Crypto

Proof of Stake vs Proof of Work: What’s The Difference?

Published

2 years ago

September 22, 2021

Cryptocurrencies are one the greatest technological revolutions of our time. This new way of thinking about money has opened the doors of financial freedom to millions of people. If this was not enough, it also gave birth to one of the most sought-after technologies: Blockchain.

Unfortunately, many people jump into crypto without having an understanding of what it is and how this works. This is an issue, as not understanding how crypto in general works will translate to not understanding the coin you are investing in. How can you make an informed decision without this knowledge?

We believe that investing in crypto shouldn’t be done without understanding the technology that supports it. While crypto has been characterized as “digital money”, it is more than that. In most cases, the value of the coin will not be entirely up to speculation as is the case of Bitcoin but also to the utility they provide.

Have you heard of the recent rise of Cardano, Polkadot, or Binance Smart Chain? These networks (and their cryptocurrencies) have gained popularity and value due to their technical prowess. The increased efficiency, lower fees, and scalability they provide are the result of their decision to move away from traditional approaches.

In this guide, we will be talking about the two most popular consensus algorithms (also known as consensus mechanisms) out there: Proof-of-work and Proof-of-stake. While we will not be solving the entire “proof of stake vs proof of work” debate, you should have a better understanding of how these operate after reading this article.

Contents

Blockchain 101

What Is A Consensus Algorithm?

What is Proof of Work?

What is Proof of Stake?

Proof of Stake VS Proof of Work

Environmental Impact

Participation

Pool Mining

Delegation

Governance

Performance

Security

Conclusion

Sources

Blockchain 101

If you have read our guides on “What Is Blockchain?” or “What is Cryptocurrency?”, you should have a basic understanding of what these two technologies are. However, in case you haven’t read them or just need a quick refresher, let’s do an overview of what blockchain is.

Blockchain was a technology developed to support the operation of Bitcoin, the first cryptocurrency to ever exist. It allows developers to create complex decentralized networks where information can be easily stored on multiple machines (nodes). By using strong encryption and validation methods, Blockchain is able to provide high security and resilience.

When using blockchain technology, data is stored in blocks that are interconnected. One block will link to the next and previous block, creating a chain. This is where the term “blockchain” comes from.

Each block contains data on the transactions that have taken place in the network, as well as any other data relevant to the network’s purposes. As these blocks are created by independent nodes usually run by users, their authenticity needs to be validated. As such, each of them will have a unique ID (“Hash”), which is the result of strong and complex cryptography.

The advantage of these hashes is that they are easy to validate but not easy to create, which makes sure that they are tamper-proof because the hash will depend on the content on the block. Modifying the block will change the hash, making it invalid and worthless to the network.

When a transaction takes place in the network, multiple nodes will work together to verify its validity. Once consensus is reached via a consensus algorithm, the transaction will be approved and stored in the blockchain.

Validating nodes need access to transaction data in order to validate future transactions. This results in another advantage of blockchain technology: Transparency. Add this to the security and scalability blockchain provides, and you will see why blockchain is becoming increasingly popular in multiple industries.

While we talked about consensus in this brief summary of what blockchain is, we didn’t elaborate on the topic. To understand the whole “proof of stake vs proof of work” deal, we need to dive deeper into consensus algorithms are.

What Is A Consensus Algorithm?

Consensus algorithms are the heart and soul of blockchain and cryptocurrency. They make sure that the nodes in the network work together and agree on different aspects of the network. Without such an agreement, networks would require a central authority, which would make a centralized network.

In the past, most networks have been centralized in nature. When you use your bank, Twitter, Facebook, Amazon, or similar services, you are trusting the authority of a central agent. It is the company behind the platforms, the one making all decisions. They decide if your balance is enough for a transaction, you can access a service or feature, etc.

Since the whole point of a decentralized platform is not having such authority, different consensus algorithms have emerged to allow the network of nodes to regulate the network instead.

As you can’t expect all users of the network to trust each other, a trustless method is needed. Nodes will trust the code behind the network instead of other users. There are several elements that are common to most consensus algorithms: Incentives, transparency, and stakes.

While centralized platforms generate profit for themselves, which allows them to pay for the infrastructure and other costs, decentralized services don’t. Due to the complexity of blockchain, resources are required, which requires incentivizing people to run nodes to provide such resources.

This reward usually comes in the form of the network’s native cryptocurrency or part of the fees collected by the network. By providing such rewards, nodes have a reason to support the network and help it grow.

This is when another element is needed to be able to validate transactions in the network and ensure no node is acting maliciously. Transparency does just this by allowing any node to check the status of the blockchain at any given time.

Finally, a way of ensuring that those validating and generating blocks act in good faith and are not doing anything malicious such as stealing funds is also needed. This is done by requiring them to provide a stake. This stake ensures that validators have something to lose if they act maliciously and include cryptocurrency, computing power, or other elements.

