TL;DR

Proof of Work (PoW) and Proof of Stake (PoS) are the most common consensus mechanisms. They are adopted by the main cryptocurrencies to protect and guarantee the functioning of their network.

Bitcoin uses Proof of Work to validate transactions and secure the network. In addition to other functions, PoW prevents double-spending. The blockchain is secured by participants called miners, who use computing power to compete for the right to confirm new blocks and update the blockchain. When a miner successfully confirms a new block, he receives BTC rewards from the network. As of December 2021, by successfully mining a Bitcoin block, a miner can get a block reward of 6.25 BTC plus transaction fees.

The main difference between PoW and PoS is the way they determine who can validate a block of transactions. Proof of Stake is the most popular alternative to Proof of Work. It is a consensus mechanism that aims to improve some of the limitations of PoW, such as scalability issues and high energy consumption. In PoS, participants are called validators. They do not need to use high computing power hardware to compete for the chance to validate a block. Instead, they need to stake blockchain-native cryptocurrencies. The network then selects a winner based on the amount of cryptocurrencies staked. The user selected as validator will receive a proportion of the transaction fees for the block they validate. The more coins staked, the greater the chance of being chosen as a validator.

Introduction

To ensure that transactions recorded on a blockchain are valid, networks adopt different consensus mechanisms. Proof of Work (PoW) is the oldest mechanism. Created by Satoshi Nakamoto, it is considered by many to be one of the safest alternatives. Proof of Stake (PoS) was created later, but today it is used in most altcoin projects.

In addition to Bitcoin, other major cryptocurrencies also use PoW, such as Ethereum (ETH) and Litecoin (LTC). PoS is used by Binance Coin (BNB), Solana (SOL), Cardano (ADA) and other altcoins. It is important to remember that Ethereum intends to change its mechanism from PoW to PoS in 2022.

What is Proof of Work (PoW) and how does it work?

Proof of Work (PoW) is the consensus algorithm adopted by the Bitcoin network and many other cryptocurrencies to prevent double-spending. It was presented by Satoshi Nakamoto in the Bitcoin whitepaper, published in 2008.

Basically, PoW determines how the Bitcoin blockchain achieves distributed consensus. It is used to validate trustless peer-to-peer transactions without the need for third-party intermediaries.

In a PoW network like Bitcoin, transactions are verified by miners. These are participants who use a large amount of resources to ensure that the network continues to function correctly and safely. Among other tasks, miners create and validate blocks of transactions. But to compete for the right to validate the next block, they use highly specialized mining hardware to solve complex mathematical problems.

The first miner who manages to find a valid solution to these mathematical problems wins the right to add their block to the blockchain and receive what we call a block reward. Block rewards are made up of newly generated cryptocurrencies plus transaction fees. The amount of block reward cryptocurrencies varies across each network. For example, on the Bitcoin blockchain, a successful miner receives as a block reward, 6.25 BTC plus transaction fees (as of December 2021). However, the number of new BTCs generated per block is reduced by 50% every 210,000 blocks (approximately every four years) due to a mechanism known as halving.

If you want to know more about the Proof of Work model, check out the article 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. Its objective is to solve the scalability problems of PoW networks. PoS is the second most popular algorithm, adopted by cryptocurrencies such as Binance Coin (BNB), Solana (SOL) and Cardano (ADA).

PoW and PoS have the same goal of achieving consensus on the blockchain, but PoS uses a different way to determine who validates a block of transactions. There are no miners on PoS blockchains. Instead of relying on powerful computers to compete for block validation rights, PoS validators rely on their cryptocurrency holdings.

To be eligible to validate a block, participants need to lock a certain amount of coins in a specific smart contract on the blockchain. This process is known as staking. The PoS protocol will then assign a participant to validate the next block. Depending on the network, this selection can be made randomly or according to the value of stakes (stake holdings). The selected validator can receive the transaction fees from the block they validated as a reward. Typically, the more coins locked in stake, the greater the chance of being selected.

See the Proof of Stake (PoS) article for more details.

Diferenças entre Proof of Work e Proof of Stake

Both are consensus mechanisms that guarantee the security and functioning of the blockchain network, but there are differences between them. The main difference is, of course, the way PoW and PoS determine which participant validates new transactions. To understand better, let's take a look at the table below:

Is Proof of Stake better than Proof of Work?

