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Proof of Work (PoW) and Proof of Stake (PoS) are the most common consensus mechanisms. They are used to protect the networks of major cryptocurrencies.
Proof of Work is used by Bitcoin to validate transactions and ensure network security. Among other things, PoW prevents double spending. The blockchain is protected by participants called miners, who use computing power to gain the power to validate new blocks and update the blockchain. A successful miner receives BTC as a reward from the network. As of December 2021, a miner who solved a Bitcoin block received a block reward of 6.25 BTC and a transaction fee.
The main difference between PoW and PoS is how they define transaction block validators. Proof of Stake is the most popular alternative to Proof of Work. This consensus mechanism aims to overcome some of the limitations of PoS, such as scalability issues and power consumption. In the PoS mechanism, participants are called validators. They don't need powerful hardware to have a chance at block validation. Instead, they must stake (lock) the native cryptocurrency of the blockchain. Based on the amount of cryptocurrency staked, the network selects a winner who receives a share of the transaction fee from the block he validated. The more coins are staked, the higher the chance of being chosen as a validator.
Introduction
Networks use various consensus mechanisms to confirm the validity of transactions recorded on the blockchain. Proof of Work (PoW) is the oldest of them. Created by Satoshi Nakamoto, this consensus mechanism is considered one of the most secure options. Proof of Stake (PoS) was created later, but is now used in most altcoin projects.
Besides Bitcoin, PoW is used in other major cryptocurrencies such as Ethereum (ETH) and Litecoin (LTC). In contrast, PoS is used by Binance Coin (BNB), Solana (SOL), Cardano (ADA) and other altcoins. It is worth noting that Ethereum plans to switch from PoW to PoS in 2022.
What is Proof of Work (PoW) and how does it work?
Proof of Work (PoW) is a consensus algorithm used in the Bitcoin network and many other cryptocurrencies to prevent double spending. It was introduced by Satoshi Nakamoto in the Bitcoin whitepaper published in 2008.
Essentially, PoW defines how the Bitcoin blockchain achieves distributed consensus. It is used to confirm peer-to-peer transactions without trust, i.e. without the need for third-party intermediaries.
In a PoW consensus network, such as the Bitcoin network, transactions are confirmed by miners. These are the participants who use a huge amount of resources to ensure the secure and correct operation of the network. Among other tasks, miners create and confirm blocks of transactions. But in order to compete for the right to validate the next blocks, they need to use specialized mining equipment that solves complex mathematical problems.
The first miner who managed to find a solution to these mathematical problems gets the right to add his block to the blockchain and receive the so-called. block reward. Block rewards consist of cryptocurrency units created and transaction fees. The size of the block reward in cryptocurrency units differs across different networks. For example, in the Bitcoin blockchain (as of December 2021), the miner received 6.25 BTC and a commission as a block reward. The amount of new BTC generated with each valid block is reduced by 50% every 210,000 blocks (roughly every four years) according to a mechanism known as halving.
If you want to learn more about the Proof of Work model, read our 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 the Proof of Work algorithm. It aims to overcome the scalability limitations of PoW networks. PoS is the second most popular algorithm used by cryptocurrencies such as Binance Coin (BNB), Solana (SOL) and Cardano (ADA).
While PoW and PoS have the same goal - achieving consensus in the blockchain, PoS implements a different way of determining the participants who verify transaction blocks. There are no miners in PoS blockchains. The priority of a participant according to the rules of the PoS algorithm does not depend on his computing power, but on the amount of cryptocurrency he possesses.
To be eligible for block validation, participants need to lock a certain number of coins in a specific blockchain smart contract. This process is known as staking. The PoS protocol can then select a participant to validate the next block. Depending on the network, the selection may be random or based on the amount of cryptocurrency being staked. As a reward, the selected validator receives a transaction fee from the verified block. Typically, the more coins he locks, the higher his chance of being selected.
For more details, please refer to the Proof of Stake article.
Difference between Proof of Work and Proof of Stake
Even though both are consensus mechanisms that ensure the security of the blockchain network, there are differences between them. The main difference, of course, is how PoW and PoS define the participants who will validate new transactions. For a clearer understanding, consider the table below:
Is Proof of Stake a better solution than Proof of Work?