The way in which each consensus algorithm approaches these elements will dictate the success of the network. Theoretically, using proof of stake over proof of work could result in added performance but lower security, making the network more useful for blockchain gaming projects than those in fintech, for example.

Understanding the pros and cons of proof of stake vs proof of stake will give you an idea of what to expect from a project.

Did you know that Ethereum is changing from proof of work to proof of stake, for example? For many experts, this announcement was of the many reasons behind the rally cryptocurrency saw in 2021. Those who didn’t understand what this meant either risked following other people’s opinions or missing out!

What is Proof of Work?

While Bitcoin is the most popular and successful example of a Proof of Work consensus algorithm, it was not the first implementation. In fact, the concept of Proof of Work has been around since 1993 before being named later in 1999.

While there are several versions of Proof of Work being used by cryptocurrencies today, Bitcoin’s approach is the most popular. You probably have heard of the term “crypto mining”, which is a concept introduced by Bitcoin. Miners are nothing else than nodes validating and generating blocks in the network.

As we said before, the authenticity of blocks is verified using hashes. Hashing is simply passing some data through a formula that produces a result, called a hash.

No matter how many times you pass the same data through the function, you will always get the same hash as a result. If just a single bit of information is changed on the original data, the hash resulting from the function will be entirely different.

The functions used to generate hashes are one-way functions. This means that it is easy to generate a hash from data by using the function… But getting the data from the hash is not an easy process.

This is when the difficulty of mining Bitcoin or other Proof of Work coins comes in. Networks using Proof of Work will set certain conditions that hashes need to meet in order to be considered valid. Miners need to brute-force inputs to generate a valid hash, effectively forcing them to solve a mathematical problem.

However, the network can easily check if the hash created by the miner is correct, facilitating the validation of data.

This is no easy process as it requires high amounts of computing power in the form of specialized equipment: This is the stake.

In Bitcoin, only the first node to provide a valid hash, therefore generating a block, will receive BTC as a reward: This is the incentive.

As multiple nodes will need to confirm the validity of the hash generated, they will have access to it at any time: This is the transparency.

What is Proof of Stake?

Proof of Stake is a consensus algorithm that was proposed as an alternative to Proof of Work. Now that we have taken a look at how Proof of Work works, understanding Proof of Stake should be easier.

In Proof of Stake, validating nodes will not be required to generate hashes that meet the conditions of the network.

This means instead of staking computing power (and the hardware that comes with it), they need to stake something else: Cryptocurrency. In order to become a validator, a node needs to “stake” a certain amount of the network’s currency. In the case of Ethereum (once it transitions to Proof of Stake), this amount will be 32 ETH.

Staking the crypto means the node will be unable to use it as long as it is operating as a validator. While this stake is “locked” and inaccessible, the node will have a chance to be chosen by the network to generate and validate blocks. The larger the stake is and the longer it has existed, the more chances the node has to be selected. This is the stake.

In the case of Proof of Work, a miner who tries to cheat or make a mistake will lose the resources used in the process (E.g. electricity). However, those who do the same in a Proof of Stake network will have a portion of their stake taken away. It will always be more profitable for nodes to act honestly, as long as the consensus is correctly designed.

If the node wins this lottery of sorts and is selected, it will receive a reward for generating the block. Most of the time, this reward will come in the form of a percentage of the fees paid by the user starting the transaction. This is the incentive.

Despite not being chosen as the consensus algorithm for Bitcoin (or original Ethereum), Proof of Stake has gained popularity over the years. Popular networks like Cardano, BSC, Polkadot, and Solana have implemented their own variations of Proof of Stake, proving its advantages in many areas.

While you might have heard people claiming that Proof of Stake is better than Proof of Work… This is not necessarily true. There are many elements that have to be considered when comparing these two approaches. The best consensus algorithm to use when it comes to Proof of Stake vs Proof of Work will depend on the use case. Let’s talk about that!

Proof of Stake VS Proof of Work

It’s time to talk about the eternal debate between Proof of Stake and Proof of Work. We have already discussed how each of these mechanisms approached consensus. However, we still haven’t referred to how these different approaches affect a network.

Environmental Impact

Let’s start by talking about a matter that has become of increasing relevance in today’s world: Environmental impact. This topic was a matter of public debate during the first half of 2021 when The New York Times made it mainstream. An article by the newspaper highlighted the high levels of energy required by Bitcoin, with the entirety of the network consuming more energy than countries like Argentina

This “revelation” resulted in a lot of discussion around the subject of Proof of Work’s energy consumption.

