Learn all about Proof of Stake, the new blockchain consensus mechanism that’s looking to be a worthy contender of the Proof of Work mechanism.
We deep dive into the fundamentals, benefits and downsides of Proof of Stake and how it is different from Proof of Work.
Things to Know Before We Start
- What are Consensus Mechanisms?
Proof of Work and Proof of Stake are both “consensus mechanisms,” which are methods for maintaining the integrity of a blockchain.
Consensus is what solves the problem of “double-spending.” If a cryptocurrency trader could spend coins more than once, the entire system would be jeopardized and susceptible to theft.
This is a difficult challenge to solve, especially with online currencies that lack a central authority, such as a bank or government.
Consensus mechanisms have been developed to keep track of how much currency or data each user within the same ecosystem has.
- Proof of Work briefly explained
Pioneer cryptocurrencies like Bitcoin run on a mechanism called “Proof of Work” or PoW.
When Satoshi Nakamoto created Bitcoin, he needed to figure out a means to verify transactions without the involvement of a third party. He built the Proof of Work system to be able to do this.
In Proof of Work, all the nodes compete against each other in a race to be the first to validate a transaction. This means all the other nodes involved except the winner waste their computational power and electrical energy.
In fact, Proof of Work is estimated to need over 1 million dollars of electricity every day between Bitcoin and Ethereum alone.
This is why ecologically conscious crypto experts suggest that Bitcoin and Ethereum (along with the other systems using PoW) are bad for the environment and newer, better solutions are needed for cryptocurrencies to become globally viable options.
The Need for Proof of Stake
Apart from the electrical energy usage of Proof of Work, another downside is that it makes transactions more expensive because of the electricity usage that is needed for the consensus mechanism.
If a node wins the race to validate a transaction, you have to charge a fee high enough to make up for all the times you spent electricity and yet couldn’t get to validate the transaction at that time. This “extra charge” is ultimately borne by the whole ecosystem concerned.
These factors show that there are flaws in the Proof of Work algorithm. This is why Proof of Stake is being looked into by major cryptocurrencies instead.
Proof of Stake is similar to Proof of Work: both are used to attain consensus and keep the underlying blockchain secure. But there is one important difference: Proof of Stake requires far less work to validate data blocks and thus requires less energy.
In Proof of Stake, there is no race amongst the nodes to validate a transaction.
Instead, they now take part in a “lucky draw” whose winner is decided by the blockchain itself. The winner then validates the transaction and gets a much smaller reward for having consumed much lesser electricity.
But then how do we know that the winning node won’t cheat and validate a wrong transaction?
Well, to volunteer in this “lucky draw” you have to stake some of your own cryptocurrency into a storage. If you cheat, you are penalized and some of your staked coins are taken away by the entity that spots the fraud.
In fact, to keep the lucky draw fair, the more crypto you stake, the higher are your chances of getting picked as the winner. However, it’s still “randomized”. Let’s have a deeper look into how this works.
How Proof of Stake Consensus Works: The Details
The Proof Of Stake method selects a node to be the validator of the next block using a pseudo-random election process based on a combination of parameters such as staking age, randomization, and the node’s wealth.
As the Proof of Stake name implies, nodes on a network stake a certain amount of cryptocurrency in order to become candidates for validating new blocks and earning the fee associated with them.
The node that will validate the new block is then chosen by an algorithm from a pool of candidates. To make the selection fair to everyone on the network, this algorithm mixes the amount of stake with other considerations.
It’s worth noting that blocks in Proof of Stake systems are “forged” rather than “mined.” Proof of Stake cryptocurrencies frequently begin by selling pre-mined coins, or they begin with the Proof of Work method and then move to Proof of Stake.
Whereas with Proof of Work-based systems, more and more cryptocurrency is generated as an incentive for miners, the Proof of Stake method typically pays miners with transaction fees.
The two most popular techniques that Proof of Stake systems use to choose their validators are known as Randomized Block Selection and Coin Age Selection.
- The Randomized Block Selection technique chooses its validators by looking for nodes with the lowest hash value and the highest stake. Because stake sizes are public, the next forger can typically be predicted by other nodes.
- The Coin Age Selection technique selects nodes depending on the length of time that their tokens have been staked. The age of a coin is determined by multiplying the number of days the coins have been staked by the number of coins staked. After forging a block, a node’s currency age is reset to zero, and they must wait a specific amount of time before forging another block. This prevents large stake nodes from controlling the consensus mechanism.
Each cryptocurrency that uses the Proof of Stake algorithm has its own set of rules and procedures to create the best possible combination for their respective ecosystem.