Proponents of Proof of Stake believe that PoS has certain advantages over PoW, especially in terms of scalability and transaction speed. Additionally, it has been said that PoS coins are less harmful to the environment compared to PoW. On the contrary, many PoW proponents argue that PoS as a new technology has not yet proven its potential in terms of network security. The fact that PoW networks require significant resources (mining hardware, electricity, etc.) makes them more expensive to attack. This is especially true for Bitcoin, the largest PoW blockchain.
As we have already said, as part of the Ethereum 2.0 update, Ethereum (ETH) is planned to be transferred from PoW to PoS. ETH 2.0 is a long-awaited update to the Ethereum network to improve its performance and address scalability issues. Once PoS is implemented on Ethereum, every participant with at least 32 ETH will be able to participate in staking to become a validator and receive rewards.
Is PoS better than PoW? Why is the second largest cryptocurrency by market capitalization switching to a new consensus mechanism?
Risk of centralization
In Proof of Work blockchains, mining involves using computing power to search for hashes of data in blocks until the correct solution is found. It is becoming increasingly difficult to find solutions for major cryptocurrencies today, and the process of computing huge numbers of hashes can be expensive due to hardware and electricity.
Therefore, to increase the likelihood of receiving a block reward, some miners pool their hardware resources in mining pools. To maximize hashing power, some large mining pools invest millions of dollars in resources and control thousands of ASIC chips.
As of December 2021, the top 4 mining pools together control approximately 50% of Bitcoin's hashing power. The dominance of mining pools makes it difficult for crypto enthusiasts to mine on their own.
How decentralized is mining then? On the one hand, there is still no single entity that can control the confirmations of the network. If this happened, a 51% attack would become possible and the network would lose its value. Some might argue that mining is still decentralized, but not strong enough. Some parties, such as mining hardware manufacturers and energy producers, still dominate mining and are reducing overall decentralization for proof-of-work consensus blockchains.
The Proof of Stake consensus mechanism takes a different approach and replaces mining power with staking. This mechanism lowers the threshold for individuals to enter to confirm transactions, reducing the importance of location, equipment and other factors. Your contribution is determined simply by the number of tokens in your account.
However, most PoS networks require running a validator node to begin confirming transactions. It can be expensive, but not as expensive as multiple mining rigs. Users then stake their tokens on specific validators, creating a model similar to mining pools. So while Proof of Stake blockchains are easier for regular users to participate in, they are still subject 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 hold the majority of the hashing power on the Bitcoin network leads to a 51% risk of attack. A 51% attack refers to an attack by an attacker or organization that manages to control more than 50% of the network's total hashing power. An attacker can override the blockchain's consensus algorithm and, for their own benefit, perform malicious actions such as double-spending, rejecting or altering transaction records, and preventing other participants from mining. However, due to the size of the Bitcoin network, it is unlikely that it would suffer such an attack.
In contrast, if an attacker wanted to attack the PoS blockchain, he would have to take over more than 50% of the coins on the network. This will increase market demand and the value of the coin, so the cost of collecting the coins could be tens of billions of dollars. Even if an attacker performs a 51% attack, the value of the staked coins will plummet due to the network being compromised. Therefore, it is unlikely that a cryptocurrency with a PoS consensus and a large market capitalization could be subject to a 51% attack.
Disadvantages of Proof of Stake
Many consider Proof of Stake to be a better alternative to Proof of Work, but it is worth noting that PoS has disadvantages. According to the reward distribution mechanism, validators with a large number of locked assets have an increased chance of validating the next block. The more coins a validator has, the more coins it can stake and the more it can earn, which is why some have criticized this scheme as “enriching the rich.” These “wealthier” validators can also influence voting on the network, since PoS blockchains often give validators control rights.
Another problem is the use of PoS by cryptocurrencies with a relatively small market capitalization. As we have already said, it is unlikely that a 51% attack will happen on popular cryptocurrencies such as ETH or BNB. However, smaller digital assets with less value are more vulnerable to attack. Attackers can obtain enough coins to gain an advantage against other validators. They will then be able to exploit the PoS system, becoming frequently chosen as validators. The rewards they earn can also be staked, increasing their chance of being selected in the next round.
Summary
Proof of Work and Proof of Stake have their place in the cryptocurrency ecosystem, and it is difficult to say with certainty which consensus protocol performs better. PoW may be criticized for generating high carbon emissions during mining, but it has proven itself to be a secure algorithm for securing blockchain networks. However, as Ethereum moves from PoW to PoS, Proof of Stake may become the preferred system for future projects.
