How to crypto? part III: Proof of Work and Proof of Stake
Our first How to crypto? article tried to explain what blockchain is and the
use cases of this technology.
While in the second one we had a brief look through the main projects and currencies.
We arrive now at our third article in our “How to Crypto” series were we will talk more about the differences in projects, and for this we need to focus on consensus mechanisms.
A central idea of blockchain technology is the distributed ledger. It is called a distributed ledger because instead of being stored in a central location, it is stored across a network of computers all around the world. For a distributed ledger to work, the entire network collectively has to agree with the contents of the ledger; this is the job of the consensus mechanism. The most popular blockchain consensus mechanisms are the Proof of Work (PoW) and Proof of Stake (PoS) systems., A number of other systems exist, such as Delegated Proof of Stake (DPoS) and Federated Byzantine Agreement (FBA) however this article will be focussed on presenting and then comparing PoW vs PoS.
Proof of Work (PoW)
The Bitcoin White Paper proposed the use of a Proof of Work system to prevent an entity from gaining a majority control over the network. Applying Proof of Work in this manner is arguably the central idea necessary for Bitcoin, as it allows for trustless and distributed consensus.
How mining works:
- A number of transactions are bundled into a memory pool (mempool).
- Miners verify each transaction in the mempool is correct, but in order to write the next block and collect the reward they need to solve a mathematical puzzle.
- The mempool contains verified transactions and after they are broadcasted to the network are added to the blockchain.
- The first miner to solve the puzzle gets rewarded with newly produced bitcoin (the block reward) and network transaction fees.
In a distributed consensus-based on the proof of Work, miners need a lot of energy. The Bitcoin POW mechanism is so costly that it consumes the same amount of electricity it takes to power a country like Switzerland in one year. Bitcoin’s current estimated annual electricity consumption is 61.4 TWh.
Proof of Stake (PoS)
Proof of Stake systems have the same goal of validating transactions and achieving consensus, however, the process is a bit different than in Proof of Work systems. With Proof of Stake, there is no mathematical problem to be solved, instead, the creator of a new block is chosen in a deterministic way according to their stake.
The stake is how many coins/tokens one possesses. For example, if one person were to stake 10 coins and another person staked 20 coins, the person staking 20 coins would be 2 times more likely to be chosen as the next block validator.
More information about the main differences on this two different protocols can be found in our previous article.
PoW vs PoS
A key difference between Proof of Stake and Proof of Work is that with PoS systems there is no new coin creation( mining). Instead, all of the coins are created in the beginning, this means the validators must be fully rewarded through transaction fees.
Cost and energy
PoS systems are designed to be more cost-efficient and more energy-saving than the PoW systems. The computational power needed to operate a PoW system is very energy intensive. Even more, the competitive nature of mining means an increasing amount of money is being invested into more powerful mining computers, which in turn will require more and more energy to be supplied.
Security
On a blockchain, a fork is a technical event that occurs because different participants need to agree on common rules. In PoW systems( Bitcoin) forks occur quite regularly, they are a byproduct of the distributed consensus. Constant forking of a blockchain is not healthy for a network and leads to instability.
PoS systems are relatively new, compared to PoW systems and the level of adoption is quite low. Therefore, it hasn’t been strongly tested, so only few securities risks have been found. One of the big issues with Proof of Stake systems is that they do not natively discourage forking. When a blockchain forks, a validator will receive a duplicate copy of their stake on the newly forked blockchain, they could potentially claim twice the amount of transactions fees as a reward. This is known as the ‘nothing at stake’ problem.
Ethereum plans on switching from a Proof of Work system to a Proof of Stake system sometime in 2018, with a proposed consensus protocol called Casper. Casper will utilize a deposit solution in which validators are required to submit a minimum deposit in order to participate. If the protocol determines a participant has violated a set of rules, such as signing off on multiple forks, the deposit will be confiscated.
Centralization
An increasing concern with blockchain projects using Proof of Work systems is the weak defense strategy against centralization, the task of mining in Proof of Work systems is becoming more and more accessible for large-scale operations. Control of blockchain networks is shifting again from the community to fewer and fewer hands, against the decentralized spirit of most cryptocurrencies.
Proof of Stake systems potentially provides a more fair solution. The amount of network control a participant can gain in a Proof of Stake system is directly proportional to how much they invest. If one participant invests ten times more than another participant, they will receive ten times the amount of control. On the contrary, under Proof of Work systems, if a miner invests 10 times more into equipment than another, they will actually receive more than 10 times the computational power. This comes as a result of bulk purchasing deals and the increased efficiency of high-end equipment.
Looking at Proof of Stake projects, we evaluated that the outcome is quite different. The location of wallets is distributed among more countries. Even though PoS solutions are not perfectly immune to centralization, in Proof of Stake, rules of governance can be created such that centralization is discouraged. This is enabled by a higher degree of independence on hardware in PoS systems. For this reason Proof of Stake has often been judged as the consensus algorithm less likely to lead to the centralization of the network.
Looking at Proof of Stake projects, we evaluated that the outcome is quite different. The location of wallets is distributed among more countries. Even though PoS solutions are not perfectly immune to centralization, in Proof of Stake, rules of governance can be created such that centralization is discouraged. This is enabled by a higher degree of independence on hardware in PoS systems. For this reason Proof of Stake has often been judged as the consensus algorithm less likely to lead to the centralization of the network.
In a few words, our research shows high centralization in Proof of Work blockchains. A big percentage of the mining hashrate is located in China because of low electricity price. Here at Pool of Stake, we are convinced that PoS is the future of Blockchains. Our research has shown that PoS adoption is increasing, and that PoS projects are less centralized and more secure than their PoW counterparts.
We move on in our next article, where we apply all our knowledge gained through this mini series, and talk about choosing, buying, tracking and securing your virtual assets.
