To understand Proof-of-Stake (PoS), we first need to understand Proof-of-Work (PoW). PoW was the first blockchain consensus mechanism and is still one of the most popular choices in achieving distributed consensus (the ability to trust a stranger without having to go through a third-party).
PoW is used in Bitcoin and Ethereum due to its strength in terms of security. But, it also comes with disadvantages such as high computation requirements, high energy costs and the threat of becoming centralized through a mining pool (51% attack).
The need for a new system has produced Proof-of-Stake.
Before we go any further let’s see what is a stake?
In crypto-terms, the stake is the cryptocurrency user owns and pledges in order to participate in validation.
How Does Proof-of-Stake Work?
Proof-of-Stake algorithms achieve consensus by requiring users to stake a number of their tokens to have a chance of being selected to validate blocks of transactions and get rewarded for doing so.
PoS shares many features with PoW but also differs in a couple of fundamental ways. As in any blockchain based consensus algorithm, the goal is still to achieve distributed consensus.
In PoS the miner of a new block is chosen in a semi-random, two-part process. The first element to be considered in this selection process is the number of user’s stake. How much of the currency in question is the user staking?
Every validator owns a stake in the network. Staking involves depositing an
amount of tokens into the system, locking it in what we can describe as a virtual safe and using it as a collateral to vouch for the block.
The more tokens 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 more significant amount than someone who stakes less.
In the majority of PoS consensus algorithms, the incentive to participate in the validation of blocks is a payout in the form of transaction fees, as opposed to freshly created currency in PoW systems.
So far, you must be thinking that PoS is a system ready to be exploited by the wealthy. The key here is to include a degree of randomness to the selection process in order to avoid a scenario where the richest users are always selected to validate transactions, consistently reaping the rewards and getting richer and richer.
The two most commonly used methods to achieve this are Randomised Block Selection and Coin Age Selection.
In Randomised Block Selection, miners 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. Naturally, there are many other ways to add randomization to the process; we used these two as an example.
Another key difference between PoW and PoS is that PoW typically mines cryptocurrency, while with PoS the total supply is premined.
Advantages of Proof-Of-Stake System
PoS is often regarded as one of the best cryptocurrency consensus algorithms. Here are some of the reasons:
PoS algorithms are energy efficient — especially when compared to PoW. Cutting out the heavy energy consumption of mining process makes PoS a greener option.
Attackers must put their assets — their stake — on the line in order to attempt a 51% attack. This is a significant risk. For comparison, attackers don’t lose their hardware when trying 51% attacks on PoW systems.
Large mining-pools (groups of miners combining their resources) can control over 51% of networks with PoW systems, leading to a genuine threat of centralization. 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 network invests 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
After all these advantages, there is something that critics point out when it comes to Proof of Stake. It is an interesting dilemma that prevents PoS from being an ideal choice for distributed consensus.
The idea is — in the event of a fork (the blockchain splitting in two) block generators have nothing to lose by supporting different blockchains leading to neverending conflict. PoW systems force users to split their computational resources in order to support both sides of the fork. But in PoS, the resources are duplicated, meaning they could potentially earn twice the rewards (from both of the split blockchains)
Still, there are solutions. For example, Ethereum’s Casper Protocol is set to require users to submit a deposit which will be confiscated if they violate pre-determined rules — such as signing off on multiple forks.
Finally, it’s important to keep in mind that various coins use various consensus mechanisms and that those mechanisms differ from one to another. Not all PoS algorithms work in the same way. Getting informed about the consensus mechanisms is something every user should do before starting to use the coin, and we hope that this article helped you learn more and do your research easier.