32. What is Proof of Work (PoW) and what is Proof of Stake (PoS)?

Both of these are consensus mechanisms. Algorithms that make the operation of blockchain secure. Proof-of-Work (PoW) and Proof-of-Stake (PoS) allow only verified users to add new transactions.

In the case of both consensus mechanisms, the potential users of the network prove that they have dedicated a resource to the blockchain. This could be coins, and it could also be energy. This allows the system to safely and authentically screen and filter out those who are not committed to the network. What are the main differences between Proof-of-Stake and Proof-of-Work? How do both consensuses work? If you want to know the answers, please join us for today’s lesson.

What is Proof of Work, and how does it work?

It’s a consensus mechanism in which computers compete as to which will be the first to solve a complex puzzle. In the cryptocurrency industry, this whole process is called mining. Why? Because the energy and resources used for the process, which are required to complete the puzzle, are often equivalent to the process of mining precious metals in the real world.

The Proof-of-Work mechanism works fairly simple. Imagine that a miner on the Bitcoin network has to guess which numbers to multiply to reach the result of 55,236,962. He keeps guessing combinations of numbers until he finally hits on the correct answer. When his computer solves the puzzle, it presents its solution to the other computers involved in the network. They then verify his solution. Interestingly, when one miner is the first to solve a problem (before the other miners in the network), she can create a new block and send it to the network of nodes. She then performs an individual audit of the already existing ledger and the newly created block. If everything is in order, the new block is added to the previous one. This creates a chain of transactions. The miner is rewarded with bitcoins for his efforts.

What is Proof of Stake, and how does it work?

In the consensus mechanism Proof-of-Stake instead of miners, we have validators. Validators are responsible for finding a block, based on the number of tokens they have invested in a given ecosystem. There is no competition here, as there is between miners, who are responsible for adding new blocks.

In the case of Proof-of-Stake, it is the amount of cryptocurrencies  held by the user that replaces the work of the miner. Adopting a staking structure secures the entire network. Why? Because it is the participant in the network who must buy cryptocurrencies, own them, stake them, and be selected to create a block and then win a prize.

Those who have spent resources on cryptocurrencies to win the prize have a vested interest in the continued success of the network as a whole.

Proof-of-Stake is a consensus that prevents unwanted attacks and counterfeit coins. Why? Because hackers attacking proof of work would have to have at least 51% of the supply of whole coins and also control at least 51% of the nodes of the entire network.

Proof-of-Work – block extraction rules and security

In the case of Proof-of-Work consensus, it takes a lot of electricity to extract a new block. The entire network is secured by the fact that only those who can prove that they have spent some resources for the ecosystem are given the exclusive right to attach a new block to the chain.

So, you won’t be surprised to learn that because of this feature, an attack on a network operating with PoW consensus is time-consuming and expensive. Hackers would have to purchase the appropriate mining equipment and configure it accordingly. What’s more – pay currently high amounts for electricity. They would then compete with the other miners to solve the puzzle and try to add a new block to the chain, using fake cryptocurrencies to do so.

Such a miner, with unholy plans, would solve the puzzle and try to transmit the new block to the rest of the network. The nodes would then conduct an independent audit and determine the legitimacy of the block and the transactions it contained. Then the nodes would notice the fake cryptocurrency. The entire mined block would be declared invalid, based on the consensus rules you are already familiar with.   

The consensus mechanism proof of work prevents the counterfeiting of cryptocurrencies. Only if the miner controls at least 51% of the network hashrate and nodes. Such an attack is almost impossible.

A 51% attack can only occur if a government, company, or other even gigantic entities would have amassed enough resources to account for more than 51% of the network. Would the attack succeed in such a situation? Not really either – the real network participants would most likely create a new branch of the chain (fork), and the previous chain would be useless. Volia – 51% attack thwarted!

Proof-of-Work consensus – advantages

• Healthy competition and renewable energy opportunities

You know that competition in the case of Bitcoin  mining is very high. To reduce the cost of electricity, companies are looking for newer and more efficient ways of mining. The cheapest forms of energy or modern technologies result in faster and more efficient mining methods.

