What is the Difference Between Proof of Stake and Proof of Work?

What You Need to Know

• This article is about consensus mechanisms, which are the methods that blockchain validation computers use to come to agreements as peers - without a centralized authority or referee.

• Blockchains need validation to make sure all nodes (computers) are working with the same ledger, or source of truth.

• Proof of Stake (PoS) is a consensus mechanism where validators are chosen to create new blocks based on the amount of cryptocurrency they hold and are willing to "stake" as collateral.

• Proof of Work (PoW) is a consensus mechanism that selects 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.

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 by ensuring 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 invented a solution to the double-spend problem that does not require any third-party oversight. His Proof of Work consensus model makes special computers called miners compete to solve complex mathematical puzzles in order to create a new block of transactions for the ledger and get a reward, but each validator node on the network checks the math before accepting the block on their version of the blockchain. If a block has an error, it won't be accepted and the miner won't be able to spend their reward because it is wrapped up in the unaccepted block.

What is Proof of Stake?

Proof of stake (PoS) is the second most common consensus mechanism and is much less energy intensive than proof of work. Instead of miners racing to solve puzzles, PoS uses an algorithm to choose validators who will add blocks to the chain. In most cryptocurrencies, the choosing algorithm picks validators at random, but it can also be designed to privilege certain validators based on other criteria, like how much they have staked.

To become a validator, you need to put up assets as collateral for a pre-set amount of time. While staked, assets are illiquid, meaning they cannot be used, converted, or transferred. For Ethereum, the required stake is 32 ETH. Once you've contributed you receive additional software to turn your computer into a validating node.  

Validators are responsible for checking that new blocks broadcasted over the network are error-free. They also create lists of transactions to add to the next block, and if they are chosen by the selector algorithm they get a fee cut from each of them. For Ethereum and some other PoS models, transactions can add a "tip" to encourage validators to add them to the next block.

If a validator tries to defraud the network (for example by proposing multiple blocks when they ought to send one or sending conflicting attestations), some or all of their stake can be destroyed. Other validators are often rewarded for discovering dishonesty. 

What is Proof of Work?

Proof of Work (PoW) is a consensus mechanism that selects mining nodes to add transactions to the blockchain 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.

Adding new blocks to the Bitcoin blockchain is called mining because it is the way that new bitcoins are introduced and requires a great deal of work - similar to how precious metals are mined.

A miner node's job is to find a random number called a "nonce (number used once)" that will solve a complex algorithm.

Here's a very simplified explanation: the miners receive all the data they need to create a new block on the blockchain every ten minutes or so - all except the nonce. The miner takes all the data for the new block and just guesses what the nonce is, and puts it all together to create a hash, then submits that to the Bitcoin protocol. If the miner is right they get to add the block and receive a reward in BTC, plus all the fees associated with the transactions on that block. If they're wrong they can guess again with a different nonce. The more powerful your computer, the more guesses you can make in one second, thus increasing your chance of solving the equation before another miner.

Once a miner solves for the nonce it broadcasts the new block to the network to be validated by validator nodes. Each validator node (AKA Full Node) on the network has a complete copy of the blockchain and can act independently to check the miner node's math. If it doesn't find an error, it accepts the updated blockchain and tells the rest of the network. Validator nodes operate independently and do not accept blockchain modifications of any sort before checking the math. This ensures miners act honestly, as it logistically impossible to convince every validator node to accept a false block.

The PoW consensus mechanism is the oldest and most reliable consensus mechanism, especially in the case of Bitcoin, which has never gone down or been compromised. 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.

What are the Downsides of Proof of Stake and Proof of Work?  

Both consensus mechanisms are vulnerable to 51% attacks, which is when the majority of nodes on the network are compromised to achieve a fraudulent outcome.

While Bitcoin has never endured a 51% attack, Bitcoin Gold, a PoW based cryptocurrency, has. Bitcoin Gold is a fork of the original Bitcoin, meaning it uses a modified version of the Bitcoin protocol, but does not interact with the Bitcoin network. In 2018 hackers threw a bunch of computing power into the network to become the majority validator, then they repeatedly sold coins to an exchange, modified the ledger to return the coins to their wallet, then sold the same coins again, each time accruing a few million dollars.

With PoS, instead of using brute computing power 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. 

Instead, PoS is vulnerable to multiple chain issues. Unlike PoW, where creating a fraudulent chain to compete with the real chain requires enormous energy expenditure, if a bad actor in a PoS system can obtain the keys to a validator node they can re-write the ledger and broadcast it to the network. It may take time for the fake chain to be discovered, and in that time the hacker can spend the fake coins they've written into their wallet. Note that this is a potential threat, and hasn't happened with the bigger PoS coins like Ethereum.

There is no perfect consensus mechanism, all have advantages and disadvantages, as well as vulnerabilities beyond what this article mentions. It is important to check a coin's consensus type and hack history before investing.

Other Consensus Mechanisms

There are lots of ways decentralized networks can reach agreement. Here are a few examples:

• Proof of History: PoH is used to establish a linear order of events in a blockchain, which improves the blockchain organization and makes adding blocks and transactions quicker than traditional PoS or PoW. Solana was the first blockchain to introduce PoH, and through it they claim to be one of the fastest cryptocurrency networks. It is important to note that PoH is not a standalone consensus mechanism. Solana employs a variant of PoS called PoH-PoS to get the security and decentralization of PoS and the performance of PoH.

• Proof of Authority: PoA gives access to a limited number of known reputable entities to grant authority in validating transactions and creating new blocks. These entities are usually organizations or individuals with a trusted reputation. This consensus mechanism is generally used on Ethereum testnets to allow developers to experiment with smart contracts and Dapps without the cost or complexity of the main Ethereum network. 

• Proof of Space/Time: These algorithms utilize unused hard drive space as a basis for consensus. In one version, the network asks validators to open a random file in the diskspace reserved for the consensus mechanism. If the file fills the requirements, the validator gets to add a block and reap the reward. Proponents of PoS/T claim they are the most energy efficient consensus mechanisms. 

• Proof of Burn: PoB participants send their cryptocurrency to a “burn” address, essentially removing it from circulation to demonstrate their commitment to the network. The selector then randomly chooses validators from the nodes who participated in the burn. 

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. Proof of Work has a long success record and while it takes a lot of energy to run, it takes a lot more to compromise it. But it is important to remember the crypto blockchain is a new technology, and a new consensus mechanism might make everything else obsolete.