When a node is chosen to forge the next block, it verifies the validity of the transactions in the block, signs it, and adds it to the blockchain. The transaction costs linked with the transactions in the block are paid to the node as a reward.
If a node wants to stop forging, its stake and earned rewards will be returned after some time, allowing the network to verify that the node hasn’t added any fraudulent blocks to the blockchain.
Here’s what a typical Proof of Stake based mechanism workflow looks like:
- Nodes carry out the transactions, all of which are gathered into a pool via the Proof of Stake algorithm.
- All the nodes competing to be the next block’s validator raise a stake. To choose the validator, this stake is coupled with other parameters like coin age or randomized block selection.
- The validator checks all the transactions before releasing the block. His stake is still locked and he’s yet to receive the forging reward, to allow the network’s nodes to verify the new block.
- If the block is validated, the stake and reward are returned to the validator. If the method uses a coin age based process to choose validators, the current block’s validator gets its coin age reset to 0. As a result, he will be a low-priority candidate in the next validator election.
- If other nodes on the network do not verify the block, the validator loses their stake and the algorithm marks the block as “bad.” To forge the new block, the process restarts from step 1.
Security of Proof of Stake
The stake in Proof of Stake acts as a financial incentive for the forger node to avoid validating or initiating fraudulent transactions.
If a fraudulent transaction is detected by the network, the forger node will lose a portion of its stake as well as its right to participate as a forger in the future. As long as the stake is more than the reward, the validator will lose more coins in the event of a fraud attempt.
A majority stake in the network, commonly known as the 51% attack, would be required to
successfully control the network and forcefully accept fraudulent transactions. Hence, this acts as a security feature for the Proof of Stake algorithm.
Features of Proof of Stake
Proof of Stake algorithms have three fundamental features no matter how they are adopted in an ecosystem:
- Fixed Number of Coins:
There are only a finite number of coins that circulate through the network at any given time. The possibility of creating new coins does not exist (as in by mining in case of bitcoin and other PoW based systems).
The network either starts with a finite number of coins, or it starts with Proof of Work to bring coins into the network and then switches to Proof of Stake.
- Transaction Fees as Reward for Forgers:
Each transaction has a fee attached to it. This is gathered and given to the entity that will create the new block. If the forged block is proven to be fraudulent, the entity loses the transaction fee as well as his stake. This is known as slashing.
- The Impracticality of the 51% Attack:
The 51% attack is impractical because it requires the attacker to own 51% of the total coins in the network, which is expensive. As a result, carrying out the attack is too time-consuming, costly, and unprofitable.
Difficulties will arise in amassing such a large percentage of total cryptocurrency because there may not be enough currency to buy, or buying more coins becomes expensive.
Validating incorrect transactions will also result in the validator losing their stake, making them reward-negative.
Advantages of Proof of Stake
The reason why so many new crypto projects are adopting the Proof of Stake system to validate their transactions is because of these advantages it has over Proof of Work:
- Energy-efficient
Energy is conserved since nodes aren’t competing for the right to add a new block to the blockchain. Furthermore, no advanced mathematical problem must be solved unlike in a Proof of Work system, saving energy.
- Truly Decentralized
In Proof of Work blockchains, an additional incentive of exponential rewards is offered to join a mining pool, resulting in a more centralized blockchain.
In a Proof of Stake system, rewards are proportionate to the amount of money invested. As a result, joining a mining pool delivers no further benefit, promoting true decentralization.
- Secure
An individual seeking to attack a network must hold 51% of the stakes, which results in a secure network as previously mentioned.
- Stable
Because there is little or no need to issue a large number of new coins as reward, the price of a given coin can be more steady.
Disadvantages of Proof of Stake
Proof of Stake also comes with a set of disadvantages, such as:
- Validators with a Large Stake can create an Oligopoly:
If a group of validator candidates get together and hold a big amount of total cryptocurrency that is in circulation, they will have a better chance of becoming the actual validator.
Increased chances means more possibility of earning higher rewards, which leads to the acquisition of a large currency share. As a result, the network may grow more centralized over time.
- Lack of Testing:
Proof of Stake is still a novel concept. Finding problems, fixing them, and making it viable for a live network with actual financial transactions still needs further research.
- The Problem of ‘Nothing at Stake’:
In the event of a blockchain split or forking, this problem outlines the nodes suffering little to no disadvantage if they support several blockchains.
In the worst-case scenario, each fork will result in many blockchains and validators, and the network’s nodes would never reach consensus.
Is Proof of Stake better than Proof of Work?
This question is still highly debatable and we are interested in hearing your thoughts in the comments!
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