• Modern Energy

Sichuan and Yunnan provinces are good examples of this. In their operation, they take advantage of the intense rainy seasons, which produce a huge amount of renewable energy. As a result, the provinces have used this to mine Bitcoin. Interestingly, in 2019, China was responsible for almost 70% of the hashrate of Bitcoin. Precisely because of this unconventional way of obtaining energy. Unfortunately, the Middle Kingdom later banned bitcoin cryptocurrency mining, in favour of its CBDC – the digital yuan.

As a result of these decisions, Chinese miners have moved to where energy is also cheap. We are, of course, talking about Kazakhstan.

• Safety

To date, the Proof-of-Work consensus mechanism is the most proven way to keep a distributed network secure. All because the entire mechanism requires expensive hardware to get started and continuous spending, rather than a single investment, as is the case with Proof-of-Stake.

Proof-of-Work consensus – disadvantages

• High-energy consumption

Blockchains Proof-of-Work consume huge amounts of energy. All this is done to ensure the security of their networks. Environmentalists argue that using this consensus is a waste of electricity.

• Waste so-called E-Waste

Life expectancy of excavators. Miners Proof–of-Work operate at full capacity 24/7. Very often, bad conditions, humidity, high temperatures or inadequate ventilation cause excavators to simply stop living and be thrown away.

Currently, ASIC mining excavators last between three and five years. Admittedly, manufacturers are developing new, better and more durable equipment. However, this does not change the fact that they generate a large amount of “mining junk.”

• Traceability

The use of large amounts of electricity can be tracked and easily located. If only thanks to thermal cameras.

Proof-of-Stake – advantages

• Performance and energy efficiency

The mechanism of Proof-of-Stake consensus is definitely more efficient and energy-efficient. The hardware requirements are a laptop, and the software is not very demanding.

• High throughput

In this mechanism, validators are selected based on the number of cryptocurrencies they own. There is no competition here to see who can solve a difficult puzzle first. The time it takes the algorithm to select a validator is much shorter than in the case of Proof-of-Work, which significantly increases the speed of transactions.

• No censorship

As we mentioned above, solving puzzles by validators Proof-of-Stake, can be done using a normal laptop. This means that such a person can work from home and control a globally distributed network. For his work, he does not need a warehouse filled with many computers.

• Barrier to entry

Validator, operating in the Proof-of-Stake mechanism, spends money only once. He buys cryptocurrency and generates blocks. He doesn’t buy expensive mining equipment and doesn’t have to maintain it. This allows more people to operate online.

Proof-of-Stake – disadvantages

• Lack of large-scale action

The Proof-of-Stake mechanisms are not yet as large as the Bitcoin network. However, this does not change the fact that more and more ecosystems are moving to this consensus mechanism. PoS systems have very high scaling potential.

• Consolidation of cryptocurrencies

Accumulating many cryptocurrencies among several validators is the most common argument against the use of Proof-of-Stake. The very nature of this system encourages you to hold as many coins as possible to increase your chance of mining a block and receiving a potential reward.

• Less security

The aforementioned lower barrier to entry for network participation, encourages more people to participate in a given ecosystem. A larger number of validators increases the likelihood of decentralization, and this simultaneously reduces network security.

Who is a miner, and who is a network validator?

A miner is a computer that solves complex mathematical puzzles based on a consensus Proof-of-Work. It consumes a large amount of energy throughout the process, but is rewarded with bitcoins for its actions.

A validator is the equivalent of a miner, however, in a Proof-of-Stake consensus mechanism. Validators stake their cryptocurrencies on behalf of a given network. These individuals are responsible for creating new transaction blocks, for which they also receive rewards.

Which is better: PoW or PoS?

Both consensus views have their place in the world of cryptocurrencies. There is no clear answer as to which one is better. Many cryptocurrencies, especially those newer than Bitcoin, use Proof-of-Stake. They operate stably and have lower costs.

However, there will be critics of this system who will argue that the more coins in the PoS system you have, the more power you can have.

On the other hand, the Proof-of-Work also takes a beating. Talk about an unlikely 51% attack or a bad environmental impact.

Remember, however, that the consensus mechanism that cryptocurrency uses is just one of many factors you must consider when investing in an asset.

Summary

Proof-of-Work and Proof-of-Stake mechanisms are algorithms that help the blockchain network function. They synchronize data, add new blocks and make the network secure. They also determine which computer, on a given network, can add the next block to the blockchain. Both are effective, and there is no clear answer as to which one is better.