Proof-of-Work versus Proof-of-Stake

What's a consensus mechanism?

Before we begin, let's first define what a consensus mechanism is.

A consensus mechanism is a method for validating new transactions and keeping the blockchain secure. Secure means it can't be played or tampered with – no double-spending is allowed.

What's Proof-of-Work (PoW)?

Proof-of-work is the original consensus mechanism for adding new transactions to the blockchain and securing it. It means performing complicated but feasible computational calculations, aka solving a math puzzle. 'I added a block by doing some computational work' hence proof-of-work.

For their trouble, the people who perform calculations are rewarded by the Bitcoin protocol with newly-issued coins. These have never been in circulation before, so they are quite literally 'mined' into existence. (hence, 'mining' and 'miners').

As the original consensus mechanism, PoW is used by older, 'first-generation' cryptocurrencies. Think Bitcoin, Litecoin, Dogecoin etc.

The benefits of Proof-of-Work

The most important advantage of the mechanism is its security. The competition is high, and the entry is expensive, so trying to undermine it from within is counterproductive. Unscrupulous miners will be detected and excommunicated even if they succeed in adding a faulty block. The block will then be discarded, but they will still end up with the electricity bill and the mining equipment bill as well.

The drawbacks of Proof-of-Work

Bitcoin mining is very lucrative for a successful miner, so there are lots of miners. But since the Bitcoin protocol wants new blocks to be added every 10 minutes or so, it has to regulate the difficulty of the math puzzle. Otherwise, new blocks will take much shorter to be solved. It leads to miners using more and more advanced (and expensive!) equipment to succeed, which is very energy-consuming. And since only one miner gets to win, the efforts of the others will effectively go to waste. This is harmful to the environment.

Confirming transactions on the Bitcoin blockchain

For a more in-depth look at mining

What's Proof-of-Stake (PoS)?

Proof-of-Stake is an alternative to Proof-of-Work. Instead of performing costly computational calculations to create new blocks of transactions, PoS achieves this via staking.

Staking is when a person who owns an amount of cryptocurrency instead of using it for trading puts it away so it can serve as their right to confirm blocks on a blockchain. Think of it as a share. You can either sell and profit, or you can retain your shares along with voting power.

Owners offer their coins as collateral for the chance to add (or validate) new blocks and profit from it. Validators are chosen pseudo-randomly depending on how much they stake and how long they've been holding the coins.

Proof-of-Stake is a more advanced method for validating new transactions. As such, it is used by younger cryptocurrencies such as Cardano, Polkadot, Solana, Tezos etc. You may think of Ethereum as Proof-of-Stake, but it's still a work in progress, and the move from Proof-of-Work hasn't been made yet.

How does Proof-of-Stake work?

The protocol chooses a potential validator from a pool of full nodes (store all data in the blockchain). The algorithm is pseudo-random: it pays attention to how big the stake is and how long the coins have been staked. The validator checks that transactions in the blocks are correct and creates a new block (well, the software on their device does). For their help, the validator receives a reward.

A user who wishes to be a validator will have to make peace with the fact that their coins will be locked for the time being. However, they can un-stake their coins at any time: they will lose the validator status but be able to continue trading.

The benefits of Proof-of-Stake

• Greener solution

Proof-of-Stake is much less energy-consuming than Proof-of-Work. So much so that you'll be good with a regular laptop. The only thing is, it should never go offline, or penalties will follow (see below).

• Low(er) barrier to entry

The threshold depends on the cryptocurrency, but in most cases, staking is cheaper than acquiring equipment for mining that can compete.

• Together instead of against each other

Blocks are validated by more than one validator. For example, Ethereum will require the help of 128 for one block. Where PoW makes miners compete against each other and the clock, PoS validators work together to secure the blockchain.

The drawbacks of Proof-of-Stake

Though it differs from cryptocurrency to cryptocurrency, Proof-of-Stake may present the following disadvantages:

• Expensiveness

In the case of Ethereum, a user will be required to stake 32 ETH to become a validator (just above 83k EUR at the time of writing). Quite an amount considering that the money cannot be used during the whole time a user wishes to remain a potential validator. The answer to this is staking pools. Just like with Bitcoin, where individuals flock into mining pools to share the costly equipment, validation pools are places where validators contribute their funds to meet the monetary threshold. When chosen, they will then share the reward per their input. Another problem is that when the coins are staked, they are excluded from circulation.

• Risk of centralisation

In the worst-case scenario, we'll end up with a few major validation pools that call all the shots. So much for decentralisation and rule of the many.

• 'Rigged system'

It does favour those who own more coins or have been in the cryptocurrency business longer. On the other hand, you could argue that they have more stake in keeping the network secure.

• Penalties

Ethereum calls this 'slashing', and it means that a part of your funds (or the whole amount, depending on the severity of the 'crime') is removed from you for bad behaviour. It may mean that a user tried to cheat the system. Or that they went offline and couldn't fulfil their obligation as a validator. Even though serving as a validator on a PoS mechanism is not as energy-consuming as with PoW, and you can do it on a regular laptop, slashing is a rather severe penalty for going offline.

To sum it up

Why should you care?

Look at it this way. Proof mechanisms largely determine the limitations and evolution prospects of a cryptocurrency. True, the most successful cryptocurrency up to date – Bitcoin – runs on an 'archaic' proof-of-work mechanism. But the cryptocurrency market is developing rapidly. There are tons of solutions on the market, and everyone is trying to outlive and outsmart its competitors. It makes sense to evolve rather than stagnate. And if you're thinking of investing in cryptocurrencies, especially long-term, you should at least consider the proof mechanism model. If nothing else, it will help you roughly estimate whether your contender has a chance for wider adoption.

Key terms

Consensus mechanism – a method for validating new transactions and keeping blockchain secure.

Miner – a person who is responsible for adding new blocks (containing newly-made transactions) to the Bitcoin blockchain.

Mining – computational work done by miners which, if done correctly and faster than everybody else, allows them to add a new block to the blockchain.

Mining pool – when miners combine their processing power to have a better chance of being first to mine a new block. If they succeed, they split the reward according to the amount of work they contributed.

Proof-of-stake – a consensus mechanism that allows validators to add a new block of transactions to the blockchain. This doesn't require much computational effort, but you have to be chosen by the protocol to validate a new block. Your chances often depend on how much crypto you have staked and how long it's been staked. Also, there's an element of randomness.

Proof-of-work – a consensus mechanism that allows miners to add a new block of transactions by performing complicated but feasible computational calculations, aka solving a math puzzle.

Slashing – a penalty when a part of your funds is removed from you for bad behaviour (e.g., when you went offline when it was your turn to validate a new block).

Staking – when a person who owns an amount of cryptocurrency instead of using it for trading puts it away so it can serve as their right to confirm blocks on a blockchain.

Staking pool – when validators combine their funds to have a better chance of being selected to mine a new block. If they succeed, they split the reward according to their contribution.

Validator – a person who is responsible for adding new blocks (containing newly-made transactions) to the Ethereum blockchain.