A blockchain is a decentralized ledger that stores transactions and lets users transfer and store digital currencies. For a decentralized network to function as intended, all participants must agree on the system’s current state and keep a record of the holdings of every network participant. This consensus is achieved by specially designed algorithms called consensus mechanisms. In simple terms, consensus mechanisms are a standardized process by which the blockchain nodes — the computers that host the blockchain and keep track of all transactions — reach an agreement.
The most widely used consensus mechanisms are called proof of work and proof of stake. Proof of work and proof of stake aim to ensure users that transactions will go through as planned, but they differ significantly in how they accomplish this goal.
Proof of work (PoW) and proof of stake (PoS) are the two most prevalent consensus mechanisms among the market’s most popular cryptocurrencies. Bitcoin is the oldest and most well-known proof of stake cryptocurrency, whereas Ethereum is the most prominent proof of stake asset.
Proof of work differs from proof of stake in that the transaction verification process used in proof of stake depends on staking, whereas proof of work’s consensus is based on mining. These consensus mechanisms add new “blocks” of transactions to the blockchain.
Before delving into the differences between the two consensus procedures, let us start with the basics.
What is proof of work?
The proof of work consensus mechanism requires miners to use powerful computers to solve complex mathematical problems called hashes. Miners are network participants who commit resources to ensure the network keeps running correctly and safely. Miners are responsible for creating and verifying blocks of transactions.
Miners utilize specialized hardware called ASICs to validate the next block to solve the hash by competing with each other. A hash is a hexadecimal string of 64 digits.
The first miner to solve the hash gets to add their block to the blockchain and get a “block reward.” Block rewards are made up of newly created cryptocurrencies and the fees that come with each transaction. The amount of cryptocurrency in a block reward varies from one network to the next.
Using this consensus mechanism, the blockchain network is secured because a bad actor must control at least 51% of the network and its processing power to make any alteration. However, in recent times, there have been instances of several miners coming together to form mining pools. These mining pools often end up controlling most of the computational power required for the network to run. This raises concerns about centralization.
What is proof of stake?
To counter the centralization of PoW networks, the proof of stake (PoS) consensus algorithm was developed in 2011. It is also an attempt to fix the scalability problems plaguing PoW networks. Many popular altcoins, including Binance Coin (BNB), Solana (SOL), and Cardano (ADA), have embraced PoS as their consensus mechanism.
While both PoW and PoS aim to achieve consensus in a blockchain, PoS uses a different methodology to decide who gets to validate a block of transactions. PoS blockchains do not employ miners. Instead of competing for block validation rights with powerful hardware, PoS validators depend on their cryptocurrency holdings.
Validators in a PoS network must stake a predetermined number of coins in a designated smart contract on the blockchain to participate in block validation. This is referred to as the “staking” process.
Once the cryptocurrencies have been staked, the PoS protocol will select a validator to verify the next block. This selection is made randomly or in accordance with the validator’s holdings (stake) and, in some cases, how long they had their assets staked. The chosen validator is compensated with a portion of the transaction fees accrued by the block they validated. Generally, the more coins they lock up, the higher their chances of being selected for block validation.
PoW and PoS key differences:
The consensus mechanisms differ mostly in how they select which network participant handles the block validation process.
Which consensus mechanism is better?
Before deciding which consensus mechanism is better, let’s consider three key factors:
- Centralization
- Security
- Energy consumption
Centralization
Mining on proof of work blockchains involves miners competing to solve the hash by devoting computational resources. As the network grows and more miners join, it becomes increasingly difficult to find the solutions for the hash. Furthermore, solving massive amounts of hashes is costly in terms of both hardware and energy consumption.
Thus, some miners pool their mining resources to increase their chances of winning block rewards. Large mining pools spend millions on thousands of ASIC miners to generate the most hashing power.
In 2022, two of the largest Bitcoin mining pools accounted for over half of all Bitcoin hashing power. Due to the prevalence of mining pools, it is now much more difficult for individual crypto enthusiasts to mine a block.
So, are PoW networks prone to centralization?
On the one hand, no single entity can govern network confirmations in a PoW network. However, if these mining pools decide to band together, a 51% attack could be launched, rendering the network useless.
