If you have some knowledge of how Bitcoin, Ethereum or any other digital currency, you have most probably come across these two terms over and over again:
Proof of work (POW)
Proof of stake (POS)
These terms may be too difficult to understand for many people but actually, they are fairly simple concepts which we will try to explain today!
Before we get down to business, though, let’s talk about cryptocurrencies first.
The Cryptocurrency Boom
Over the past years, the term cryptocurrency has gained solid ground and more and more people are starting to understand its use and potential value.
A cryptocurrency is a digital currency, created and managed through advanced encryption techniques, known as cryptography. The concept of digital money became a reality with the creation of Bitcoin in 2009. Since then, the cryptocurrency market has come a long way. Currently, there are over 17,600 different cryptocurrencies, available for people to purchase, exchange, trade, invest in and use as payment in several companies that accept it.
The reason why so many people are drawn to the cryptocurrency market is because the concept and characteristics of cryptocurrencies are challenging the economy and the traditional idea of money by introducing various benefits, including:
Low barriers to entry
Privacy & Security
Can facilitate international trades
Cryptocurrency is not bound by exchange rates, interest rates or transaction charges which means you can use crypto at an international level and experience no problems. Lots of time and money can be saved if you’re transferring money from one country to another. Cryptocurrencies operate at a universal level. This makes transactions easier than ever!
Your account is not owned by anyone else. You are basically the sole owner of the corresponding private and public encryption keys which is what makes up your cryptocurrency network identity or address. No other financial institution or instrument can give you individual ownership of your account/address.
What Is Mining?
Before going into many technical details, we should also briefly explain what mining is.
Mining is the process of validating transactions with a computer in a network. You solve complex algorithms to prove the correctness of a transaction and thereby add a new block to the chain. You add a “block” to the long public list of all transactions, known as the blockchain. In exchange, you will get rewarded with cryptocurrency.
To become a miner you don’t just need a good Internet connection. You should have solid power processor and know that depending on which cryptocurrency you’re mining and how fast your computer is, the cost of electricity would end up being quite high.
Sometimes, you may end up spending more on mining and don’t earn back enough in cryptocurrency.
For example, if a transaction happens on the Bitcoin network, the more computers and computing power there is, the faster you have to validate transactions to compete with other miners in the network and earn a fraction of a Bitcoin.
A central aspect of blockchain technology is the distributed ledger. The ledger contains a record of all the previous transactions. It’s not stored in a central location but across a network of computers located all over the world.
For this whole operation to work, the network must collectively agree with the contents of the ledger. This is the job of the consensus mechanism. Its purpose is to simply verify that all information being added to the ledger is absolutely valid. This is done to make sure that the next block being added represents the latest transactions on the network. Thus, invalid data and double-spending are prevented. Moreover, the consensus mechanism also keeps the network from being derailed through constant forking.
There are many different consensus mechanism, each with their unique pros and cons, however, they all serve the same purpose we explained above. They only differ in methodology. The main difference between consensus mechanisms is in the way in which they delegate and reward the verification of transactions.
The two most popular blockchain consensus mechanisms are the Proof of Work (PoW) and Proof of Stake (PoS). We will now move on to explaining more about each of them and comparing them. Note that those two are the most popular ones, there are other systems that exist such as Delegated Proof of Stake (DPoS), Federated Byzatine Agreement (FBA) and more.
Proof of Work (PoW)
PoW follows a simple rule: Mining a block and receiving a reward depends on how much computational work is done by the miner. The first miner whose computer manages to solve the cryptographic puzzles of each block will be the one to receive coins as a form of reward. This means that the miners in a network have to compete with each other, using their own computational power.
Bitcoin and many altcoins follow this consensus mechanism to confirm the authenticity of the blockchain.
Let’s give you an example with everyday life. Imagine a classroom full of students. The teacher is assigning a task to all the students. The one who not only comes up with the correct answer but also answers first is the one who will get the reward. The student should have a lot of brain power to execute the task correctly and as quickly as possible to get ahead of the other students.
It’s the same with the Proof of Work mechanism.
