confirms that the block is correct, the block is finalized and closed.
Different Proof of Stake (PoS) schemes will employ various block verification methods. For example, Ethereum switched from PoW to PoS. In addition, it now uses shards for transactions.
A validator will verify the transaction by adding it to the shard block, which will be attested to by 128 validators. After the shards have been validated and blocks created, two-thirds of the validators must agree that the transaction in the shard block is valid before the block can be closed.
What is Proof of Work?
The Proof of Work consensus protocol is a system that works in tandem with a reasonable amount of effort to keep the network from becoming corrupted by various activities. It is a decentralized consensus algorithm that relies on members who can solve mathematical problems or complex equations to prevent the system from being jammed or hacked. PoW is widely used in cryptocurrency mining, particularly Bitcoin, which uses a proof of work consensus algorithm. Miners solve the equations here, and a new block is created, which is then added to the ledger. PoW is used in cryptocurrencies where miners are required to mine new blocks/tokens and where transaction validation is required. This allows miners to profit in exchange for their mining skills. They are compensated with Bitcoin and other cryptocurrencies.
This algorithm employs SAH-266 hash functions, which provide the system with a robust mechanism, resulting in a highly secure peer-to-peer network. As a result, no centralized authority is required in this system. Furthermore, scaling Proof of Work necessitates a massive amount of energy. This is because it only rises as the number of miners and the network expands. To address this issue, Proof of Stake is used as an alternative to Proof of Work.
Proof of Stake vs. Proof of Work
You must understand the distinction between them to comprehend both consensus algorithms fully. PoW differs from PoS, and we will discuss some key differences below, considering specific parameters.
- Consumption of Energy
Regarding energy consumption, Proof of Work has a high level of energy and electricity consumption. In comparison, Proof of Stake consumes little energy. Therefore, the energy consumption for PoS could range from low to moderate.
- Tools Needed
Heavy equipment, such as computers with GPUs and hard drives, is used in the Proof of Work consensus protocol. Performing these mining operations requires the computer to be highly efficient. On the other hand, PoS does not require tools or equipment.
Proof of Work provides tight security because miners must crack the hash functions to create or validate the new block. On the other hand, PoS makes a secure network and locks the crypto. However, this security has gone untested several times in Proof of Stake.
The rewards in Proof of Work are given to the first miner who solves the equation. The payments are made in the crypto they’re mining. On the other hand, Proof of Stake does not provide block or coin rewards. As a result, the validators instead take the transaction fees.
Proof of Stake Variants
- Delegated Proof of Stake (DPoS)
In 2014, Daniel Larimer founded Delegated Proof of Stake (DPoS), a consensus algorithm. Cryptocurrency projects such as BitShares, Steem, Ark, and Lisk use Delegated Proof of Stake (DPoS).
In DPoS, an election system is used to select nodes to verify blocks. These nodes are called “Block Producers” or “Witnesses.” In the DPoS System, the user can direct his vote or delegate voting authority to another entity on his behalf. DPoS is more decentralized due to the low entry threshold.
- Leased Proof of Stake (LPoS)
Leased Proof of Stake (LPoS) was introduced in 2017, and the consensus algorithm was created to address various issues with PoS and its variant, DPoS.
The LPoS system operates similarly to PoS, but it employs leasing to provide nodes with small stakes and incentives to participate in the consensus.
The LPoS system is used in the WAVES blockchain platform, and the leaser must have 1,000 WAVES to participate in block generation. If enough coin holders wish to lease their coins, the node balance can become empty; thus, 1000 WAVES are required to generate a block. Once the node is chosen for block production, the leaser will receive a percentage of the node’s revenue.
- Hybrid Proof of Stake (HPoS)
HPoS is a hybrid of PoS and PoW. When PoS is combined with PoW, the security of the blockchain is increased. In those implementations, miners use Proof of Work to generate blocks, and PoS validators vote on the validity of those blocks.
Decred and Hcash are two projects that use HPoS.
- Nominated Proof of Stake (NPoS)
In a nutshell, Nominated Proof-of-Stake is the process of selecting validators to be allowed to participate in the consensus protocol. NPoS is a variation of PoS and is used in Substrate-based Blockchains such as Kusama, Edgeware, or Polkadot.
Validators are chosen to participate in the consensus method using NPoS.
Validators and Nominators are two significant actors in the NPoS. Validators are in charge of infrastructure and network upkeep. Nominators or Token Holders choose 16 validators and contribute to the network’s security.
Benefits of Proof of Stake
- Energy conservation
Because nodes are not competing for a block in the blockchain, PoS saves energy. Furthermore, there is no need for mathematical computations in Proof of Stake, which saves energy.
- Correct Validation
Validator nodes are used in PoS to validate blocks, whether they are correct or incorrect. Accurate blocks are rewarded, while inaccurate blocks are penalized, with the owner losing specific stakes if fraudulent transactions are approved.
- Extreme Scalability
Compared to Proof of Work, Proof of Stake is much more scalable. As PoW is based on computation requirements, it is slower to process transactions, raising scalability concerns.
However, this is not the case with PoS because it is decentralized and allows individuals and groups to participate, making it highly scalable.
The Drawbacks of Proof of Stake
- Restrictions on Access
Because PoS necessitates the staking of cryptocurrencies, individuals can use fiat money to purchase that specific PoS-based blockchain cryptocurrency or exchange crypto coins from other platforms.
The more cryptocurrencies you stake, the more likely you will be chosen as a validator and earn the rewards. As a result, the individual must purchase more cryptocurrencies to stake more and earn more.
The same thing happens with Proof of Work. If an individual or group of individuals has money, he can use it to purchase highly computational mining equipment, increasing his rewards.
- The 51% Attack
Proof of Stake has the disadvantage of allowing a 51 percent attack, in which an individual or groups of individuals can control the blockchain if they hold 51 percent of the cryptocurrencies.
In new and low-valued cryptocurrencies, an individual or group on PoS-based blockchain platforms can gain an advantage over others. This advantage may increase their chances of being chosen as validators.
As a result, a person or group of people who have been chosen validators frequently collect more transaction fees, increasing their stake and chances of being chosen validators.
- Recently Introduced Technology
PoS has been around for a while, but it is still in its infancy. It functions somewhat differently than Proof of Work and has some advantages. For example, Proof of Stake can be more energy efficient and use less electricity. In addition, PoS allows for the creation of more coins/tokens than Proof of Work.
The most significant difficulty is transitioning from Proof of Work (PoW) to Proof of Stake (PoS). With that said, Ethereum successfully managed to make its transition to PoS from PoW in the recent “Merge” event.
Furthermore, some people are concerned about rewards because they believe that the rewards from staking are lower than those from mining.
Peercoin, the first cryptocurrency to use Proof of Stake (PoS), was introduced in 2012. Nxt, Cardano, Blackcoin, and Algorand were among the other cryptocurrencies that used PoS in 2017.
There are several advantages to incorporating the Proof of Stake (PoS) mechanism into the blockchain. First, network synchrony is critical for ensuring protocol safety. Even though many blockchains are actively using various variants of Proof of Stake (PoS), its true potential is yet to be realized as we watch the outcome of Ethereum’s Merge.