Proof of Work (PoW) and Proof of Stake (PoS) are the models that are called ‘consensus mechanisms’, which are a current requirement to confirm transactions that take place on a blockchain, without the need for a third party.
There are currently discussions about Ethereum switching from Proof of Work to Proof of Stake. This change could affect the overall market related to crypto mining. This is an important risk factor that people, as an investor, should know.
So, before we discuss the differences and comparisons between PoW and PoS, let’s see the definitions and the features of the two terms in detail.
Proof of Work
Proof of Work (PoW) is a requirement to define an expensive computer calculation, also called mining, which needs to be performed in order to create a new group of trustless transactions on a distributed ledger called blockchain.
The concept of Proof of Work existed before crypto assets. The idea was first published by Cynthia Dwork and Moni Naor in a 1993 journal article; however, it was not termed until 1999 as the actual term “Proof of Work” was coined by Markus Jakobsson.
How does the Proof of Work works?
The implementation of the PoW consensus protocol can be summarized as follows:
A new transaction is broadcast to the network.
Miners rush to compute a hash value that matches that of the transaction.
The first one to solve the hash receives the reward.
A new “block” is created, which includes the recently concluded transaction.
Presently, the Bitcoin network mines one block of transactions every ten minutes. Certain alterations to the Bitcoin blockchain have enabled Ethereum, the other primary user of PoW, to complete this task in 16 seconds (approx).
The complexity of a PoW puzzle depends upon the number of nodes in that network. A puzzle’s complexity is directly proportional to the computational power required to solve it. This causes certain severe ramifications for a PoW-based blockchain.
Key Features of Proof of Work
Image: Go Cryptowise
A few key features that define the Proof of Work system:
The puzzles are asymmetric, which means that it is difficult for miners to solve but the correct answer is easily verified by the network.
The puzzles have no skill involved, they require brute force. This ensures certain miners do not gain an unfair advantage over others. The only way for a miner to improve their odds of solving a puzzle is to acquire additional computational power; something that is very energy and capital intensive.
The puzzle parameters are periodically updated in order to keep the block time consistent. The Bitcoin protocol, for example, has a block generation target time of 10 minutes. So for example, if the average block time over two weeks has decreased to below 10 minutes, the network will automatically increase the difficulty. This, in turn, increases the number of calculations and the average time required for the puzzle to be solved.
Why do we see Proof of Work continuing to grow and be viable?
The reasons why we see Proof of Work continuing to grow and be viable because of the following reasons:
Consensus and SPV Clients
Incentives Align with the Community
Forking and Double Payment
The Rich get Richer
Staker vs. Community
How are Transactions Verified?
As you can imagine, thousands of people use Bitcoin, Ethereum, and other blockchains that use the Proof of Work model. Every block contains different transactions within it, which must each be independently verified. For the Bitcoin network to achieve this without a third party, someone must use their computational power to solve a cryptographic algorithm, otherwise known as Proof of Work.
Once this is achieved, not only is the transaction marked as valid, but it is also posted to the public blockchain for everyone to view.
Proof of Stake
In Proof of Stake, instead of miners, there are validators. The validators lock up some of their cryptos as a stake in the ecosystem. After that, the validators bet on the blocks that they feel will be added next to the chain. When the block gets added, the validators get a block reward in proportion to their stake.
Proof of Stake systems have the same purpose of validating transactions and achieving consensus, however, the process is quite different than in Proof of Work systems. With Proof of Stake, there is no mathematical puzzle, instead, the creator of a new block is chosen in a deterministic way based on their stake. The stake is how many coins/tokens one possesses. For example, if one person were to stake 10 coins and another person staked 50 coins, the person staking 50 coins would be 5 times more likely to be chosen as the next block validator.
A key advantage of the Proof of Stake system is higher energy efficiency. By cutting out the energy-intensive mining process, Proof of Stake systems may prove to be a much greener option compared to Proof of Work systems. Additionally, the economic incentives provided by Proof of Stake systems may do a better job of promoting network health. Under a Proof of Work system, a miner could potentially own zero of the coins they are mining, seeking only to maximize their own profits. In a Proof of Stake system, on the other hand, validators must own and support the currency they are verifying.
Another key distinction between Proof of Stake and Proof of Work is that under Proof of Stake, there is no new coin creation (mining). Instead, all of the coins are created in the very beginning. This means the validators must be fully rewarded through transaction fees as opposed to newly minted coins.
Why is Proof of Stake better than Proof of Work?
The Proof of Stake model is a much better model than Proof of Work because it solves lots of issues:
Centralization: Centralized organizations buying thousands of devices (known as ASIC’s) which generate the highest mining power. This type of operation is known as a ‘mining pool’ and it allows people to ‘pool’ their resources together to give them the greatest chance of solving the cryptographic sum first.
Electricity Consumption: The total amount of electricity required to keep the Bitcoin network functional is more than the amount used by more than 159 individual countries. Not only is this bad for the environment, but it also slows down the rate at which cryptocurrencies can increase their real-world adoption. This is because electricity bills must be paid using fiat currency.
