If you’ve been researching cryptocurrency and blockchain technology for some time now, you’ve likely come across the terms Proof of Work (POW) and Proof of Stake (POS). Though these terms may seem like overly specific technical jargon, they are actually as fundamental to cryptocurrency as blockchain itself.
The security, decentralization, and functionality of digital assets are largely influenced by which of these systems a given blockchain network uses. This article will specifically examine the Proof of Stake system, its role, its differences from Proof of Work, and specific blockchains that use it.
Understanding consensus mechanisms
Proof of Stake and Proof of Work are different types of consensus mechanisms. A consensus mechanism is a function of blockchain networks that ensures nodes can agree on which state of the ledger is accurate. As many are aware, a blockchain is a timestamped history of all transactions that take place on a network. These transactions are stored in blocks, which are arranged linearly such that every new block contains a reference to the block before it. This ensures blocks are arranged in chronological order in a complete chain of transactions, hence forming a blockchain.
However, this system alone cannot sustain a decentralized monetary network. Firstly, with thousands of nodes capable of producing blocks, there is yet no authority to determine which block the network should store transactions in next. Furthermore, if all nodes are able to spam the network with blocks free of consequence, then network security drops. If one block is validated which contains illegitimate transactions, then the network’s integrity is sullied.
This is unlikely to happen, as thousands of other network nodes are constantly validating the state of the ledger and the legitimacy of each transaction in a block. However, measures must be taken to ensure nodes are disincentivized from dishonest behaviour to begin with. Thankfully, consensus mechanisms help create consensus among nodes regarding the one true state of the blockchain, in a fair and unbiased manner. They also provide the right incentive structures for rewarding honest network participants, while punishing dishonest ones. POS and POW systems both achieve decentralized network consensus, but in different ways.
What is the difference between Proof-of-Stake and Proof-of-Work?
Proof of Work and Proof of Stake are both used to validate and secure a blockchain. However, they are very different from each other. Let’s take a look at the key differences between the Proof of Work and Proof of Stake models.
Proof of Work
Proof of Work (POW) is the consensus mechanism used by Bitcoin, the first and most popular cryptocurrency. Before creating a block, network nodes must spend energy working to solve a computationally difficult math problem before creating a block; a process called mining. This involves locating a hash value that solves the equation associated with a specific block.
Every block equation is different, but all are designed so that they are highly difficult to solve, yet easy to verify once the correct answer is found. This way, once a correct hash is located and a block is created, it can be validated by network nodes across the world within minutes and added onto the public blockchain. As compensation for spending the energy to find the correct hash, successful nodes are rewarded with a newly minted batch of Bitcoin. That amount is currently 6.25 BTC per block as well as all transaction fees spent on that block. Rates can vary at different times, and between different coins.
POW creates consensus by requiring blocks to have a correct hash before earning legitimacy. From there, the longest chain is determined by the network to be the true transaction ledger, which all nodes can agree on. POW aligns both positive and negative incentives to maximize network security. Honest miners will be rewarded with newly generated Bitcoin and transaction fee revenue. Meanwhile, dishonest miners will likely be dismissed by other nodes and receive no block rewards, meaning they’ll have spent time, money, and energy on mining for nothing.
Finally, the difficulty of this math problem adjusts itself regularly. The more hash power competing to mine a block on the network, the more difficult the problem becomes. The difficulty is adjusted so that a new block is mined approximately every ten minutes, no matter how many active miners there are.
Proof of Stake
Whereas Proof of Work requires real-world resources to be spent mining a block, Proof of Stake (POS) is a blockchain-native method of achieving network consensus. Chains using Proof of Stake include validators rather than miners for examining transactions in each new block to ensure that they are valid. The people chosen as validators are those that stake the platform’s native cryptocurrency. Just as miners pay in energy if they mine dishonest blocks, stakers pay in cryptocurrency if they dishonestly validate a new block. On the other hand, honest stakers are rewarded with the network’s transaction fees which is paid out in cryptocurrency.
One fundamental difference between Proof of Stake and Proof of Work is that chains running on the former typically do not produce new coins for the network. Therefore, validators are rewarded in transaction fees, and not a block reward. However, both Proof of Work and Proof of Stake chains may include a burn pool to which transaction fees are allocated, thereby constantly reducing a cryptocurrency’s supply.