Proof of Stake supporters argue that PoS has some benefits over PoW, especially in terms of scalability and speed of transactions. They also claim that the PoS mechanism is less harmful to the environment than PoW. On the other hand, many PoW advocates argue that PoS, as a newer technology, has not yet proven its potential in terms of network security. The fact that PoW networks require a significant amount of resources (mining hardware, electricity, etc.) makes it expensive and difficult to execute attacks. This is particularly true for Bitcoin, which is the largest PoW blockchain.

As mentioned, Ethereum (ETH) intends to change its PoW system to PoS with the Ethereum 2.0 update. ETH 2.0 is a long-awaited upgrade to the Ethereum network that is expected to improve its performance and resolve scalability issues. After implementing PoS on Ethereum, anyone with at least 32 ETH will be able to participate in staking to become a validator and receive rewards.

Is PoS better than PoW? What made the second largest cryptocurrency by market capitalization decide to adopt a new consensus mechanism?

Centralization risk

In Proof of Work blockchains, mining involves using computing power to hash block data until a valid solution is found. For today's top cryptocurrencies, mining solutions are increasingly difficult and the process of achieving large amounts of hashes can be very expensive in terms of hardware and electricity.

Therefore, some miners prefer to accumulate their resources in mining pools to increase the chances of obtaining block rewards. Some large mining pools invest millions of dollars and control thousands of ASIC mining hardware to generate as much hashing power as possible.

Currently, as of December 2021, the 4 largest mining pools control around 50% of Bitcoin's total hashing power. The dominance of mining pools makes it very difficult for individual crypto enthusiasts to mine.

But how decentralized is mining then? On the one hand, there is still no single entity capable of controlling confirmations on the network. If this were to happen, a 51% attack would be possible and the network would lose its value. Some argue that although mining is still decentralized, it no longer has a high degree of decentralization. Certain areas like mining equipment producers and energy producers still dominate mining and reduce the overall decentralization of Proof of Work blockchains.

The Proof of Stake consensus mechanism takes a different approach and replaces mining power with the staking process. This mechanism lowers barriers to entry and makes it possible for any individual to confirm transactions, reducing the emphasis on location, equipment and other factors. Your stake is simply determined by the amount of tokens you have.

However, most PoS networks require you to launch a validator node to begin confirming transactions. It can be an expensive process, but not as expensive as maintaining multiple mining rigs. Users then offer their staked tokens to certain validators, in a model similar to mining pools. Therefore, although Proof of Stake makes it easier for individual users to participate, it is still susceptible to the same centralization problem as mining pools.

Security risks

In addition to the risk of centralization, the fact that the four largest mining pools have the majority of the Bitcoin network's hashing power could potentially increase the risk of a 51% attack. A 51% attack refers to a potential attack on the security of a blockchain system by a malicious actor or organization that becomes capable of controlling more than 50% of the network's total hash power. In this case, the attacker could change the blockchain's consensus algorithm and benefit from double spending, rejecting or altering transaction records, or even blocking the mining process of other miners. However, this is unlikely to happen with Bitcoin due to the size of its network.

On the other hand, in an attack on a PoS blockchain, it would be necessary to own more than 50% of the coins on the network. This would cause market demand and the price of the currency to increase, which could cost billions of dollars. Even if a 51% attack occurred, the value of staked coins would drop dramatically as the network was compromised. Therefore, a 51% attack is unlikely to happen to a cryptocurrency that uses PoS consensus, especially if it is a large market cap coin.

Negative aspects of Proof of Stake

Many see Proof of Stake as the best alternative to Proof of Work, but it is important to note that there are also shortcomings in the PoS algorithm. Due to the reward distribution mechanism, validators with more staked assets have a greater chance of validating the next block. The more coins a validator accumulates, the more coins they can stake and receive rewards. Many criticize it by saying that this system “makes the rich richer”. These “richer” validators can also influence voting on the network, as PoS blockchains often grant governance rights to validators.

Another concern is the security risks for smaller market capitalization cryptocurrencies that adopt the PoS mechanism. As mentioned, a 51% attack is unlikely to happen with more popular cryptocurrencies like ETH or BNB. However, digital assets with a lower value are more vulnerable to attacks. Hackers can acquire enough coins to gain an advantage over other validators. As a result, they can abuse the PoS system, often being chosen as validators. The rewards obtained can be used in the staking process, increasing the chances of being chosen again in the next round.

Final considerations

Proof of Work and Proof of Stake are consolidated mechanisms in the crypto ecosystem. It is difficult to say which of the consensus protocols works best. PoW may be criticized for creating high carbon emissions during mining, but it has proven to be an efficient algorithm for ensuring the security of blockchain networks. However, with Ethereum's upgrade from PoW to PoS, Proof of Stake may become the most used mechanism for new projects in the future.