Cryptocurrencies have come a long way since Bitcoin’s inception in 2009. With each passing year, users have taken a deep interest in this phenomenon, seeking to observe its inner workings.
One of the aspects coming from these observations is how blockchains produce the cryptocurrencies we use by following specific systems. People began discovering the proof-of-work (PoW) and proof-of-stake (PoS), the two most used models for verifying transactions and creating new coins.
The question, though, is what exactly are the differences between each, and is there a better method? Read on to find out.
What is a consensus mechanism?
Before looking at the comparisons, we need to understand why a consensus mechanism exists. A consensus mechanism is merely a method for a large distributed set of computers to agree or reach consensus over a single cryptographic dataset in a network.
Virtually all cryptocurrencies rely on blockchains, which are, by their very nature, decentralized. In a centralized system, one body has all the power to make any changes to a particular database without external consultation.
In a non-centralized environment with countless nodes connected to a network globally, some model is necessary to confirm everyone is in agreement. Therefore, a consensus mechanism is coded in nearly all blockchains ensuring transactions are efficient, transparent, secure, real-time, and genuine.
At this moment, the two most consistently utilized consensus algorithms are proof-of-work and proof-of-stake. Let’s have a look at the distinctions between the two and how they differ.
So, what is proof-of-work?
Bitcoin is the first project to popularize proof-of-work. When we speak of mining, we refer to proof-of-work. Before a blockchain is launched, a developer/s will code rules over how nodes will create blocks.
These blocks need solving through cryptographic hashes. A hash is a numerical function of random calculations to produce an encrypted output. Due to their complexities, advanced computers, namely CPUs (central processing units), GPUs (graphics processing units), and ASICs (application-specific integrated circuits), are necessary to calculate these equations.
Nodes around the world compete to work out the hashes. Whichever miner or group is first to successfully solve this acquires the privilege to add the next block in the chain and receive any transaction fees associated with it.
Hence, it is called ‘proof of work’ because of the enormous effort from the miner and the proof which is publicly verifiable. Prominent examples of cryptos utilizing this approach are Bitcoin, Litecoin, Ethereum, Zcash, Dogecoin, etc.
Pros and cons of proof-of-work
Success in mining depends on the cost of electricity and the computing hash rate. The cheaper the power is, and the more powerful a computer is, the higher chances of solving each block with reduced cost.
These factors present both benefits and challenges. On the pro side, analysts consider proof-of-work cryptocurrencies more resistant to attacks because of the high mining cost. There is less incentive and considerable financial risk for malicious actors to cheat the system.
Secondly, aside from receiving a block, miners also receive any transaction fees associated with that block. These are probably the main advantages of proof-of-work. On the con side, proof-of-work coins consume astronomical processing power, which is environmentally harmful as many rely on coal-powered electricity.
Analysts consider this practice to be wasteful for the most part. From a mining perspective, the required computers are expensive to acquire and incur further costs for maintenance. Consequently, mining favors more affluent miners who are also fortunate in accessing relatively cheap power.
Analysts consider proof-of-work as far less scalable because of the work requirement for every block. For instance, Bitcoin is capable of handling roughly five transactions per second. Cardano, which employs proof-of-stake, is said to process around 1000 every second.
This scalability problem increases the chances of higher-than-normal transaction costs when there is network congestion.
What is proof-of-stake
Proof-of-stake is a model designed to achieve the same goals of consensus but differently. This system completely rids of mining, relying instead on what experts typically refer to as validators or sometimes forgers.
These individuals, who could be anyone, select the cryptocurrency to invest in and stake those coins in a locked wallet over a specified period. An algorithm automatically selects the person to validate blocks based on the size of their stake.
The bigger the stake, the bigger the reward. Depending on the coin, validators receive a cut of the fees or portion of a freshly-generated token they’ve staked. ‘Stakers’ don’t need to do any other work, meaning far less computing power is required.
Staking is a financial motivator for the forger or validator not to act maliciously. Should they decide to behave fraudulently, they stand to lose their entire stake and the right of future staking.
Well-known coins using this method include Cardano, Polkadot, Binance Coin, Stellar, Solana, and countless others.
Pros and cons of proof-of-stake
From an environmental perspective, proof-of-stake clearly beats proof-of-work. Such is this advantage that some cryptocurrencies, most notably Ethereum, are in the progress of moving towards staking.
Besides, as an investor, there is no need for expensive processors, worrying about electricity costs or much work generally. As briefly mentioned, the scalability of proof-of-stake is far superior to its counterpart, meaning cheaper transacting costs habitually.
Unfortunately, staking also does often favor moneyed individuals who stand a greater chance of earning bigger rewards. Some analysts consider proof-of-stake as less secure than proof-of-work since the work demanded on the former is not as substantial on the latter.
The 51% attack refers to an individual or group controlling more than 50% of a blockchain’s mining power. While similar malicious violations are rarely feasible on any cryptocurrency, they are likelier with PoS than PoW because less computational work exists.
Which is better?
Now that we’ve gone in-depth on this couple, it’s natural for one to wonder which is better. Firstly, both consensus mechanisms rely on significant financial resources. To some extent, each does inherently prioritizes wealthier individuals.
If observing the scalability aspect, PoS is generally superior to PoW as there is a less time-consuming procedure to validating blocks. In simpler terms, sending and receiving money using a PoS coin is usually faster and cheaper.
The more relevant distinction is energy consumption. Concerns over the power used in proof-of-work systems are well-documented. Fortunately, experts laud proof-of-stake as being far healthier for the environment.
Therefore, objectively deciding on the overall better system depends on the lens one is looking through. However, much of the literature suggests some existing coins should move over to staking to mitigate environmental concerns.
Observing the differences between proof-of-work and proof-of-stake is beneficial to understanding the behind-the-scenes of digital currencies. From the end-user perspective, one should see the differences over confirmation times and fees as they begin transacting with different coins.
If one is considering investing in mining or staking, the article should serve as a guide into the advantages and disadvantages. Ultimately, the models have the same goal, but the way they go about this is unique.