Proof of Stake (PoS) is a consensus mechanism to maintain the integrity of the blockchain through validators.
Validators achieve integrity by preventing users from creating new cryptocurrencies they have not earned. The difference is that instead of achieving this through mining, as with Bitcoin, validator nodes that consume less energy are used here. This system is based on crypto staking to obtain the right to validate new blocks and transactions. This grants the node in question a certain amount of new cryptocurrency. Cardano is an example of a Proof of Stake blockchain.
Why do we need to prove anything?
When it comes to a centralized system, preventing double-spending is quite simple. A single entity manages all transactions taking total control of account fund movements. For example, if John sends $10 to Mary using a centralized system like PayPal, this company ensures that Mary gets her money and that John cannot send those same coins to someone else.
But cryptocurrencies have a problem when trying to offer this same service but in a decentralized way. No central entity can prevent something like this from happening. Instead of a single entity, thousands of users are running node software on blockchains like Bitcoin worldwide.
These nodes are in charge of making sure to enforce the network rules. And they must understand each other and pursue the same rules if they don’t want to be isolated from the network. But this task is quite complex. So the idea of a decentralized currency, although tried in the past, did not arrive until recently when someone came up with the concept of Bitcoin.
In this case, Satoshi Nakamoto established a consensus mechanism with the Proof of Work (PoW). The mechanism makes all nodes agree on what is valid and what is not within the network. Subsequently, other consensus mechanisms would arrive, such as Proof of Stake, which seeks to improve the problems of PoW.
How does Proof of Stake work?
Proof of Stake reduces the computational and energy resources a blockchain requires to verify blocks and transactions. Instead of the mining as PoW, this system relies on the amount of cryptocurrency a validating node provides as collateral, an activity called staking, to participate in the process.
The system randomly selects Validators to create these blocks or validate them. The system considers the amount of cryptocurrency the person stakes for the selection. The node with more cryptocurrencies or tickets has more chances as if it were a lottery. However, not everyone can become a validator, as cryptos usually require a minimum requirement. In the case of Ethereum 2.0, this level is at 32 ETH. Cardano does not impose a definite quantity. If the stake of a node is low, it is very difficult to get selected as a block creator. Nodes aggregating the stake of several users are known as Stake Pools.
More than one node must validate the blocks, and when the correct number of validators have verified the block, it gets created and finalized. If the node includes false transactions or tries to cheat the system, it will lose its cryptocurrencies, and the system will expel it from the network so it cannot participate again. Not all Proof of stake mechanisms work the same; each blockchain might implement different methodologies. For example, when Ethereum transforms into a PoS blockchain, it will use shards for sending transactions.
How does it work in Ethereum?
Ethereum 2.0 is the most ambitious project that will use Proof of Stake. A series of improvements to Ethereum will evolve from PoW to PoS. While implementing this new consensus mechanism is complex, which is why developers delayed it so long, here we will try to see how it works on a general level.
There are particular nodes in this system called validators. They are responsible for selecting the following block to add to the Ethereum chain. A node must contribute ethers as collateral to become a validator. A cost similar to what a miner might have in PoW allows him to find blocks. For this work, validators receive a reward from the native cryptocurrency, ETH.
Provided they perform either of these two activities:
- They attest that a block is correct and follows the network’s consensus rules.
- They created a block the rest of the blockchain determined to be valid.
Although they can also be penalized:
- When they validate a block with false transactions or historical information, the protocol will remove some of the staked cryptocurrencies. In addition, the network can kick them out of the network for bad behavior.
- There could be minor penalties if the validator disconnects from the network.
In addition, a validator on Ethereum needs at least 32 ETH to participate, which at the time of this writing is equivalent to $32,000.
Advantages and Disadvantages of Proof of Stake
Although this mechanism seems superior to Proof of Work, the reality is that it has its advantages and disadvantages as well, which are necessary to analyze if you want to understand well what it implies for the crypto ecosystem and the future of blockchains that implement them.
POS Pros
- Transactions can be added to the blockchain more efficiently than with PoW, both in the number of resources needed and in time for processing.
- The environmental impact is also lower with PoS than PoW, which many consider a green alternative by reducing the amount of energy consumed by cryptocurrency mining.
- PoS, in theory, can economically incentivize more nodes to become block validators, which could bring more decentralization.
Cons of POS
- As this is a new technology and an improvement to some blockchains, it has not yet been thoroughly tested to determine no significant risks.
- A Proof of Stake consensus mechanism can lead to a more centralized network, which goes against the ideals of cryptocurrencies.
- There is a fear that PoS may not be as secure and resilient as Proof of Work.
Proof of Stake vs. Proof of Work
The arguments of which system is better are plentiful, and each side has its own to defend itself (PoW vs. PoS). We can observe that people’s arguments to attack a system can also be used to protect it. For example, let’s take energy consumption, a rather delicate issue for the crypto ecosystem.
While for Proof of Stake advocates, it is essential to use a more efficient mechanism that does not use energy to secure the blockchain, for Proof of Work advocates, it is necessary to keep the blockchain immutable. In addition, the concentration of Bitcoin mining has been a topic of discussion in the past. But also a weakness that you can blame on PoS and its validators.
Some estimate that Bitcoin mining consumes almost as much as Switzerland, but you’ll never hear about traditional banking consumption. Bitcoin consumption is efficient because miners go where they find the cheapest energy and would otherwise be wasted because of how difficult it is to transport it long distances. That is why the issue of energy consumption is so difficult to analyze without taking one side or the other.
Blockchain Scalability
Another aspect that differentiates them significantly is the issue of scalability. In the end, both mechanisms achieve scalability, PoW through a second layer, which for PoS advocates, makes no sense if you can achieve it by simply transforming the system into a Proof of Stake blockchain. Bitcoin has improved network congestion and thus fees, thanks to improvements like SegWit. But all these solutions have a limit on the main blockchain.
That is why you must implement solutions like Lightning Network that allow you to lower costs and enable speedy transactions, thanks to not having to include all of them in the main cryptocurrency blockchain. There are other less essential differences that we highlight here below in the table.
Summary
- With a PoS or Proof of Stake system, those who stake cryptos can validate blocks and transactions based on the funds they have used.
- Proof of Stake originated as an alternative to Proof of Work (PoW), the first consensus mechanism employed by Bitcoin and Ethereum.
- While PoW requires solving a cryptographic problem, the PoS mechanism requires participants to keep a certain amount of cryptocurrencies locked.
- The blocks added to the blockchain are chosen randomly, with the possibility that nodes with more cryptocurrencies have a better chance.