In 2008, Satoshi Nakamoto presented to the world the official Bitcoin whitepaper on his new invention: the peer-to-peer electronic cash system. That day, cryptocurrencies, as we know them, were brought to life. Bitcoin uses for its consensus an algorithm called proof of work (or PoW) that makes sure transactions are handled not by a central authority or a middle person, but the network itself by the power of the computer hardware.
A few years later, new blockchains were developed, and some started using the proof of stake consensus algorithm, which has been gaining more and more popularity over time.
In this article, we will spell out the characteristics of each protocol and study the differences between each method.
Proof of work in a nutshell
Satoshi Nakamoto implemented PoW into Bitcoin, an electronic cash system he is considered to be an inventor of as well. In his whitepaper, published on 31st October 2008, he described PoW as a technology that would solve the double-spending coins.
Simply put, PoW provides evidence-based on executed work, made possible thanks to computing power. This evidence is then accepted by the network nodes as evidence created based on the hash function calculation.
Definition of PoW
Like we’ve determined above, PoW uses computational power to solve a cryptographic task called a hash function. The miner represents a node in the network that creates a new block in the blockchain-based on the work they perform. Miners are trying to find a specific hash based on the inputs predefined by some factors, including the hashrate, which represents the entire network’s performance.
Let’s look at how Bitcoin PoW. Its purpose is to maintain the average block mining time at 10 minutes. So once in 10 minutes, a new block is created and added to the existing blockchain. This process is called mining for resembling real-life mining of commodities. A miner who creates a new block is rewarded by a fresh bitcoin. That remuneration serves as an incentive for miners to perform the work.
PoW in Bitcoin operates on the basic rule that the longest chain wins. The newly-mined block is not yet final and needs to wait for confirmation, or, to be more specific, for six confirmations. Because at the moment of mining, some other miner could mine a different block, and the next one can be added behind the one by the same miner. That is why some exchanges wait for 6 or more confirmations of the block – they simply don’t want to take the risk that your transaction will not be validated.
Pros and cons of PoW
Certain advantages of the PoW method need a special mention. The main one I see is strong security of the blockchain itself that can hardly be cheated. Once the blocks are final, they can’t be rewritten, so it's a very safe and trustworthy system. Any attempt to rewrite the recent part of the blockchain would be very expensive for potential attackers, and it is therefore practically impossible to rewrite the older parts.
The number of miners and hashing power are on the rise, the security of the network is also growing. Current statistical data suggests that for 51% of attackers any hacking attempts are simply too costly.
But in some areas, the PoW method is still inferior to the PoS. The PoW is relatively expensive and uses resources inefficiently. Costly equipment that wears out quickly is not the only type of expense that miners have to deal with. Add to this the excessive heat it generates and exorbitant electricity bills, with most of them simply wasted.
PoW-based blockchains are very slow. On average, it takes BTC miners a full 10 minutes to find a new block. Moreover, when network congestions occur, transaction fees skyrocket due to low transaction throughput.
The days are long gone when bitcoins could be mined on your laptop. Due to the increased mining difficulty, bitcoin can only be mined on specialized and very expensive hardware – ASIC. Thanks to this limitation, there are very few groups of miners, but this, in turn, means that they own most of the mining power, which reduces the degree of decentralization and, in addition, increases the possibility of an attack.
Coins based on PoW
Besides Bitcoin, other networks using PoW are Bitcoin forks like Litecoin, Dash, and Dogecoin, with some additional upgrades such as smaller block time to provide faster transactions, or a private feature. But even with these improvements, they are not as effective as most of the PoS protocols.
Another PoW network is Ethereum that has implemented EVM (Ethereum virtual machine) to enable smart contracts. It is a major improvement, but Ethereum developers are aware of the scalability issue that will be solved in the evolution version, in Ethereum 2.0.
Some new types of PoW blockchains are Kulupu and Kadena, both based on the Substrate framework. They will be connected to the Polkadot ecosystem in the future and promise to solve the scalability issue that plagues Bitcoin and Ethereum. But they are still in their test versions, so we’ll have to wait for them to finish their mainnets and connect to Polkadot by the parachain slot. Only then I will be able to talk a little bit more about them and their scalability solution.
Proof of stake in a nutshell
PoS is a newer type of consensus that aims to solve the scalability issue most PoW blockchains are notorious for, as well as the energy consumption problem.
To understand what PoS is, imagine transferring the work to the staking process, which is determined by stakers.
How does proof of stake work?
To outline the proof of stake definition, imagine a consensus protocol where nodes are pseudo-randomly selected for proposing the next block into the blockchain to the number of locked coins. Once the node is elected and gets the right to create a new block, it starts validating the transactions that will be inserted into the block. Then it signs it and proposes the block to other validators of the network.
The proof of stake model incentivizes individual users to stake the underlying cryptocurrency to participate in the consensus. Because the probability of creating a new block and adding it into the blockchain is based on the number of staked coins, users are motivated to stake as many coins as they can. Not only do they get rewarded, but also maintain the security of the particular blockchain. The number of coins used as a reward is based on the sum of transaction fees paid or the incentivizing budget.