51% Attack: A 51% attack is used to describe the unfortunate event that a group or single person gains more than 50% of the total mining power. If that happened in a Proof of Work blockchain like Bitcoin, it would allow the person to make changes to a particular block. If this person was a criminal, they could alter the block for their gain.
Take a look at the following example.
You decide you want to stake coins to earn some Proof of stake rewards.
The blockchain has a total of 1000 coins in circulation.
Your purchase and stake 100 coins.
This means you have staked 10% of the total coins in circulation.
You now have a 10% chance of winning every reward.
How does the Proof of Stake works?
Instead of initiating a race to be the first validator, the PoS protocol randomly selects a validator based on their stake in the network. Suppose, you have tokens worth 10% of the block in your wallet. It gives you the ability to validate only 10% of the block.
Nodes in a network will be able to join these pools at any point of time and any phase. Obviously, validators will be chosen from these pools. To uphold the principle of decentralization, there will be “no priority scheme” in this process.
How are Transactions Verified?
The Proof of Stake model uses a different process to confirm transactions and reach consensus. The system still uses a cryptographic algorithm, but the objective of the mechanism is different.
While Proof of Work rewards its miner for solving complex equations, in Proof of Stake, the individual that creates the next block is based on how much they have ‘staked’. To make things simple for you, the stake is based on the number of coins the person has for the particular blockchain they are attempting to mine.
However, technically speaking, individuals are not mining. Instead, they are called ‘forgers’, because there is no block reward. While Bitcoin, which uses the Proof of Work model, awards a block reward every time a new block is verified, those who contribute to the Proof of Stake system simply earn the transaction fee.
Comparisons between Proof of Work and Proof of Stake
Cost and Energy: Proof of Stake systems have the potential to be a much more cost-efficient and green alternative to Proof of Work systems. The computational power required to operate a Proof of Work system is very energy-intensive. The Bitcoin network, for example, requires an annual energy consumption comparable to that of Colombia (57.6 TWh annually). In addition, the competitive nature of mining means an increasing amount of money is being invested in more powerful mining computers, which will require more and more energy to be supplied. Proof of Stake systems does not require mining or the accompanying energy-hungry processing power. As a result, Proof of Stake systems requires a mere fraction of the energy to run. The lower energy costs also make the role of validating more accessible to anyone in the community, whereas the role of mining is becoming increasingly reserved for large-scale operations.
Security: Proof of Stake systems in crypto is relatively newer than Proof of Work systems and it still has not seen the same level of adoption. As a result, it has not been as rigorously tested as Proof of Work systems and a few potential security risks have been identified. Constant forking of a blockchain is not healthy for a network and leads to instability. In Proof of Work systems, if a blockchain is forked, miners will have to make the decision to continue supporting the original blockchain or switch to the newer forked blockchain. In order to support both sides of the fork, a miner would have to split their computational resources between the two. In this way, Proof of Work systems naturally discourages constant forking from occurring through an economic incentive. On the other hand, Proof of Stake systems does not inherently discourage forking. When a blockchain forks, a validator will receive a duplicate copy of their stake on the newly forked blockchain. If a validator signs off on both sides of the fork, they could potentially claim twice the amount of transaction fees as a reward and double-spend their coins; this is known as the ‘nothing at stake’ problem. A participant is not required to increase their stake in order to validate transactions on multiple copies of a blockchain, thus, there is no economic incentive preventing this bad behavior.
Centralization: An increasing concern with blockchain networks utilizing Proof of Work systems is the risk of centralization. The role of mining in Proof of Work systems is becoming increasingly reserved for large-scale operations. Control of blockchain networks is moving from the community at large to fewer and fewer hands, contrary to the decentralized ethos of most crypto assets. Proof of Stake systems potentially provides a more fair solution. The amount of network control a participant can gain in a Proof of Stake system is directly proportional to how much they invest. If one participant invests ten times more than another participant, they will receive ten times the amount of control. On the contrary, under Proof of Work systems, if a miner invests 10 times more into equipment than another, they will actually receive more than 10 times the computational power. This comes as a result of bulk purchasing deals and the increased efficiency of high-end equipment. As a result, it is becoming increasingly less profitable and more difficult for individuals to compete against large mining farms.
Proof of Work vs. Proof of Stake at a GlanceProof of Work Proof of Stake 1. Participating nodes are called miners. 1. Participating nodes are called validators or forgers. 2. Mining capacity depends on computational power. 2. Validating capacity depends on the stake in the network. 3. Mining produces new coins. 3. No new coins are formed. 4. Miners receive block rewards. 4. Validators receive transaction fees. 5. Massive energy consumption. 5. Low to moderate energy consumption. 6. Significantly prone to 51% attacks. 6. 51% of attacks are virtually impossible.
As a result, the world’s second most popular cryptocurrency – Ethereum, is in the process of attempting to move from Proof of Work to Proof of Stake.
While Proof of Stake does manage some of the problems posed by the Proof of Work mechanism, it creates several new completely different problems. In the world of cryptocurrencies, Proof of Work is the most common protocol. In the Proof of Stake world, most cryptocurrencies currently use a combination of both.
Cover Image: CoinCentral