Decentralized cryptocurrency networks need to make sure that nobody spends the same money twice without a central authority like Visa or PayPal in the middle. To accomplish this, networks use something called a “consensus mechanism,” which is a system that allows all the computers in a crypto network to agree about which transactions are legitimate. In today's decoder article, we will be comparing and contrasting the two most common consensus mechanisms being "Proof of work" and "Proof and stake".
“Proof of work” and “Proof of stake” are the two major consensus mechanisms cryptocurrencies use to verify new transactions, add them to the blockchain, and create new tokens. Proof of work, first pioneered by Bitcoin, uses mining to achieve those goals. Proof of stake — which is used by Cardano, the ETH2 blockchain, and others — uses staking to achieve the same things. Let's first start with PoW.
Proof of Work
Proof-of-work is a system where computers compete against each other to be the first to solve complex computational problems. This process is commonly known as "mining".To simply this concept, let's use an analogy from Nathaniel Popper's book "Digital Gold":
“It is relatively easy to multiply 2,903 and 3,571 using a piece of paper and pencil, but much, much harder to figure out what two numbers can be multiplied together to get 10,366,613.”
Using this analogy, we can imagine that a miner in Bitcoin’s network must figure out which two numbers can be multiplied to reach 10,366,613 by guessing combinations of numbers until it hits the correct answer. Once a computer determines that 2,903 can be multiplied with 3,571 to make 10,366,613, the computer presents the solution to the other computers in the network, which can easily verify that 2,903 and 3,571 do, in fact, equal 10,366,613 when multiplied.
When a miner solves this computational problem before other miners, they are allowed to create a new block (a grouping of transactions) and broadcast it to the network of nodes, which will then individually perform audits of the existing ledger and the new block. Should everything check out, the new block is "chained" onto the previous block, creating a chronological chain of transactions. The miner is then rewarded with bitcoins for supplying their resources (energy).
Mining requires a great deal of electricity and secures the network by ensuring that only those that can prove they have expended resources are granted the right to append a new set of transactions to the blockchain.
Because of this feature, it is difficult, time-consuming, and expensive to attack a proof-of-work system like Bitcoin’s. Attackers would need to purchase and set up mining equipment and pay for the electricity to run the equipment. They would then compete to solve the computational problem and attempt to add a block of transactions containing counterfeit bitcoins to the chain.
Proof-of-work makes it impossible to counterfeit bitcoin unless a miner controls more than 50% of the entire network — this means they must control at least 51% of both the cumulative computing power of miners, known as the hash rate and the nodes in the network. If they did control more than half of the network, the bad miner could broadcast a bad block to the network and have their nodes accept the block to the chain.
Given how large Bitcoin’s network has grown and how much energy miners contribute to the proof-of-work system, such an attack would be nearly impossible today.
Proof of Stake
Proof-of-stake reduces the amount of computational work needed to verify blocks and transactions that keep the blockchain, and thus a cryptocurrency, secure. In PoS, the owners offer their coins as collateral for the chance to validate blocks. Coin owners with staked coins become "validators", the equivalent of "miners" in PoW.
Validators are then selected randomly to validate the block. To become a validator, a coin owner must "stake" a specific amount of coins. For instance, Ethereum will require 32 ETH to be staked before a user can become a validator. Blocks are validated by more than one validator, and when a specific number of the validators verify that the block is accurate, it is finalized and closed.
Proof-of-stake is designed to reduce the scalability and environmental sustainability concerns surrounding the proof-of-work protocol by effectively substituting staking for computational power, whereby an individual's mining ability is randomized by the network. This means there should be a drastic reduction in energy consumption since miners can no longer rely on massive farms of single-purpose hardware to gain an advantage.
When it comes to security, the 51% attack is a concern when PoS is used, but, like with PoW, it is very unlikely. A 51% attack is when someone controls 51% of a cryptocurrency and uses that majority to alter the blockchain. In PoS, a group or individual would have to own 51% of the staked cryptocurrency.
It is not only very expensive to have 51% of the staked cryptocurrency—staked currency is collateral for the privilege to "mine." The miner(s) that attempt to revert a block through a 51% attack would lose all of their staked coins. This creates an incentive for miners to act in good faith for the benefit of the cryptocurrency and the network.
In conclusion, both proof-of-work and proof-of-stake consensus mechanisms have their own advantages and disadvantages but are robustly secure against a 51% attack. Advantages of PoW include providing an incentive to move to renewable energy sources in order to support mining activities as well as being secure.
Disadvantages of the PoW system, on the other hand, include immense energy consumption, promoting the creation of monopolies of miners as well as E-waste from old mining equipment.
Advantages of PoS include increased efficiency as it uses very little energy to secure the blockchain, lowering the barrier to entry as no specialized hardware is needed to partake in mining, as well as increasing throughput as there will no longer be a need to solve complex computational problems which will increase transaction speeds in the process.
Disadvantages include the fact that it encourages coin hoarding which can lead to centralization, defeating the whole purpose of cryptocurrencies. It is also unproven at a large scale as there has yet to be a PoS system to reach the size and security of Bitcoin.