Those new to the game have likely stumbled across the terms “Proof-of-Work” and “Proof-of-Stake” along their journeys to blockchain enlightenment. You may understand that these concepts are important, but don’t know what exactly they entail. They are different, usually competing frameworks that allow blockchains to arrive at a consensus. And, although the details are complex, the broad strokes aren’t too difficult to comprehend.
The need for consensus
Distributed systems like blockchains don’t rely on a central authority to guarantee the truth. There is no banking institution, for example, to ensure transactions are accurate. Instead, information is validated through the coordination of a large number of nodes that make up the network. Each node has a cryptographic mechanism that is implemented to reach consensus. The major difference between Proof-of-Work and Proof-of-Stake networks is how this mechanism works.
Proof-of-Work networks
Proof-of-Work consensus is used for the majority of blockchains today. It was first proven useful for monetary transactions by computer scientist Hal Finney is 2004. Later, its first practical application to finance came when the mysterious and potentially pseudonymous Satoshi Nakamoto released Bitcoin in 2009. This is why the mechanism is now sometimes referred to as the “Nakamoto Consensus”.
The Proof-of-Work consensus mechanism works through the process of “mining”. Miners on a PoW network have computers that solve complex math problems to verify the information of a potential new block is correct. This is done through cryptographic hashing.
The topic of cryptographic hashing is daunting in of itself, but the main points of interest are as follows: First, blocks contain both transactional data and a random number called a “nonce”. The data and the nonce are fed to an algorithm to receive a unique alphanumeric hash. Hashes are basically the fingerprints for any given data set. Changing the nonce results in a different hash. Miners use special programs to run through an astronomical amount of nonces to obtain a hash that satisfies specific requirements (perhaps the target hash has to begin with at least a certain number of zeroes.)
Once the math problem is solved, the miner transmits the nonce and data to all other participants on the network, who then verify the conditions have been met. If a majority of the others validate the information, the miner gets to add the block to the chain and claim a reward in the form of that blockchain’s unique coin.
The “work” in a PoW network is the solving of this complex math problem. It takes an enormous amount of computational power and thus, energy to solve the equations. Each miner is responsible for providing their own hardware and paying for the necessary power to engage in the mining operation. This incentivizes miners to be truthful regarding transaction information because if they attempt to game the system, it has to be verified by at least 51% of other participants. For that to happen, the malicious agent would have to control 51% of the network’s computational, or hashing, power. In large networks such as Bitcoin’s, the cost to acquire such power is prohibitive. This is why sizable PoW networks are seen to be very secure.
Proof-of-Stake networks
Proof-of-stake consensus is an alternative blockchain framework conceived in 2012 by Sunny King and Scott Nadal, the creators of the first PoS network, Peercoin. The mining process is completely bypassed in a true Proof-of-Stake system. Here, network participants called validators add blocks to the chain. Each validator must stake -invest- a specified amount of the network’s cryptocurrency as collateral for participation. For doing so, they are rewarded a set amount for each successful addition. Validators “forge” or “mint” coins rather than mine them.
The more a validator stakes, the more likely they are to be chosen to add a block. To prevent unfairness, many PoS consensus algorithms institute a randomization factor into the selection process. Single validators may be prevented from being selected after they add a block for a certain amount of time. Or, validators who have not gotten to add a block in a long period of time could have the odds weighted in their favor.
However, since adding blocks is much less computationally intensive, what stops validators from acting in bad faith for their own personal gain? Well, when they stake themselves to the network, they are unable to retrieve their invested crypto until a predetermined time in the future. If administrators or other participants in the network find a validator compromising the integrity of the blockchain, that validator will have a portion (or all) of their stake confiscated. This works because the rewards for minor malfeasance, say approving blocks on two different forks in a chain, are less than the amount they’ll lose for getting caught.
For major attacks such as adding counterfeit blocks, malicious agents would have to control over 51% of cryptocurrency’s circulation. With large networks, this is even more impractical than controlling 51% of the hashing power of a PoW network. In smaller networks, the potential gains from controlling a majority of the circulation are simply not there.
Advantages of Proof-of-Stake consensus
While both frameworks have strengths, Proof-of-Stake blockchains have some distinct advantages.
The first is the reason the mechanism was created originally: reduced energy consumption. Using computers to mine cryptocurrency is a gigantic energy drain. It’s estimated that the energy used to mine Bitcoin alone could power the country of Switzerland[1]. That computing power is only used to maintain the security of the Bitcoin network and cannot be used to serve any scientific or otherwise useful function. In the age of climate change, expending that kind of energy to secure a cryptocurrency’s network can be looked at as misguided.
Another benefit of PoS consensus is increased accessibility. Although PoS networks do require a (sometimes sizable) initial stake, it usually pales in comparison to what someone would have to spend on competitive mining equipment. Most of the large PoW networks with desirable coins need specialized hardware to see worthwhile results. This hardware can cost many thousands of dollars for a single unit, and you’re inevitably competing with dedicated mining farms with hundreds of such devices.
While the amount staked in a Proof-of-Stake system directly correlates to the amount of rewards you receive, it is a linear relationship. The giant mining farms benefit from economies of scale, meaning the more bulk hardware and electricity they purchase, the bigger price breaks they receive. So, although the rich get richer in both methods, in a Proof-of-Work blockchain, the rich get richer-er.
The third pro in favor of PoS is the greater level of decentralization. Before typing a strongly worded letter claiming that the whole point of any blockchain is decentralization, consider the fact that Bitcoin hashing power is dominated by a small group of mining pools[2]. This makes sense. Individual Bitcoin miners have a very small chance of ever adding a block. By joining a pool, they can enjoy a portion of the rewards. However, if the top five pools ever banded together, they would control well over 51% of the network’s hashing power and gain the ability to add fraudulent blocks. It isn’t likely, but more probable than a single entity staking over 51% of a major network’s coin circulation. The cost-to-benefit ratio just doesn’t make sense.
Proof-of-Stake has a final advantage: scalability. PoS allows for the possibility of “sharding” the network to improve scalability. In this context, sharding means splitting a blockchain into multiple shards within a network. Each shard has the ability to create new blocks. This drastically increases the number of blocks, and therefore transactions, able to be processed in a given moment.
When Proof-of-Work networks are sharded, the hashing power required to take over the shards is reduced by the same factor. This results in reduced security for sharded PoW networks. PoS doesn’t have this concern, as validators are randomly chosen. It is much more statistically improbable that a single validator would hold enough of a stake to control even a shard of a blockchain.
If your head hurts now, don’t worry. Give it some time to sink in and the differences between PoW and PoS consensus mechanisms become clearer. PoW networks are still much more common, but adoption of PoS is rising. Ethereum, the 2nd-largest cryptocurrency network in the world plans to begin a transition to a PoS system by the end of 2020[3]. This event could mark the start of a broader shift in crypto assets to the more efficient consensus mechanism.
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[1] Niall McCarthy, “Bitcoin Devours More Electricity Than Switzerland[Infographic]”, Forbes, Jul. 8 2019, https://www.forbes.com/sites/niallmccarthy/2019/07/08/bitcoin-devours-more-electricity-than-switzerland-infographic/#6349d6c921c0
[2] “Pool Distribution”, BTC.com, Aug. 20 2020, https://btc.com/stats/pool?pool_mode=day
[3] Jake Simmons, “Ethereum 2.0 launch in 2020 after all? Buterin speaks out”, Crypto News Flash, Jul. 14 2020, https://www.crypto-news-flash.com/ethereum-2-0-launch-now-in-2020-buterin-speaks-out/
