Proof-of-Work and Proof-of-Stake are two blockchain consensus models that are used to ensure the validity of transactions in cryptocurrency trading. Proof-of-Work involves solving complex cryptographic mathematical equations using computing power. In contrast, Proof-of-Stake miners put up digital coins for the right to validate new block transactions.
Proof-of-Work Explained
With the Proof-of-Work (PoW) model, cryptocurrency miners compete against each other to solve complex problems using high-powered computers. Those first to do so are given the authority to add the new block of transactions and then rewarded with digital currency for their work. When a block is authenticated, it’s added to the blockchain.
Proof-of-Work requires increasingly fast computers, the use of significant energy resources, and processes that eventually slow down transaction times as a cryptocurrency network grows. Bitcoin (BTC-USD) is the best-known example of a crypto that uses Proof-of-Work.
Proof-of-Stake Explained
With the Proof-of-Stake (PoS) model, miners have to pledge a "stake" of digital currency before they can validate transactions. A miner’s capacity to validate blocks depends on how many coins they have put up for stake and how long they have been validating transactions. The more coins they own, the more power they have for mining. The miner chosen for each transaction is chosen randomly through a weighted algorithm that takes the miners' relative power into account. Ethereum (ETH-USD) originally used Proof-of-Work, but as of September 2022 it has transitioned to Proof-of-Stake.
Proof-of-Stake was developed as an alternative to Proof-of-Work because of concerns about:
- How much energy Proof-of-Work uses
- Its environmental impact
- Its vulnerability to attacks
- Questions about its scalability
PoS vs PoW: How They Work
Proof-of-Work blockchain models verify transactions through a consensus algorithm that requires miners to solve a cryptographic equation by trial and error. This requires expensive computers and uses up a significant amount of energy. Those that verify the transaction first receive compensation in the form of coins.
Proof-of-Stake is a consensus algorithm that requires miners to stake all or a portion of their coins to validate transactions. Miners are chosen to verify a block randomly but those who have a larger stake or have been staking longer have an advantage. The miners chosen must all agree to verify transactions. After they have verified a block, it is added to the chain and they receive a fee in the form of cryptos. If they don’t verify it properly, their own stake will be affected and they will lose some or all of their coins. This provides more security to the process since there is no incentive to cheat or steal coins.
The main upside of Proof-of-Work is that it is trusted and has a long track record while the main upside of Proof-of-Stake is that it requires less energy, is more secure, and is scalable. Investors may be familiar with Proof-of-Work protocols and have invested considerably in Proof-of-Work mining operations but likely will appreciate the reduced mining costs of Proof-of-Stake. Users of cryptocurrencies might also feel more secure using Proof-of-Stake networks and appreciate the lower ecological footprint. The adoption of lower mining footprints through Proof-of-Stake models could make more people adopt cryptocurrencies, which could help scale existing currencies.
Takeaway: Proof-of-Stake increases network scalability by reducing transaction times.
PoW vs. PoS: Electricity Demand
Cryptocurrency critics often point to the sector’s significant electricity use and emissions. That energy demand is primarily from the Proof-of-Work consensus model which has become a substantial user of electricity globally. For example, Bitcoin has an energy cost per transaction of 830 kWh.
Learn more about Bitcoin vs. Ethereum.
In contrast, a Proof-of-Stake cryptocurrency like Ethereum has an energy cost per transaction of just 0.03 kWh. The additional energy use of Proof-of-Work methods make it difficult for miners following those protocols to be as profitable as with other models since the electricity and computing costs often means their expenses greatly reduce their profit margins.
Proof-of-Work projects also struggle to scale their transactions leading to slowdowns in transaction times. That has led to suggestions for changes in block sizes and different transaction channels off the chain. But many believe these solutions would only be temporary and would lead to increased centralization, something that many in the crypto world would not like to see.
That’s not the case with Proof-of-Stake, where the validators are randomly chosen for each block and validate the node through consensus. This speeds up transaction time and requires a much lower energy load, allowing for faster and more secure transactions as well as network scalability.
Proof-of-Stake vs. Proof-of-Work: Risk of Attack
Proof-of-Work prevents attacks by making miners expend resources to compete against each other to more quickly solve cryptographic equations to confirm each blockchain block. It relies on miners to act in good faith and follow consensus rules.
One significant threat in Proof-of-Work networks is a majority attack. That’s when a group gains control of over 50% of mining power and can then prevent transactions from being confirmed, spend coins twice, and create forks in the blockchain making alternative versions of the blockchain seem valid.
Since Proof-of-Stake only allows miners to validate blocks if they have provided a "stake" or security deposit, this motivates attackers to confirm legitimate transactions and avoid forking the blockchain since they would lose their stake. For that reason, Proof-of-Stake can be an effective way to prevent cryptocurrency attacks since there is no benefit to the attackers to disrupt the blockchain to steal or double-spend coins.
Takeaway: Proof-of-Work models carry a risk of a majority attack where miners can take over a network and disrupt the blockchain.
Bottom Line
While Proof-of-Work is the most well-known blockchain consensus model, alternative consensus models like Proof-of-Stake might be more efficient since they can increase security, reduce energy use, and allow networks to more effectively scale. Given the ecological impacts of Proof-of-Work, alternative models are likely to gain prominence in the coming years.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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