Proof of work (PoW) vs proof of stake (PoS) - what’s the difference?

31 May 2021

What are consensus mechanisms?

Consensus mechanisms verify transactions stored on a blockchain. They prevent people from spending money twice, stop fraudulent transactions from being verified and added to the blockchain and ensure users can send money to one another safely without worrying about theft.

A consensus mechanism solves problems like expensive international payments by authenticating transactions autonomously - by consensus - without paying middlemen.

PoS and PoW are popular and well-tested consensus mechanisms used to validate cryptocurrency transactions worldwide.

In exchange for verifying transactions, miners (PoW) and validators (PoS) are paid either a mining fee or some transaction fees. The payment encourages more people to participate in the network, which raises the currency price, which drives even more people into the network, ad infinitum.

Anyone with a computer can mine or validate most cryptocurrencies. However, some cryptocurrencies, like Bitcoin, are too expensive for the average person to mine, as the required equipment costs enormous sums of money.

So, what is proof of work (PoW)?

PoW was first implemented in the 90s to help email programs verify which emails were spam and which were legitimate. Essentially, the more work that goes into an email, the less likely it is to be spam.

Satoshi Nakamoto, Bitcoin’s founder, sought to use PoW to cut out financial intermediaries that profit from charging people for sending money internationally. 

How does PoW work?

PoW is based on a branch of mathematics called cryptography, hence the name crypto-currencies. The PoW mechanism requires members of a network to solve a mathematical puzzle in exchange for a reward. No two puzzles are ever repeated, so once it's solved, the network knows the transaction is authentic.

Miners are competing to solve the puzzle first or be the closest to solving it within a predetermined timeframe, which requires brute force computing power. Currently, mining Bitcoin requires enormous computing power and absurd amounts of electricity, so the process isn't exactly open to anyone. The chance of any miner being rewarded for mining any given block is in direct proportion to the amount of computing power they have.

The more miners, the more competitive the process and the less likely any miner will successfully mine the block. PoW is closer to a lottery than a race. Anyone on the network could successfully mine any block regardless of their computing power. The mining reward can be anything but is usually an amount of the currency being mined. For example, miners currently receive 6.25 Bitcoin for every block they successfully mine, worth around $250,000.

The common complaints about PoW are that it is enormously energy-intensive, which is terrible for the environment. In addition, it pays more frequent rewards to people with better mining equipment, and it's limited in how many transactions it can process in a given timeframe - currently seven transactions per second.

As a result of damning recent media reports about the energy needed to mine Bitcoin, crypto investors have sought ways to reduce Bitcoin's and other crypto's carbon footprint. Many people believe PoS solves this problem and more.

What is proof of stake (PoS)?

Proof of stake was first discussed on Bitcoin forums in 2011 and was developed in 2012 by two developers called Scott Nadal and Sunny King. The first coin to use PoS was Peercoin, which offered buyers a fairer mining system that required much less energy.

PoS has the same purpose as PoW but uses a different process. Instead of having miners compete for a prize, a PoS algorithm chooses validators randomly to authenticate transactions on the blockchain. As a result, there are no puzzles to complete, and therefore no considerable energy requirement.

Unlike a PoW system, PoS doesn't let anyone validate blocks. Instead, you have to stake a certain amount of coins. The more coins you own, the higher the chance of being chosen to validate the next block.

In exchange for validating the transactions, you are paid some of the network fees, which is usually less than the amount you staked. Were you to validate a fraudulent transaction, you would lose all the coins you staked, which deters people from validating fraudulent transactions.

Many existing cryptocurrencies seek to adopt a PoS consensus mechanism, like Ethereum, which developers believe will help increase the number of transactions per second into the thousands.

Some networks already use PoS, like Cardano, which lets people stake their coins in exchange for a reward, paid in crypto. You can add your coins to a pool that, when selected to validate a set of transactions, shares the rewards. So, rather than pooling computing resources and sharing the mining profits, which happens on the Bitcoin network, you can join any pool and receive a reward.

The PoS mechanism isn't without faults. For example, you could be penalised for running a faulty node due to incorrect configuration, which might not be your fault. Additionally, if the node disconnects from the network due to internet failure, you could also face a financial penalty. 

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