If you’re into crypto, by now, you definitely know that blockchains are based on certain algorithms to achieve distributed consensus and enable transactions and data exchange. Bitcoin, the pioneer in the sphere, introduced us to the proof-of-work mechanism. As time goes by, PoW doesn’t seem that great anymore. More technologically advanced consensus algorithms emerged, and proof-of-stake is one of the most efficient options available. Proof of Stake (PoS) is a consensus algorithm that allows nodes to come to an agreement on the status of the blockchain without spending large amounts of computational power. This makes PoS a more environmentally friendly option than Proof of Work (PoW). In this article, we’ll take a closer look at how PoS works and what benefits it can offer.
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Proof-of-Stake in Layman’s Terms
To put it simply, Proof of Stake is one of the most popular consensus algorithms on blockchain networks. In PoS, the generator of the next block chooses a node with a greater balance — the amount of resources, for example, coins, if we are talking about cryptocurrencies. Therefore, the staker with the greatest balance has more chances to generate a new block. The node does not receive a reward for the creation of the block itself: instead, remuneration is paid for the transaction.
There are two basic possible node selection options:
- randomly from the “richest” nodes
- randomly from the oldest nodes
The process of validating blockchain transactions is called staking.
Instead of solving a cryptographic problem, transactions are validated by “freezing” a certain number of miner coins as collateral. Coins are frozen until an “agreement” on the validity of transactions is reached. After reaching a consensus in the network, transactions are added to the blockchain, and coins are kept frozen for some time in order to protect against attacks on the network. When coins are unfrozen, miners get them back, plus a small commission for recording transactions on the blockchain. Such an algorithm is designed to discourage attackers from validating fake transactions because of the risk of losing “collateral.”
The amount of rewards earned is proportionate to the number of coins that the miner holds. This system is designed to be more secure than Proof of Work, as miners have a financial incentive to act honestly and avoid validating fraudulent transactions.
Where PoS Is Used?
Today, several major blockchain industry players use this protocol to validate transactions. Proof-of-stake-backed coins include Cardano (still under development), OmiseGo, QTUM, and Ardor. Ethereum has been planning its transition to PoS since 2019 (the new version is to be called the Merge), and it seems like it’ll finally come to life in September 2022.
A hybrid system could combine the security of PoW with the efficiency of PoS, providing the best of both worlds. A hybrid of PoW/PoS consensus mechanisms is used by Dash, Stratis, HShare, and Pivx.
How PoS Changed Mining?
Bitcoin’s Proof of Work spawned an entire mining industry and became an impetus for the development of specialized equipment since the computing resources spent on hashing blocks are huge and far exceed the capacities of the largest supercomputers.
At the same time, the notorious “other side of the coin” was revealed: PoW quickly turned into a monster, devouring electricity in a race for mining profitability. In 2012, the overall capacity of the BTC network already exceeded the most powerful supercomputer in the world in terms of performance, and the first alternative, less energy-consuming approach to verifying transactions — Proof of Stake — appeared on the horizon.
PoS System: Pros and Cons
Advantages of Proof of Stake
PoS has the following advantages:
- A significant reduction in energy consumption (in relation to to the PoW method);
- To create a double-spending attack, it is necessary to concentrate more than 50% of the total amount of the entire currency, which will cost a fortune. In the event that the attacker can still control such an amount of funds, they will upset the balance by their actions, which makes attacks financially impractical.
- Exiting PoS is a fairly quick process: you only need to bring your stake to the stock exchange and sell it. In the case of Proof of Work, you do not know how long it will take you to sell your equipment and at what price.
- Profitability in PoS systems grows if the user reinvests the received reward: his profitability will grow as part of a long-term strategy. In Proof of Work, the same result is more difficult to achieve because you regularly have to invest in mining equipment.
Disadvantages of Proof of Stake
At the same time, PoS is not devoid of downsides:
- The concentration of funds in the hands of a few can lead to the centralization of the network. Besides, the users with the largest stake (over 51%) can manipulate the network — for instance, they can cancel transactions and impose new rules. While this attack is not profitable, it’s still possible.
- Additionally, there is the nothing-at-stake problem (empty stack), which makes PoS systems inherently unstable in the eyes of many cryptocurrency enthusiasts. An attacker can try to fork a blockchain, that is, create a longer alternative chain by spending “non-existent” resources. Moreover, other miners can support it since they also do not spend “genuine” resources. Through a fork, an attacker can decline certain transactions and carry out a double spending attack.
Proof of Stake vs Proof of Work – Which One Is Better?
Disputes between proponents of Pow and PoS have been going on for a long time, but their nature is more theoretical. Practice shows that the role of developers in security matters is still very high.
At the same time, many consider the hybrid version of PoW and PoS implementation to be the safest solution. This approach is already actively practiced — many cryptocurrencies have a PoW stage when a currency is issued through classic mining and a PoS stage, which follows it up.
Nevertheless, despite the fact that PoS systems will always be easier to implement and generally more reliable in terms of security, most serious cryptocurrencies will most likely not refuse to use a proof-of-work system too.
Delegated Proof of Stake (DPoS)
DPoS is one of the modifications of the proof-of-stake consensus algorithm, where blocks are signed by elected representatives. The owners of the largest balances choose their representatives, each of them receiving the right to sign blocks on the blockchain network. Each representative with one or more percent of all votes falls into the council. The next representative is selected (in a circle) from the formed “board of directors,” who will sign the next block. In the event that, for any reason, the representative missed their turn in signing, they lose the delegated votes and leave the “board of directors,” after which the next most suitable candidate is chosen in their place. The owners of the balances delegating their votes in no way lose control over them.
The main advantages of the DPoS algorithm are:
- Balance holders have the opportunity to delegate their votes (while not transferring the balance itself);
- Balance holders have the opportunity to earn additional income from their ownership;
- Minimized costs of supporting the blockchain network. Unlike classic PoS, the amount of “unnecessary work” is reduced when choosing the next voter.
Leased Proof of Stake (LPoS)
As the name implies, LPoS is another modification of the proof-of-stake algorithm. At the moment, it is supported only by the NXT and Waves platforms. As part of this algorithm, any user can transfer their balance to lease it to mining nodes, and for this, mining nodes share a part of the profit with users. Thus, this consensus algorithm allows you to earn income from mining activities without mining itself.
Although PoS has a few drawbacks, this consensus mechanism has proved to be more advanced than PoW in terms of energy efficiency and simplicity of mining. The way staking is organized encourages users to hold coins and participate in processes taking place on the blockchain. PoS is definitely a great option for miners, and blockchain developers say it proves to be more efficient for transaction validation in many cases.
Disclaimer: Please note that the contents of this article are not financial or investing advice. The information provided in this article is the author’s opinion only and should not be considered as offering trading or investing recommendations. We do not make any warranties about the completeness, reliability and accuracy of this information. The cryptocurrency market suffers from high volatility and occasional arbitrary movements. Any investor, trader, or regular crypto users should research multiple viewpoints and be familiar with all local regulations before committing to an investment.