Why Proof of Stake had to emerge from Proof of Work
Proof of Work is absolutely effective at what it’s designed to do, especially in the context of Bitcoin. Due to the incentives involved, Bitcoin mining has become a full-fledged industry, turning Bitcoin into the most powerful computer network in the world by far. Vast amounts of energy are spent protecting the network every day.
However, this very benefit is considered by many to be one of Bitcoin’s greatest flaws. Environmental and ethical concerns abound regarding Bitcoin’s consensus mechanism, which now causes it to use more electricity than all of Finland. There has been scathing criticism towards Bitcoin, with many arguing that it contributes to global warming. Most notably, Elon Musk, whose company invested in Bitcoin in February, stopped accepting it for car purchases in May due to its suspected carbon footprint. If mining Bitcoin is an environmental burden, what is the alternative?
Well, the alternative is called staking, and the coins that use this method are called Proof of Stake coins. Staking involves locking up one’s cryptocurrency for a period of time and earning network transaction fees as a reward. Since it doesn’t require mining, staking is a far more efficient method of ensuring network consensus than Proof of Work. Various Proof of Stake networks have used this quality to market themselves against Bitcoin. Furthermore, the fact that these coins can be staked to passively accumulate more coins proves enticing to early adopters.
Here are some examples of popular Proof of Stake coins available in Canada.
The top 3 Proof of Stake coins in Canada
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- Symbol: ETH
- Trades on: Coinberry, Wealthsimple Crypto, Coinbase
- Highest price 2021: 4,878.26
Though Ethereum is currently a Proof of Work chain, it is slowly but steadily making a transition over to Proof of Stake. Vitalik Buterin, the co-founder of Ethereum, shares the environmental concerns of many crypto critics. The environmental impact of POW cryptocurrency is motivating his push for the new consensus mechanism.
Part of this transition took place this past August when Ethereum implemented the London Hard Fork. This upgrade kept Proof of Work but introduced ETH burning alongside classic block rewards. Now, new ETH is regularly generated, while old ETH is regularly burned, each at varying rates.
One week this year happened to be net-deflationary for ETH, but overall the cryptocurrency’s supply continues to increase. Many suspect that ETH’s rise this year has partially been spurred by investors who are holding in anticipation of ETH staking. As the second-largest cryptocurrency, Ethereum’s transition is likely to have large ramifications on the rest of the market.
- Symbol: ADA
- Trades on: NDAX, CoinSmart, Coinberry
- Highest price 2021: $3.09
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Cardano is a blockchain platform created by Charles Hoskinson in 2017, with development duties inherited by the Cardano Foundation and IOHK. Cardano began integrating smart contracts onto its platform in September of 2021. Many view it as a competitor to Ethereum. Cardano CTO Romain Pellerin disagrees with the comparison, however, on the grounds that Cardano is a Proof of Stake chain. In fact, Charles Hoskinson has even argued that Elon Musk should accept ADA for Tesla payments, in place of Bitcoin.
Binance Coin (BNB)
- Symbol: BNB
- Trades on: Binance Exchange, Kucoin, Crypto.com
- Highest price 2021: $686.31
Binance Coin is the native cryptocurrency of the Binance Smart Chain (BSC). It is issued directly by Binance Exchange. Binance is now the largest cryptocurrency exchange platform in the world by trading volume. Originally, Binance Coin was a mere token on the Ethereum network for lowering trading fees on Thor exchange. However, utilities of the token have since expanded to travel bookings, entertainment, and financial services.
Binance regularly uses its profits to buy back and burn its tokens. It also recently implemented an auto-burn feature, using part of the user’s transaction fees on BSC for burning. As a Proof of Stake coin with no block rewards, this means BSC is a deflationary currency, growing in value over time due to scarcity. Combined with the ability to stake coins, BSC incentivizes users to buy and hold the coin.
Is Proof of Stake superior?
Proof of Stake coins represents a less energy-intensive alternative for crypto trading and network security compared to Proof of Work. They provide strong incentives for crypto savers by allowing them to profit by simply holding and staking their assets.
That said, Proof of Stake is not flawless. Compared to Proof of Work, it has often been criticized for spurring wealth inequality by easily rewarding large holders of the cryptocurrency through staking. By comparison, Proof of Work represents a more competitive market-based approach to securing the network, which doesn’t result in the overconcentration of a cryptocurrency in one party’s hands.
The choice between Proof of Stake or Proof of Work coins comes down to your ethics, interests, and goals!