Proof of Work vs Proof of Stake

Proof of Work (PoW) and Proof of Stake (PoS) are two of the most popular consensus algorithms for a blockchain. Due to the decentralised nature of cryptocurrencies and blockchain networks, there is a need to set up an efficient decision-making method. To illustrate this, take the example of how centralized banks work.

There is a central authority in the traditional banking system that validates and makes decisions concerning transactions among parties. For instance, if you wish to transfer $1000 to a friend, Mark, your bank would need to confirm if you have that amount within your account. The transaction would be processed if you have that amount in your bank account and sent to Mark’s bank account. Still, if there is a limitation to your account, the transactions wouldn’t be processed. However, cryptocurrencies aren’t set up like this because of their decentralised nature. There is no central authority, but instead thousands of computer nodes responsible for authorising and verifying such transactions.

These nodes have to reach a consensus, which may not always be straightforward as they are multiple computer nodes involved. This is why the consensus algorithms were introduced: to ease decision-making among computer nodes in cryptocurrencies and the blockchain ecosystem. These consensus mechanisms are embedded in the blockchain network and are responsible for running a smooth decision-making process.

Proof of Work (PoW) is the first and most famous of all blockchain consensus algorithms. It was developed by Satoshi Nakamoto, the creator of Bitcoin. Satoshi recognised a need to devise a protocol that would allow for the addition of new blocks to the blockchain. The Proof of Work consensus algorithm was made to determine the conditions for new blocks to be added to the blockchain.

The Proof of Work creates a series of cryptographic puzzles that computer nodes (miners) need to solve to create a new block. The computer nodes can solve these puzzles with the use of a guess-check mechanism. This means they have to go through a series of wrong answers before they are able to generate the correct answer that would allow them to develop a new block.

Computer nodes (miners), while solving the cryptographic puzzles, need to hash certain data sets and proffer the answer to them before they can successfully introduce a new block. The hash is a string of random letters and numbers created when a miner runs data through a hash function. When data is run through the hash function, it creates a unique hash; this means that if the same data is repeatedly run through a different hash function, it will generate the same result. However, alternating a detail in that data set would cause a completely different hash.

Therefore, through the guess-check mechanism, miners run data sets through a hash function to generate the correct hash. The computer node that successfully finds the right hash receives a reward, often in new coins. However, the process of solving these cryptographic puzzles can be energy and time-consuming. This is because miners use specialized computer hardware usually stored in a warehouse to solve these puzzles. Once a block has been successfully created, the computer nodes begin to assemble a new block to solve another cryptographic puzzle for a chance at another reward.

Miners use specially designed computers for mining, such as ASIC, FPGA, and GPU, among others. Miners purchase hundreds of these specially designed computers working simultaneously to increase their chances of earning a reward. However, critics are sceptical that this may lead to an unbalance in its decentralized nature. This is because major companies with more of these machines have a higher chance of consistently mining blocks, making them a form of centralized institution.

The mining process involves the validation of transactions which are then introduced as new blocks to the blockchain network. In this regard, the miners get rewards for every validated transaction on the blockchain network. It is important to note that miners do not mine transactions but rather mine several transactions within a block. This may explain why there may be a little delay when processing transactions on the blockchain. This is because once a block is filled with transactions, the next block has to be compiled before it can be verified and authenticated by the miner which may take a few minutes.

Other than Bitcoin, some notable cryptocurrencies that use the Proof of Work consensus include Litecoin, Ethereum, Dogecoin and Bitcoin Cash.

Proof of Stake was created as an alternative to solve the limitations of Proof of Work. Proof of Stake was designed to reduce energy consumption. The Proof of Work protocol doesn’t provide a sanctioning strategy for punishing miners who might try to create a fraudulent block. Although the network may reject the block, there is no sanction that would deter others.

In this regard, Proof of Stake eliminates the need for specialised hardware or machinery in introducing new blocks. This has allowed for more inclusion in the mining process as it removes the need for specialised skills to operate complex machinery.

