Crypto 101: Proof of Work vs Proof of Stake

April 23, 2022 written by 01NODE

Have you heard the big news ? Ethereum is finally moving to Proof of Stake . But why though? Here is what it means

First, let’s talk about proof-of-work and proof-of-stake then proceed to talk about Ethereum’s transition to POS.

They are the two most popular consensus mechanisms used by cryptocurrencies to verify new transactions, add them to the blockchain, and create new tokens are “proof of work” and “proof of stake.”

The essence of PoS and PoW is so that transactions can be verified without the need to use a third party while providing security to the network.

Proof of work (PoW)

Proof of Work is based on an advanced form of mathematics called ‘cryptography’. Cryptography uses mathematical equations that are so difficult that only powerful computers can solve them. No equation is ever the same, meaning that once it is solved, the network knows that the transaction is authentic.

Proof-of-work is a competitive approach to verifying transactions, which naturally encourages people to look for ways to gain an advantage, especially since monetary value is involved. The penalty for miners submitting invalid information, or blocks, is the sunk cost of computing power, energy, and time.

Thousands of individual devices all compete to become the first to solve the cryptographic algorithm. Whoever gets there first, wins the reward. one of the major issues with Proof of Work is that it is not a fair system, because those with the most powerful and expensive hardware devices will always have the greatest chance of winning the reward.

Proof of Work is the current way how to mine Ethereum, Bitcoin, Dash, and some other cryptocurrencies.

Proof of Stake (PoS)

Proof of stake is a type of consensus mechanism used to validate cryptocurrency transactions. With this system, owners of the cryptocurrency can stake their coins, which gives them the right to check new blocks of transactions and add them to the blockchain.

Proof-of-stake uses an army of validators to authenticate transactions and add them to the blockchain. A person can become a validator by staking (keeping) coins which also means making your coins available to be used in the proof-of-stake process. It enables coin holders to monetise their holdings rather than leaving them idle in their crypto wallet. Blocks are validated by more than one validator, and when a specific number of the validators verify that the block is accurate, it is finalized and closed.

In proof of stake, the validators’ staked crypto funds serve as an economic incentive to act in the network’s best interests. In the case that a validator accepts a bad block, a portion of their staked funds will be “slashed” as a penalty. The amount that a validator can be slashed depends on the network.

Proof-of-stake (POS) was created as an alternative to Proof-of-work (POW), the original consensus mechanism used to validate a blockchain and add new blocks.

Block Creators Validators Miners
Resource required to win blocks Cost or Tokens Energy
Cost of Participation Cost of Coins or Tokens Cost of Equipment and the energy to run it
Strength Energy efficiency allows more scalability Cost of equipment and energy provide robustly security
Weakness Network control can be purchased Enormous expenditure of energy

Limitations of the Proof-of-work consensus

  1. Proof of Work blockchains give people who purchase powerful hardware devices a greater chance of winning the mining reward. What this has resulted in is 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. Consequently, just four mining pools (of which the majority are located in China where electricity is cheap) control more than 50% of the total Bitcoin mining power. This is an unfair system as it means that the average person has no chance of ever winning the mining reward.
  2. Proof of Work blockchains like Bitcoin use large amounts of electricity. This is because the cryptographic sum that miners must solve is incredibly difficult. A recent study found that 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!
  3. 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. A recent example of a 51% attack happened against the Verge blockchain, which allowed the hacker to walk away with 35 million XVG coins. At the time of the attack, this amounted to a real-world value of $1.75 million!
  4. Scalability
  5. Long transaction time

Ethereum Transition to Proof-of-Stake

Ethereum’s developers understood from the beginning that proof of work would present limitations in scalability that would eventually need to be overcome — and, indeed, as Ethereum-powered decentralized finance (or DeFi) protocols have surged in popularity, the blockchain has struggled to keep up, causing fees to spike.

While the Bitcoin blockchain mostly just has to process incoming and outgoing bitcoin transactions, much like a vast checkbook, Ethereum’s blockchain also has to process a vast array of DeFi transactions, stablecoin smart contracts, NFT minting and sales, and whatever innovations developers come up with in the future.

Their solution has been to build an entirely new ETH2 blockchaim — which began rolling out in December 2020 and should be finished in 2022. The upgraded version of Ethereum will employ a faster and less resource intensive consensus mechanism called proof of stake – with the goal being to maximize speed and efficiency while lowering fees.

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