Proof-of-Work (PoW) was the first blockchain consensus mechanism and is still arguably the most popular choice in achieving distributed consensus (the ability to trust a stranger without having to go through a third-party).
PoW is used by the likes of Bitcoin and Ethereum (for now) and several other cryptocurrencies. Strong as it may be, it comes with disadvantages like high computation requirements, high energy costs and the threat of centralisation-by-mining-pool.
Once you understand PoW and its downfalls, the need for a system like Proof-of-Stake (PoS) becomes clear.
But first — what’s a stake?
In crypto-terms, the stake is the cryptocurrency a user owns and pledges in order to partake in validation — more on that soon.
How does Proof-of-Stake work?
A one sentence description tends to be a good starting to point when trying to explain complex ideas. So in short:
Proof-of-Stake algorithms achieve consensus by requiring users to stake an amount of their tokens so as to have a chance of being selected to validate blocks of transactions, and get rewarded for doing so.
PoS shares many similarities with PoW, but also differs in fundamental ways. As in any blockchain based consensus algorithm, the goal is still to achieve distributed consensus — to create a secure system whereby users are incentivised to validate other peoples’ transactions while maintaining complete integrity.
In PoS the miner of a new block, in this case known as the forger, is chosen in a semi-random, two-part process. The first element to be considered in this selection process is a user’s stake. How much of the currency in question is the user staking?
Every validator must own a stake in the network. Staking involves depositing an amount of tokens into the system, locking it in what you can think of as a virtual safe, and using it as a collateral to vouch for the block.
The more a user stakes, the better their chance of being selected since they’d have more skin in the game — acting maliciously would see them set back by a greater amount than someone who stakes less.
In the majority of PoS consensus algorithms, the incentive to partake in validation of blocks is a payout in the form of transaction fees, as opposed to freshly created currency in PoW systems.
Not much is random about that first part, in fact it’s probably got you thinking that PoS is ripe to be abused by the wealthy. The key here is to include a degree of chance to the selection process so as to avoid a scenario where the richest users are always selected to validate transactions, consistently reap the rewards and grow richer and richer.
The second element adds the ‘random’ to the semi-random selection process, although the way in which this is done differs from blockchain to blockchain. The two most commonly used methods are Randomised Block Selection and Coin Age Selection.
In Randomised Block Selection, forgers are selected by looking for users with a combination of the lowest hash value and highest stakes. The Coin Age Selection method chooses validators based on how long their tokens have been staked for. These are by no means the only methods of selecting validators, though. Some currencies combine the aforementioned methods while others are experimenting with their own.
Another difference worth noting between PoW and PoS, is that unlike in PoW systems where more and more cryptocurrency is continually created as rewards for miners, the total amount of cryptocurrency units are usually created at launch in PoS systems.
That’s often the reasoning behind using transaction fees as reward for validators. That being said, in certain cases new currency can be created by inflating the coin supply which can then be used as reward.
Advantages of Proof-Of-Stake
PoS is widely regarded as one of the best options for a cryptocurrency consensus algorithms. Here’s why:
- Energy Efficiency
PoS algorithms are energy efficient — especially when compared to PoW. Cutting out the energy-intensive mining process makes PoS a greener option.
Attackers must put their assets — their stake — on the line in order to attempt a 51% attack. A big deterrent. For comparison, attackers don’t lose their hardware when attempting 51% attacks on PoW systems.
Large mining-pools (groups of miners combining their resources) can control over 51% of networks running PoW systems, leading to a very real threat of centralisation. This comes as a result of the exponential increase in reward per investment on PoW systems, as opposed to the linear increase on PoS systems.
If a user on a PoS based network investments twice as much as another user, they’ll have twice as much control. The same scenario on PoW would grant the user exponentially more control.
The ‘Nothing at Stake ‘ Problem
For all its plus points, critics of the Proof of Stake system are quick to point out the economic challenge known as the Nothing at Stake problem. It’s an interesting little dilemma that allegedly prevents PoS from being an ideal option for distributed consensus.
The idea here is that in the event of a fork (the blockchain splitting in two), block generators have nothing to lose by supporting different blockchains, essentially preventing the conflict from ever resolving.
In PoW systems this is guarded against since users would have to split their computational resources in order to support both sides of the fork. In PoS systems, however, validators’s stakes would be duplicated onto both chains meaning they could potentially claim twice the amount of rewards.
Simulations have shown that forging on several chains is possible, even profitable, but PoS advocates have demonstrated several work-arounds. Ethereum’s Casper protocol, for instance, is set to require participants to submit a deposit which will be confiscated if they are deemed to have violated a pre-determined set of rules — such as signing off on multiple forks.
Ethereum’s Casper Protocol
Ethereum, the second largest cryptocurrency by market cap, is transitioning from a PoW to a PoS system, codenamed Casper. While we still don’t know the exact details of how and when the transition will take place, we know that it will be a two part process, with the first part including a hybrid PoW/PoS system, before moving on to PoS completely.
The reasoning behind the move makes an interesting read:
“Transitioning the Ethereum network from PoW to PoS has been on the roadmap and in the Yellow Paper since the launch of the protocol. Although effective in coming to a decentralized consensus, PoW consumes an incredible amount of energy, has no economic finality, and has no effective strategy in resisting cartels. Excessive energy consumption, issues with equal access to mining hardware, mining pool centralization, and an emerging market of ASICs each provide a distinct motivation to make the transition as soon as possible.”
It’s important to keep in mind that different cryptocurrencies use different consensus mechanisms (PoW, PoS, DPoS etc.) and it’s just as important to remember that the consensus mechanisms themselves differ from one another. Not all PoS algorithms work the same way, for instance.
Doing your own proper due diligence on a cryptocurrency involves understanding its inner workings. We hope this article helps you do that.