Summary
Proof of Work (PoW) and Proof of Stake (PoS) are the two most common consensus mechanisms used by mainstream cryptocurrencies to ensure their own network security.
Bitcoin uses proof of work to verify transactions and ensure network security. In addition, proof of work can prevent double spending. The security of the blockchain is guarded by participants called "miners", who use computing power to compete with each other for the right to confirm new blocks and update the blockchain. Successful miners are rewarded with Bitcoin by the network. As of December 2021, miners can receive a block reward of 6.25 Bitcoins for each successfully mined Bitcoin block, plus transaction fees.
The main difference between Proof of Work and Proof of Stake is the way validators of block transactions are selected. Proof of Stake is the most popular alternative to Proof of Work and is a consensus mechanism that aims to improve the limitations of Proof of Work, such as scalability and energy consumption. Participants in Proof of Stake are called "validators" and do not need to use powerful hardware to compete for the opportunity to verify blocks. Instead, they only need to stake (lock) the blockchain's native cryptocurrency. The network then selects the winner based on the amount of cryptocurrency staked and takes a certain percentage of the transaction fees from the blocks they validate as a reward. The more tokens staked, the more likely you are to become a validator.
Introduction
To ensure that the transactions recorded in the blockchain are valid, the Proof of Work (PoW) mechanism appeared first. This mechanism was created by Satoshi Nakamoto and is recognized as one of the safest alternatives. Proof of Stake (PoS) came later and is currently very common in altcoin projects.
In addition to Bitcoin, proof of work is also used in major cryptocurrencies such as Ethereum (ETH) and Litecoin (LTC). In contrast, proof of stake is used in Binance Coin (BNB), Solana (SOL), Cardano (ADA) and other altcoins. It is worth noting that Ethereum will switch from proof of work to proof of stake in 2022.
What is Proof of Work (PoW) and how does it work?
Proof of Work (PoW) is a consensus algorithm used by the Bitcoin network and many other cryptocurrencies to prevent double spending. The concept was proposed by Satoshi Nakamoto in the Bitcoin white paper published in 2008.
Proof of Work essentially determines how the Bitcoin blockchain achieves distributed consensus. It verifies peer-to-peer transactions in a trustless manner without the need for a third-party intermediary.
In a proof-of-work network like Bitcoin, transactions are verified by miners. They are participants in the network who use a lot of resources to ensure the continued security and normal operation of the network. Miners are also responsible for tasks such as creating and verifying block transactions. In order to win the right to verify the next block, miners need to use highly specialized mining hardware to solve complex mathematical problems.
The first miner to successfully solve these math problems wins the right to add a block to the blockchain and earns the so-called block reward. The block reward is made up of newly generated cryptocurrency and transaction fees. The amount of cryptocurrency in the block reward varies depending on the network. For example, a miner who successfully mines a block from the Bitcoin blockchain will receive a reward of 6.25 Bitcoins and transaction fees for each block (as of December 2021). However, due to the halving mechanism, the number of new Bitcoins generated per block will decrease by 50% every 210,000 blocks (about four years).
For more information about the Proof of Work model, please read What is Proof of Work (PoW)?
What is Proof of Stake (PoS) and how does it work?
Proof of Stake (PoS) is a consensus algorithm introduced in 2011 as an alternative to Proof of Work, designed to address the scalability limitations of Proof of Work. Proof of Stake is the second most popular algorithm, used by cryptocurrencies such as Binance Coin (BNB), Solana (SOL), and Cardano (ADA).
Although proof of work and proof of stake have the same goal of reaching consensus in the blockchain, proof of stake uses different methods to determine the validators of block transactions. There are no miners in the proof of stake blockchain. Proof of stake validators compete for the right to verify blocks based on their personal cryptocurrency holdings, rather than relying on computer performance.
Participants can obtain the right to verify blocks by locking a certain number of tokens in a specific blockchain smart contract. This process is called "staking". The proof-of-stake protocol will then assign validators to verify the next block. Depending on the network, the selection process will be random or based on the amount held (stake amount). The selected validators are rewarded with transaction fees from the blocks they verify. Generally speaking, the more tokens staked, the more likely they are to be selected as a validator.
For more details, please read "Proof of Stake (PoS) Explained".
The Difference Between Proof of Work (PoW) and Proof of Stake (PoS)
Although both are consensus mechanisms for ensuring the security of blockchain networks, there are some differences between the two. Obviously, the main difference between proof of work and proof of stake lies in the way of selecting participants to verify new transactions. To make it clearer, let's take a look at the following table:
Is Proof of Stake Better Than Proof of Work?