While mining remains decentralized as of now, many believe it is no longer decentralized enough. Some geographical regions, mining equipment manufacturers, and energy providers still dominate the mining market, which decreases the overall decentralization of proof of work blockchains.
In contrast to the traditional mining process, the proof of stake consensus mechanism relies on staked resources. This approach makes verifying transactions easier and more efficient, removing the need for specialized infrastructure. The number of tokens you have directly correlates to your stake affecting your chances of being chosen as a block validator.
However, node operators must run a validator node to validate transactions on PoS networks. The operational costs can be high, but are still lower than owning and maintaining multiple mining hardware.
However, even in this case, users often stake their tokens under specific validators to avoid paying the upfront costs of running a validator node. This creates a model quite similar to mining pools. So, while it is true that proof of stake is more accessible to the average user, it nevertheless suffers from the same centralization issues as mining pools.
Security
The possibility of a 51% attack on the Bitcoin network is heightened because a handful of large mining pools can supply the majority of the network’s hashing power. A 51% attack is an attack on the integrity of a blockchain network by a malicious actor or a group that controls more than 50% of a network, in the case of PoW, denoted by hashing power.
When in control, the attacker could override the blockchain consensus algorithm and execute malicious acts to benefit themselves, including double spending, rejecting or modifying transaction records, or blocking others from mining. However, in the case of large networks like Bitcoin, this is highly improbable to occur as the cost of attack would be immense.
In comparison, an attacker on a PoS blockchain must control more than half of the network’s native tokens to launch an attack. The market demand and price of that token would climb quickly in such a scenario. This can amount to tens of billions of dollars. If they succeed in launching a 51% attack, the value of the tokens they have staked will plummet as the integrity of the network is compromised.
As a result, a 51% attack on a cryptocurrency that relies on the PoS consensus is highly improbable, especially if the cryptocurrency in question has a sizable market capitalization.
Energy
Proof of work requires significantly more energy than proof of stake. According to the Cambridge Center for Alternative Finance research, the Bitcoin network consumes as much energy as a developed nation like Malaysia or Sweden.
PoW also requires more sophisticated hardware, which contributes to the problem. Some Bitcoin miners employ massive amounts of cryptocurrency mining hardware to remain profitable. These systems are power-hungry and require additional equipment to keep them cool. This further adds to already immense energy consumption.
Proof of stake needs far less energy and no specialized equipment to function efficiently. Therefore, it is a greener alternative to proof of stake networks. According to the Ethereum Foundation, the Ethereum network’s energy consumption is expected to drop by approximately 99.95% when PoS is fully implemented.
Conclusion
The debate over whether or not to use proof of work or proof of stake in a cryptocurrency is a highly contested topic, with every member of the cryptocurrency community expressing a different opinion. Currently, most cryptocurrency transactions use currencies based on proof of work. On the other hand, with notable blockchains such as Ethereum making the switch to PoS, more blockchains are likely to follow suit.
Important Takeaways:
- Proof of work is a decentralized consensus technique in which network participants are required to solve a complex mathematical problem.
- It is used in cryptocurrency mining to validate transactions and create new cryptocurrencies.
- Proof of work makes peer-to-peer cryptocurrency transactions safe.
- Scaling proof of work requires substantial energy, which increases as more miners join the network.
- Proof of stake (PoS) was developed as an alternative to Proof of Work (PoW).
- Proof of stake (PoS) enables network participants to validate block transactions using staked assets.
- Proof of stake (PoS) is seen as less risky since it structures rewards in such a manner that an attack is less lucrative.
Important Disclosures:
Certain statements in this document might be forward-looking statements, including those identified by the expressions “anticipate”, “believe”, “plan”, “estimate”, “expect”, “intend”, “target”, “seek”, “will” and similar expressions to the extent they relate to the material produced by Bytex staff member. Forward-looking statements are not historical facts but reflect the current expectations regarding future results or events. Such forward-looking statements reflect current beliefs and are based on information currently available to them. Forward-looking statements are made with assumptions and involve significant risks and uncertainties. Although the forward-looking statements contained in this document are based upon assumptions the author of the material believes to be reasonable, none of Bytex’s staff can assure potential participants and investors that actual results will be consistent with these forward-looking statements. As a result, readers are cautioned not to place undue reliance on these statements as a number of factors could cause actual results or events to differ materially from current expectations
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