Proof-of-stake is what’s known as a consensus mechanism, as is proof-of-work. They are both mechanisms by which a blockchain can maintain its integrity.
Consensus needs to be achieved on a blockchain as a solution to the “double spend” problem of money in the digital realm. To have value, users of a cryptocurrency have to be able to only spend their coins one time. Otherwise, people could send the same transaction over and over, and the currency would be worthless.
This is a tough problem to solve in the absence of any kind of centralized governing authority like governments or banks. The first digital currency to solve this problem was the Bitcoin network using proof-of-work (PoW).
Proof-of-stake (PoS) has started to be seen as a potential alternative to proof-of-work. Some developers believe that PoS could be more efficient than PoW while accomplishing the same thing, although the subject is still being debated.
What Is Proof-of-Stake (PoS)?
Proof-of-stake is a different consensus mechanism that can be used by blockchain technology to verify their transaction history. While miners in PoW networks use electricity to mine blocks, validators in PoS commit stakes to validate blocks.
Why Do Blockchains Need Consensus?
In centralized systems, preventing double spending is relatively easy. A single entity manages the ledger of transactions, simplifying the process. If Alice wants to give a dollar to Bob, the central manager just takes a dollar from Alice’s account and gives it to Bob. Nothing more is needed. Third-party payment apps like PayPal function in this manner.
With cryptocurrencies, however, things get more complicated because there is no single entity controlling the system. Keeping a record of the ledger of transactions becomes more difficult.
Instead of one central server, many thousands of people around the world run the Bitcoin software. These individuals are referred to as “nodes.” The nodes need to have a way to agree with each other, or to “achieve consensus.” All the nodes need to be on the same page for the network to function seamlessly.
Accomplishing this is harder than it might sound. This made decentralized digital currency something that eluded the grasp of researchers and developers for decades. That is, until 2009 when the Bitcoin network launched, thanks to Satoshi Nakamoto. That’s the pseudonym used by the person or group who wrote the Bitcoin white paper and invented the proof-of-work algorithm that first made cryptocurrency a real-world phenomenon.
Proof-of-Stake vs Proof-of-Work
Proof-of-stake has hopes of being an improvement over proof-of-work, but this has yet to be proven and is still a topic of much debate. It seems likely that proof-of-stake will indeed use less energy than proof-of-work, but other variables seem less clear.
Namely, it’s not certain if proof-of-stake will be as secure against threats like 51% attacks, and it remains to be seen if PoS will wind up being decentralized or not.
Let’s first take a look at how PoW works before getting into how PoS is different.
Proof-of-work is the most commonly used consensus mechanism. So far, it has proven to be secure and reliable. The two things that make up the backbone of a PoW network like Bitcoin and fundamental to how Bitcoin mining works.
Miners are the people who run computers that maintain the network by solving complex mathematical problems. The miner that first solves the problem gets to add the next block of transactions to the blockchain and also earns the new coins minted along with that block. This process creates a verifiable history of transactions on the blockchain.
PoW has shown to be a strong and secure consensus mechanism. It would be so difficult to overtake a large PoW network that any potential bad actors would be incentivized to become honest participants in the network instead. In other words, it’s easier and more rewarding to just become a miner than it is to attack the network.
Some of the main criticisms of the PoW mechanism of achieving consensus are that the process can be energy-intensive, it has difficulty scaling, and it can trend toward centralization due to the high costs of entry.
With PoS, validators are the network participants who run nodes. They do this by staking crypto on the network, which involves locking up a certain amount of coins for a set period, making them unusable. Validators who do this become eligible to be randomly selected to find the next block.
Other validators then “attest” that they also believe the block to be valid. Once enough validators have done this, the block will be added to the blockchain. All validators involved in the process are rewarded with new coins. Validators that propose blocks or go offline for a time get punished by having some of their staked crypto slashed by the protocol.
One of the main differences between PoS and PoW is that PoW requires network participants to expend energy in the form of electricity to mine blocks. PoS requires network participants to stake their crypto on the network, or in other words, to deposit money. For this reason, proof-of-stake is praised for using less energy than proof-of-work.
While some argue in favor of proof-of-stake potential decentralization, others criticize it.
For example, when Ethereum upgrades to Ethereum 2.0 and a proof-of-stake model, it will require a minimum of 32 ETH (about $67,200 at the time of writing) to become a validator. The average individual cannot afford this.
So, centralized exchanges will deposit the crypto necessary to become validators (using the crypto they have on deposit from users) and distribute some of the rewards to their account holders. This could wind up making the entire system even more centralized than proof-of-work, with a few large exchanges being the only validators.
Proof-of-Stake and 51% Attacks
A 51% attack refers to an event where an individual or group attempts to gain control of a network by controlling the majority of hashing or staking power.
It’s unclear if PoS networks are more or less prone to 51% attacks than PoW networks. The subject is mostly theoretical, and 51% of attacks have rarely occurred in the real world.
Conducting this type of attack against a network as large as Bitcoin would be practically impossible due to the enormous amount of computational power required.
When it comes to proof-of-stake, attackers would have to buy up more than half the number of tokens being staked. From there, the attacker could become the sole validator and control the network.
One theory is that this could be difficult to achieve because of how high it would drive the price of any particular token. The hope is that people would rather participate honestly in the system by staking tokens than go through the trouble of trying to attack the network, which could get expensive fast.
While it’s not too hard to answer the question “what is proof-of-stake,” answers to how it works over the long-term on a large scale are lesser-known. Some existing tokens do utilize PoS, but they tend to be altcoin cryptos that are younger and smaller than Bitcoin or Ethereum.
Proof-of-stake could be an improvement over proof-of-work or it could be a regression. The world will have more certainty on the matter after the Ethereum network upgrades to the Ethereum proof-of-stake model known as ETH 2.0.
While it does take significant energy to validate transactions using proof-of-work, some reports indicate that over 70% of the energy used to mine bitcoin comes from renewable sources. On top of that, the total energy used is also a fraction of that needed to power the gold mining or banking industries.
However, it’s significant that the Bitcoin network has faced criticism for its high energy usage. Less energy-intensive consensus mechanisms might not be a bad thing if they can achieve similar results.