Some blockchains have higher boundaries for people to participate in the consensus or become the staking validator. For example, if you would like to become the validator of an incoming PoS implementation known as Ethereum 2.0, you’d need to stake 32 ETH. For DPoS blockchains, the path to becoming one of the groups that are already validating is very demanding.
But blockchains that simplify the way to participate in the consensus itself also exist. Algorand has a very low limit for its validators, equal to $1, and Cardano enables people to pick a staking pool they want to support without any minimal investment at all. Those solutions increase the decentralization level of their blockchain, and I am a big fan of that kind of approach. Because, why impose boundaries when we can have a better decentralization degree?!
Pros and cons
There are two main advantages of the proof of stake protocol: Efficiency and energy thriftiness. Efficiency, meaning faster transaction, finality, and better scalability. Finality is the moment when the transaction is written in the blockchain forever.
Bitcoin transactions are final after 6 confirmations that take 10 minutes each. So, for a successful transfer of money, you have to wait for an entire hour! That sounds insane nowadays when projects like Solana, Algorand, EOS, or BNB have the finality of the transactions below 3 seconds. The same is applicable to scalability. Because the block time lasts approx. 10 seconds and the number of transactions that can fit into one block of size 1 megabyte is limited, the scalability is restricted to 7 transactions per second (TPS) for the Bitcoin network. PoS blockchains enable thousands, and even tens of thousands of TPS, depending on their technology. That’s quite a difference between proof of work and proof of stake!
While many people criticize crypto because of its significant carbon footprint, they are mostly talking about Bitcoin and other PoW networks. While Bitcoin can use as much energy as a medium-sized country, a PoS network can exploit for its operation an amount of energy comparable to a family house or an office building. That can be a huge argument in favor of PoS blockchains once they start securing their network and maintaining a decent level of decentralization.
The most common argument of PoS critics is that decentralization is not sufficient enough since big token holders control major shares and can influence the network.
I get their point and I agree that it can be a problem for some blockchains. The development teams in particular maintain a large number of coins for themselves in the beginning, so it always depends on their approach and strategy of coin distribution. I would judge each project individually because, with the increasing usage and price of any particular blockchain, the possibility of some whale seizing control is decreasing. Just because the price for 33% or 51% to attack the network would be enormous.
Proof of stake cryptocurrencies
First, I would like to point out that not all PoS blockchains maintain a high level of decentralization because some of them allow their developers and biggest whales (mostly the same group of people) to be in the oligopoly of the low-set of validators. The less decentralized versions of PoS are used in EOS or Tron, and proof of stake authority is used by Binance Smart Chain.
I like the idea of the ouroboros proof of stake blockchain consensus protocol, which is used in Cardano and Polkadot. The idea is to join stakeholders in the pools, so even a small bag holder can indirectly participate in the consensus and earn some stake interest from the transaction fees.
One of the most remarkable upgrades is the pure proof of stake algorithm used in the Algorand blockchain. This improvement allows almost everyone who wants to become a validator of the network to start with minimal computational and investment barriers. One can start proposing blocks with literally just one dollar. In Algorand, the finality is very fast and the level of decentralization is high because the validator selection process is random and cryptographically secured.
Keep in mind that Ethereum is also going to move towards proof of stake, and we are talking about the second-highest capitalized cryptocurrency! Once Ethereum 2.0 becomes fully functional, it will start using the advantages of PoS such as high scalability and transaction throughput, while retaining its signature level of security and decentralization. So the proof-of-stake coin list is likely to grow.
Are there any other protocols?
Proof of work and proof of stake are the most common protocols. However, there are other positions on the consensus technologies list that also deserve mention. In the volatile world of cryptocurrencies, it is hard to predict which technology will explode the next year. Let us look at the concepts of proof of space, proof of time, and proof of burn protocols.
Proof of space (PoS) is a protocol developed by Bram Cohen, the author of the famous BotTorrent. The proof of space algorithm proposes validating transactions by the nodes with the largest storage space. Cohen argues that mining with this algorithm is accessible to any user and less energy-consuming. Proof of space implies that miners provide the free disk space of a node to the network, and the more memory the user allocates for the needs of the project, the higher the probability of creating a new block. The most notable proof of space-based cryptocurrency is Chia (XCH).
Proof of elapsed time (PoET) is a protocol offered by Intel Corporation. The PoET algorithm works like this: each participating node in the network must wait for a randomly determined period, and the first one to endure the allotted d time wins a new block. Each node in the blockchain network generates a random waiting time and goes into hibernation mode for the specified period. The node with the shortest wait time creates a new block in the blockchain, broadcasting the necessary information throughout the peer-to-peer network. The same process is repeated to discover the next block.
Proof of burn (PoB) is a concept where miners send coins to a special address that “burns” them so the tokens cannot be returned or spent. This transaction is recorded on the blockchain as proof that the coins were burned, and the user is then rewarded. The idea behind PoB is that by burning a cryptocurrency, the user demonstrates the willingness to make short-term losses for the sake of long-term investment. The reward is a lifetime mining license, and the more coins the user burns, the more likely they are to open the next block in the network.
Final thoughts
We hope this overview has helped you understand a little better how proof of work and proof of stake consensus mechanisms work. In our next publication, we are comparing proof of stake and proof of work head-to-head and trying to predict what the future holds for each of these protocols.