Digital assets are morphing how the world does business.
Crypto’s main targets include streamlining the process of various transactions such as lending money, opening bank accounts, and more.
These operations take place on the blockchain network, and there’s no central authority to oversee them. But the network has to verify transaction data to make sure that all info is accurate.
We can’t address the blockchain and crypto transactions without mentioning Proof-of-Stake and Proof-of-Work. These are the key methods of verifying crypto transactions. They are known as consensus mechanisms.
Even though they are different processes, the result is the same – verification of data and a completed transaction. But one has undeniable advantages over the other – the Proof-of-Stake.
The battle for blockchain consensus
Blockchain technology and its applications have been gaining popularity at the speed of light during the past years. Companies worldwide and across various industries are finding all kinds of innovative ways to fit the blockchain into their business models. This way, blockchain reached an inflection point in the public consciousness and enterprise use.
This growth and constant development that the blockchain has been seeing triggers an increased interest in providing the computing power behind the blockchain. It’s already become a cliché in the media to see how Bitcoin mining “consumes more energy” than small countries.
Competition to create new blocks becomes fiercer with each day, and one of the main reasons is that rewards can be enormous. As new blocks get mined, thousands of dollars worth of Bitcoin are up for grabs. And this is happening every ten minutes.
All this growth has a challenge involving scalability and cost. The more transactions and nodes are added to a network, the more difficult it is to fit all those transactions in a block. It also becomes more complicated to establish consensus across the global network.
Amidst this change and growth, many people are starting to question the foundations of Proof-of-Work consensus as laid out by Satoshi Nakamoto in the Bitcoin white paper.
Proof-of-Work uses a lot of electricity, and it concentrates mining power and rewards to the institutions that are willing to invest millions in mining equipment and electricity.
Proof-of-Stake consensus is the main challenger of Proof-of-Work’s hardware and electricity-based paradigm.
If you wonder why we need consensus, the answer is pretty complex. In a conventional data storage system, third parties are the entities that deal with record keeping. But it’s essential to note that a single centralized source of truth systems also means that there is a single source of failure.
Various firms and companies lose customer info when their systems are hacked. Blockchain overcomes this by offering a copy of the data to everyone on the network. Via the public ledger, anyone on the network can see and check its accuracy.
Since this is a shared ledger, updates on the record need the approval of everyone on the network – this is exactly where the consensus mechanisms enter the building.
A good consensus algorithm establishes a state in which everyone agrees.
What is Proof-of-Work?
Proof-of-Work is the original consensus algorithm for multiple Blockchains. Developed by Satoshi Nakamoto in 2008, it remains the protocol that governs the Bitcoin blockchain.
On a technical level, Proof-of-work is a series of cryptographic puzzles for a computer to solve to create a new block in a blockchain.
The puzzles are known as cryptographic hash functions. They are solvable using guess and check. The computers attempting to solve the puzzle have to check trillions of wrong answers before finding the correct one.
Even if we have thousands of computers working on the same problem, it will still take about ten minutes for one of them to find a correct answer.
As a result, massive warehouses have popped up worldwide, and there are hundreds of specially designed computers known as ASICs that are all mining Bitcoin simultaneously. These companies are winning a lot of the mining rewards.
It’s safe to say that they concentrate. Over time, this could mean that there will be a centralized institution that runs Bitcoin.
It is a significant drawback involving the digital asset, and it’s compromising the original vision and security of the network.
That’s where Proof-of-Stake starts to shine.
What is Proof-of-Stake
Proof-of-Stake (PoS) is a blockchain consensus algorithm. The participant to create the next blockchain block is selected based on how many coins or tokens the individual participants are currently staking.
PoS is similar to voting, although the process does not involve one person one vote. Instead, the participants known as validators are staking a certain amount of crypto behind the block that they want to add to the chain. This stake then determines their voting power. Various blockchains are setting different limits for this amount.