Due to its use of computational resources to solve “riddles”, this consensus algorithm requires immense amounts of energy. This is especially true when compared to Proof of Stake. According to many experts, the energy consumed by Proof of Stake can be 99% lower than Proof of Work. This trend resulted in many investors referring to Proof of stake cryptocurrencies as “green coins”, which caused in an increase in their adoption.

There has been much controversy around the article published by the times. Crypto enthusiasts have been quick to point out that more than 60% of the energy used to mine comes from renewable sources. However, as this is the case for all crypto, this is definitely a win for Proof of Stake.

Participation

One of the most important aspects of crypto is to decentralize services that have historically been centralized. In theory, this goes beyond allowing anyone to make use of the network but also letting them participate in supporting it.

As we saw, Proof of Work networks require nodes to compete with each other to solve mathematical problems. This means that most of the time, those with better hardware and software will have a higher chance to earn rewards. True, there are networks that address this issue but most of the time, mining is a costly process that requires investment and technical knowledge.

On the other hand, Proof of Stake also requires technical knowledge to set up the software (although less than Proof of Work). However, as Proof of Stake requires nodes to stake a large amount of crypto, it also requires a big investment upfront.

Take the example of Ethereum 2.0, which will require 32 ETH to be a validator. At this time, that is more than $95 thousand, making it difficult for anyone to operate as a validator despite technically being capable with a good PC.

To work around this, Proof of Work makes use of Pool Mining, and Proof of Stake has implemented features like Delegation.

Pool Mining

A mining pool is essentially a group of crypto miners that combine their resources together so that they have a greater chance of winning the mining reward. If a miner in the pool receives the reward, it is split between the other miners based on their processing power.

Trying to mine established cryptos (E.g. Bitcoin, Litecoin) solo is virtually impossible and will almost certainly be unprofitable. It is not recommended to try mining alone for this reason.

Delegation

Staking crypto is not only for the rich and powerful. With delegation, you delegate your coins to a validator that does the hard work of maintaining a node for you, in exchange for a small commission taken off your staking rewards.

When you delegate, you still maintain custody of your coins at all times. A lot of big crypto exchanges such as Binance and Coinbase run validators which allow you to stake directly on their platform with no minimum balances required.

Governance

Most decentralized networks have also implemented mechanisms of governance to allow their users to participate in decision-making. This allows the community to guide the future of the network, ensuring it serves the purpose of the many instead of some.

In the case of Proof of Stake, token owners will have the say when it comes to the governance of the networks. This translates to those with the highest amount of tokens having more impact on the decision-making process, as tokens operate effectively as shares. This creates a positive feedback loop which many critics have claimed diminishes decentralization.

When it comes to Proof of Work networks, these voting powers are given to nodes and miners, meaning that token holders don’t have a say. While this could be seen as that Proof of Stake offers more users the chance to participate (which is true)… there is not much difference in practice, as those with the most resources have more power.

Performance

Proof of Stake networks doesn’t have to deal with solving mathematical problems before creating and validating blocks. This means that these networks can process a higher number of transactions per second, improving the efficiency of the network.

Another advantage of Proof of Stake vs Proof of Work when it comes to performance is that it allows the use of “sharding”. This allows the network to generate more than one block at a time by dividing the workload between validators.

This increased performance also translates to higher scalability as consensus is reached before the block is constructed. The result is a decrease in the resources that are lost to reach consensus.

Security

Security is the area where Proof of Work shines. Not only has it been more tested than Proof of Stake, but its approach toward consensus also ensures that attacks are harder to do.

When it comes to blockchain, one of the most well-known threats are “51% attacks”.

As consensus is needed to perform any transaction or trick the network, any malicious actor who gets 51% of the network can take control. In the case of Proof of stake, this means buying 51% of the currency. In the case of Proof of Work, it means capturing 51% of all the computing power, which is harder.

This doesn’t mean that Proof of Stake is not safe. However, when it comes to the theory, it would be easier for an attacker to take control of the network. This is the result of the market being the only safety preventing such an event from happening.

In reality however, it would cost billions of dollars for someone to do a 51% attack on the major cryptos which makes it extremely unlikely as the attacker would gain nothing from it and lose billions in the process when the coin value tanks.

Conclusion

Understanding the difference between these approaches will allow you to make better decisions when investing in a cryptocurrency.

As we said before, Ethereum’s upgrade is such an example as the network requires high performance to support the vast number of projects running on it… For those who don’t understand the advantages of Proof of Stake in that regard, the change would probably seem unimportant.

Both Proof of Stake and Proof of Work are popular consensus mechanisms for a reason. Both provide great security, transparency, and staking methods. However, each of them shines in different areas.

This makes the process of talking about Proof of Stake vs Proof of Work difficult. However, the consensus is that Proof of Stake is better for scalable projects where performance is needed, while Proof of Work is better for projects in which the best security is paramount.