Proof-of-stake supporters believe that proof-of-stake has advantages over proof-of-work, especially in terms of scalability and transaction speed. Some argue that proof-of-stake tokens are less harmful to the environment than proof-of-work. In contrast, many proof-of-work supporters believe that as a relatively new technology, the jury is still out on the potential of proof-of-stake for network security. Proof-of-work networks require a lot of resources such as mining hardware and electricity, which makes them more expensive to attack. This is especially true for Bitcoin, the largest proof-of-work blockchain.
As mentioned earlier, Ethereum (ETH) will switch from proof-of-work to proof-of-stake when it upgrades to Ethereum 2.0. Ethereum 2.0 is the long-awaited upgrade of the Ethereum network, which aims to improve network performance and solve scalability issues. After Ethereum implements proof-of-stake, all users holding 32 Ether can participate in staking to become validators and obtain rewards.
Is Proof of Stake better than Proof of Work? What made the second largest cryptocurrency by market cap adopt this new consensus mechanism?
Centralization Risk
Mining in a proof-of-work blockchain requires using computing power to repeatedly crunch block data until a valid solution is found. For current mainstream cryptocurrencies, finding a solution is becoming increasingly challenging. The process of exhaustively calculating hash values requires expensive hardware and electricity.
Therefore, some miners prefer to concentrate their mining resources into mining pools to increase their chances of getting block rewards. Some large mining pools invest millions of dollars and operate thousands of application-specific integrated circuit (ASIC) mining hardware in order to generate as much hash power as possible.
As of December 2021, the top four mining pools control nearly 50% of Bitcoin's total hash power. Under the monopoly of mining pools, it is extremely difficult for cryptocurrency enthusiasts to mine blocks on their own.
So, how decentralized is mining? On the one hand, no single entity has full control over network confirmations. If this were to happen, a 51% attack could occur and the network would lose value. Some would argue that while mining is still decentralized, it is no longer as decentralized. In a sense, mining equipment and energy producers still control the lifeblood of mining, making the overall Proof of Work blockchain less decentralized.
The Proof of Stake consensus mechanism takes a different approach, replacing mining power with staking. This mechanism lowers the barrier to entry for individuals to confirm transactions, reducing reliance on location, equipment, and other factors. Staking is determined simply by the number of tokens held.
However, most proof-of-stake networks require running a validator node to start confirming transactions. This can be expensive, but it is not as expensive as running a few mining machines. Users delegate their tokens to specific validators, forming a model similar to a mining pool. Therefore, although it is easier for ordinary users to participate in proof-of-stake, like mining pools, it is still susceptible to centralization issues.
Security Risk
In addition to the centralization risk, the top four mining pools control the majority of the hash power of the Bitcoin network, which increases the risk of a 51% attack. A 51% attack is a security attack on a blockchain system that is launched by a malicious individual or organization that controls more than 50% of the total hash power of the entire network. The attacker will have full control over the blockchain consensus algorithm and perform malicious actions for personal gain, such as causing double-spending problems, refusing or changing transaction records, or preventing others from mining. However, given the size of the Bitcoin network, the probability of such an attack is extremely small.
In contrast, if someone were to attack a proof-of-stake blockchain, they would need to own more than 50% of the tokens in the network. This would cause market demand and token prices to rise, and would cost tens of billions of dollars. Even if a 51% attack was successfully carried out, the value of the tokens staked by the attacker would drop sharply due to the destruction of the network. Therefore, cryptocurrencies that use proof-of-stake consensus, especially those with large market capitalizations, are almost immune to 51% attacks.
Disadvantages of Proof of Stake
Many people believe that proof of stake is an optimal alternative to proof of work, but it is worth noting that the proof of stake algorithm also has flaws. Due to the reward distribution mechanism, the more assets a validator stakes, the more likely it is to get the opportunity to verify the next block. The more tokens a validator accumulates, the more tokens he can stake and earn, so many people accuse this of "rich people get richer". Since proof of stake blockchains usually give governance rights to validators, these "richer" validators also affect the voting rights of the network.
Another concern is that smaller cryptocurrencies adopting proof of stake poses a security risk. As mentioned above, popular cryptocurrencies such as Ethereum or Binance Coin are almost immune to 51% attacks. However, smaller digital assets with lower value are more vulnerable. An attacker who gains enough tokens can gain an upper hand over other validators. As long as they are frequently selected as a validator, they can take advantage of the proof of stake system. They can then re-stake the rewards they earn to increase their chances of being selected in the next round.
Summarize
Both proof of work and proof of stake have their place in the cryptocurrency ecosystem, and it is difficult to judge which consensus protocol is more effective. Proof of work has been criticized for its high carbon emissions during mining, but it is still recognized as a security algorithm to protect blockchain networks. Nevertheless, as Ethereum switches from proof of work to proof of stake, the proof of stake system will gain more favor from new projects in the future.