Here’s what Garrick Hileman, the head of research at Blockchain.com, said, as interviewed by Business Insider.
“In Proof-of-Stake, the cryptocurrency holders' vote' to approve legitimate transactions. As a reward for voting on legitimate transactions, ‘stakers’ are paid in newly created cryptocurrency over time.”
Advantages of Proof-of-Stake
Cost efficiency The main advantage of PoS is that miners do not need to invest increasing sums of money in more and more powerful computing equipment. Such equipment also consumes massive amounts of electricity.
Cost efficiency is important, and PoS was developed “in response to the high computational costs of proof of work protocols,” according to Catherine Mulligan, a professor of computer science at the University of Lisbon’s Instituto Superior Técnico as Business Insider quotes her.
Greater scalability and throughput
PoS also delivers greater scalability and throughput compared to PoW. It is because transactions and blocks can be approved quicker without the need to solve extremely complex equations.
“Two major benefits of proof of stake over proof of work are that PoS can be less energy-intensive and have greater transaction throughput (speed) and capacity,” according to Hileman.
Regarding scalability, PoS does not rely on physical machines to generate consensus. This means that it’s more scalable. There is no need for huge mining farms or sourcing large energy supplies. More validators to the network will turn out cheaper, simpler, and more accessible.
PoS cuts the need for complex computations, which means more energy efficiency. The power to validate transactions is transferred to those with the most holdings of the network’s native currency. Those players with a significant stake in the system are less likely to manipulate it. If they do it, they could have their stake destroyed.
Besides the fact that there’s no need for tech knowledge and sophisticated computer systems, you don’t even have to stake holdings on your own. Exchanges are operating stake pools, and this means that you can commit some of your holdings to a pool and gain rewards in return.
This is another advantage that PoS has. Users' needs and blockchains are changing, and so is PoS. The mechanism is very versatile, and it can easily fit more blockchain use cases.
More and more users are encouraged to run nodes since this is more affordable. This incentive and the randomization process are making the network more decentralized, as a blog post by the crypto exchange Binance notes.
Even if there are various stake pools, there’s a much higher chance for an individual to forge a block under PoS successfully.
Energy efficiency with an eco-friendly system
PoS is more energy efficient compared to PoW. The cost of participating relies on the economic cost of staking coins and not on the computational cost of solving puzzles. This decreases the energy required to run the consensus mechanism and creates a more eco-friendly system.
Staking can be seen as a financial motivator for the validator not to process fraudulent transactions. In case the network finds a fraudulent transaction, the validator will lose a part of their stake and the rights to take part in the future.
As long as the stake is higher than the reward, the validator could lose more coins than it would be able to gain via fraud.
It’s important to mention that to effectively control the network and approve fraudulent transactions, a node would have to own the majority stake in the network.
This is also known as the 51% attack. It’s almost impossible to gain control of the network, and this is because you would need to get 51% of the circulating supply.
In other words, to save money and create a disincentive for bad actions, PoS moves the incentive and punishment system into the blockchain. It’s important to highlight that it’s not making an investment in expensive hardware and electricity.
On the other hand, the PoS participants invest in the token itself. They are also setting aside a certain amount of wealth as collateral. Based on the amount of collateral they wager, the network will select someone to build the next block.
PoS also beats PoW when it comes to speed. The Motley Fool addresses the following instance: “For example, Ethereum only processes 30 transactions per second as a proof-of-work blockchain. The network expects to process as many as 100,000 transactions per second once it’s transitioned to proof of stake and launched its shard chains.”
How blocks of transactions are added to a network has changed a lot since the invention of Bitcoin.
We don’t have to rely solely on computing power to generate the crypto consensus like Satoshi initially intended. The Proof-of-Stake system comes with a lot of benefits, and history is on its side.
As things seem to evolve, Bitcoin will remain the only one of a handful of Proof-of-Work networks left. Proof-of-Stake is here to stay, and it will probably shape the future of blockchain technology.