The puzzles don’t require skill but rather a strong hardware force. This is done to make sure no miner will have an advantage over the other. The only way to improve the odds of solving the puzzle and getting the coins is to add computational power. This, as you should know, is quite costly, not to mention energy-intensive.
The puzzle parameters are updated periodically to keep the block time consistent. For example, the Bitcoin protocol has a block generation target for 10 minutes.
Every concept or approach has benefits and disadvantages. PoW is not an exception.
As mentioned, this type of consensus mechanism requires a lot more electrical power, which costs miners. Sometimes, what he has to pay for electricity would be higher than what he gains out of mining.
High computing power is also quite expensive. You need to build yourself a supercomputer which for everyday middle-class people is very expensive.
One more thing miners should take into consideration is that as time goes by and more and more cryptocurrencies are released, their reward might become quite minimal.
To sum it up, Proof of Work is a protocol with a main goal of deterring cyber-attacks. It’s a concept that existed before Bitcoin but Satoshi Nakamoto applied this technique and truly revolutionised the way traditional transactions are done.
Proof of Stake (PoS)
Let’s talk about Proof of Stake (PoS) system and find out how it differs from PoW.
PoS follows a simple rule: Validating a new block depends on how large of a stake a person holds or basically how many coins they posses and the respective age of the stake. The validators don’t receive rewards. Instead, they collect network fees. Ultimately, this type of system is cost and energy efficient, as compared to PoW, however, they are less proven.
Let us give you an example with altcoins and specifically Nxt which uses PoS. If you have a certain amount of coins in your digital wallet, you will also be able to see for how long you have had them. Keep in mind that moving the coins from one digital wallet to another will reset their age.
The amount you have is considered a security deposit. If the Validator has a significant stake in Nxt coin with good aging, it means they are committed and have a higher chance to validate a block. This will create a network of trusted and loyal Validators.
In PoS, unlike PoW, it’s not about “mining”, but “forging” which is done by the Validator who will process and forge a new block to the chain.
What are the advantages of PoS?
Probably the best thing about this system is that there’s no need for expensive hardware, your normal computer will do just fine with a Validator’s client. We’ve already mentioned that it won’t consume high electricity as PoW does.
Also, the higher the stake the validators have (and the long they have had it too), the more chances to be picked up for “forging” and earn transaction fees.
Of course, there are issues with PoS, including the fact that only a small group of people who own a majority of coins/tokens can be the validators. However, this is something that’s evolving and at some point in the future it is more likely to change.
Proof of Stake systems in crypto are a relatively newer mechanism, compared to Proof of Work. It hasn’t been strictly tested and there are a few security risks identified. Ultimately, the constant forking of a blockchain can lead to instability of the network.
Which Is More Secure - PoW or PoS?
Any system strives to provide a safe environment, free from hacker attacks. That’s especially true if this service is related to money. So, which one is safer, PoW or PoS?
With Proof of Work, the so called “bad actors” are cut because of economic and technological disincentives. If someone wants to program an attack it would be very expensive and certainly not worth it. A hacker would need more money than what he would be able to steal.
A PoS system is cheaper to attack. Therefore, it should be absolutely bulletproof. That’s why the Casper protocol is being created. It will introduce circumstances and strict rules under which a “bad validator” might lose their deposit if the protocol determines that they acted in a way that violated their rules.
As you’ve probably already figured out, both PoW and PoS have their pros and cons. Many cryptographers and computer scientists are working on finding solutions to upgrade those two algorithms.
It’s important to know that:
- PoS and PoW are introduced to prevent cheating;
- Their early development was focused on detecting cyber attacks;
- Solving a complicated cryptographic puzzle and getting rewarded with coins is called Proof of Work (PoW);
- In Proof of Stake (PoS), the network chooses the creator of a new block, based on the amount of coins they posses
- The number of digital currencies never change;
- Proof of Stake is technically an improved version of Proof of Work but it still needs to be optimised.
PoS is cost-effective and environmentally friendly but it has some serious drawbacks when it comes to centralisation and security. PoW, on the other hand, is costly and requires high computing power, however, it’s much safer.
We will have to wait and see how those two algorithms will develop in time.
Hope you enjoyed reading our article. Don’t forget to provide your comments.
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