Main Points

• Proof of Stake (PoS) is a consensus mechanism that selects blockchain transaction validators based on their economic stake in the system. 

• Proof of Work (PoW) is a consensus mechanism that selects blockchain transaction validators based on the amount of computational effort they have extended.

• The Proof of Stake model was created to solve the problem of PoW's high energy consumption.

If you follow crypto news, you've probably heard that Ethereum is slated to switch from a Proof-of-Work consensus mechanism to Proof-of-Stake sometime near the end of this year. If you're wondering what consensus mechanisms are, why they are important, and how Proof of Stake differs from Proof of Work, then you're in the right place. 

This article breaks down some of the most frequently asked questions surrounding Proof of Stake. 

What is Proof of Stake?

Proof of Stake (PoS) is a consensus mechanism that selects blockchain transaction validators based on their economic stake in the system. 

What is a consensus mechanism, and why is it important?

A consensus mechanism is used in blockchain technology to ensure the blockchain maintains its integrity. They allow cryptocurrencies to be decentralized because they ensure that cryptocurrency users cannot spend their coins more than once - known as the "double spending problem." 

In traditional finance, the double-spend problem is solved by using trusted third parties like banks and payment processors and relying on the government to keep these third parties honest. 

With the introduction of Bitcoin, Satoshi Nakamoto created a solution to the double-spend problem that does not require any third-party oversight. Instead, Nakamoto created the Proof of Work consensus mechanism. This model uses cryptography to establish trust and eliminate the double-spend problem by algorithmically verifying the legitimacy of each transaction. 

What is Proof of Work?

Proof of Work (PoW) is a consensus mechanism that selects blockchain transaction validators based on the amount of computational effort they have extended. The guiding principle behind POW is that everyone trusts the ledger that has the most work, or computational power, put into it.

In PoW, the participants are known as miners. Miners listen for transactions being broadcast, collect them into a block, and then solve the cryptographic puzzle based on the block's transaction data.

The PoW consensus mechanism is used by most cryptocurrencies, including Bitcoin, of course, and Ethereum in its current implementation. However, PoW requires enormous amounts of energy to achieve consensus, and most crypto blockchains are designed so that the puzzles become more difficult over time, requiring even more energy in the future.

The Proof of Stake model was created to solve the problem of PoW's high energy consumption.

How does Proof of Stake differ from Proof of Work?

Rather than putting forth tremendous amounts of computational work or effort to validate transactions, the PoS protocol attributes mining power to the proportion of coins held by a miner. The quantity of coins held by a miner is referred to as "stake." 

Miners are more likely to add additional blocks to the chain (and therefore earn the block reward) if they have a greater stake in the system. Additionally, miners are limited to mining a percentage that is reflective of their ownership stake. So if a miner owns 2% of all the coins available, they can only mine 2% of blocks. 

Limiting the number of transactions one can verify helps to limit the risk of a 51% attack where someone could penetrate the network of a PoW cryptocurrency by hacking more than half of the participating computers. While Bitcoin has never endured a 51% attack, Bitcoin Gold, a PoW based cryptocurrency, has. 

With PoS, a hacker trying to exploit this attack would need to obtain 51% of the network's cryptocurrency. It would be disadvantageous for anyone with a 51% stake in a cryptocurrency to carry out an attack of this nature because it would lead to a fall in the value of that cryptocurrency which means the value of their holdings would also decline. Those with a stake in a network are incentivized to maintain a secure network to protect their holdings. 

To further incentivize validators to act with integrity, the PoS model penalizes miners that propose blocks with false transactions by slashing a significant portion of their staked resources and banning them from the network altogether.

Ethereum’s switch to Proof of Stake

Ethereum developers are working on a major ecosystem upgrade known as ETH 2.0. The ETH 2.0 upgrades are intended to make the network more scalable, secure, and sustainable. A key component of these upgrades is the introduction of staking through the Beacon Chain.

What is staking?

Staking is the act of depositing your cryptocurrency to a system to become a transaction validator. To become a full Ethereum validator, you must stake at least 32 ETH. Those without 32 ETH for staking can still become a validator by adding a smaller stake and joining a staking pool. 

What is the Beacon Chain?

The Beacon Chain is Ethereum's PoS blockchain that went live on December 1, 2020. Currently, the Beacon Chain is running alongside Etheruem's PoW blockchain, the mainnet. These two blockchains will coexist for the foreseeable future until the mainnet merges with the Beacon Chain and the network fully transitions to PoS.

Final Thoughts

Proof of Stake was introduced as an alternative to the energy-intensive Proof of Work consensus model. Under PoS, participants are economically incentivized to act with integrity, therefore eliminating many security risks.