The miners, or rather validators, in this case, act as investors. Still, there are specific requirements you need to meet before you can participate in the mining process. Miners have to hold a minimum amount of cryptocurrencies locked in a wallet. The funds locked in the wallet are then staked in a pool with other investors. Investors cannot withdraw the funds until the staking process is completed. Miners then place stakes on the block that would be validated. Investors who place stakes on the selected block receive a reward. You can increase your stake compensation by increasing your initial stake; that is, the higher your stake, the higher the reward. This reduces energy consumption as individuals can mine from their personal computers.

However, unlike in the Proof of Work, the mining process does not generate new coins for the validators. Instead, investors receive their rewards in the native currency or tokens, either via ICO (Initial Coin Offering) or ECO. Apart from its incentive system, Proof of Stake has a sanction system for investors who try to manipulate the mining process. Investors who try to manipulate the process lose their collateral (stake). This serves as a deterrence to miners not to attempt to manipulate the process as they lose their collateral. They may also be restricted from participating in subsequent rounds of the staking pool. The validators just like in the Proof-of-Work do not validate transactions but rather blocks of transactions. However, the validation process consumes less time because more transactions can be contained in a block and it takes less time to process a block. Therefore, the Proof of Stake would allow for faster transactions that consume less energy on the blockchain.

Some cryptocurrencies that use the Proof of Stake consensus algorithm are Cardano (ADA) and Polkadot (DOT) although DOT uses a type of PoS known as Nominated Proof-of-Stake (NPoS). Ethereum is also moving away from PoW towards PoS with the upgrade of Ethereum 2.0.

Read also: What is Consensus Algorithm?

Proof of Work, the first Blockchain, has several limitations that Proof of Stake aims to resolve. Proof of Work because of the nature of its mining process consumes a lot of energy. In fact, an article on bitcoin power consumption by BBC News notes that bitcoin mining consumes more energy than Argentina, United Arab Emirates (UAE), and The Netherlands. Proof of Work has also facilitated an avenue for some groups of individuals or corporations to accumulate mining power which goes against the Blockchain’s core principle of decentralisation.  Proof of Stake is more user and environmentally friendly. It eliminates the need for complex machinery allowing users to operate from their personal computers.

Another issue of concern that arises with Proof of Work is the time it takes to validate a transaction. It takes the Blockchain approximately 10 minutes to complete the process. Bitcoin blockchain also has a limitation in that it can only handle around 7 transactions per second. This limitation has resulted in an increase in the transaction fees as bitcoin adoption increases. This is because more pressure is put on the Blockchain as more people are completing transactions on the bitcoin network. This is why Bitcoin Improvement Proposals (BIPs) are being put in place to improve scalability.

Ethereum also uses Proof of Work, although strategies are being put in place to allow a shift to Proof of Stake. Developers were able to implement some modifications to The Proof of Work algorithms that enable it to process transactions in about 16 seconds. However, it cannot process more than 15 transactions which are still substantially low.  The Proof of stake would be implemented as part of Ethereum 2.0. Yet, it is still unclear how long the entire shift would take as Ethereum 2.0 is still undergoing a series of upgrades.

Proof of stake aims to minimize transaction fees, increase the number of transactions processed per second. However, critics argue that Proof of Stake is still theoretical, and there is no proof that it can eradicate the limitations of Proof of Work and perform all the functionalities. It also notes that investors (validators or forgers) may also accumulate mining power by putting higher stakes. Therefore there is no proof that Proof of stake is better than Proof of Work. Dash is one of the successful implementations of Proof of Stake and allows users to complete transactions in just a few seconds.

Other important details you need to note about Proof of Work and Proof of Stake include:

Proof of Work (PoW) and its proposed alternative Proof of Stake (PoS) are consensus mechanisms in Blockchain applications. While Proof of Work is dependent on computational power and solving cryptographic puzzles, Proof of Stake encourages users to place stakes. There are still several debates ongoing about which is superior to the other. However, they are both undergoing restructuring and modifications to maximise their functions and effectiveness.