Proof of Work vs. Proof of Stake

Proof-of-work (PoW) and proof-of-stake (PoS) are the two most common consensus mechanisms used by public blockchain networks. These systems provide security and incentivize distributed participants to cooperate for the greater good of the network

Anyone in the world can participate in a public blockchain-based system. No single company, central bank, or government manages blockchains such as Bitcoin, Ethereum, Dogecoin, or Monero.

This is because these technologies are decentralized. Like the Internet, there is no one person or group responsible for their upkeep and maintenance. However, with decentralization comes some important challenges:

1. How do you create a robust, trustless system that's resilient to malicious agents?
2. If anyone can join a network, how do you promote honest participation and dissuade bad actors?
3. With no overarching manager, how do you pick who gets to propose, verify, and record data on the blockchain?

This is where proof-of-work (PoW) and proof-of-stake (PoS), more generally known as blockchain consensus mechanisms, come into play.

Proof-of-work is a type of consensus mechanism that requires network users to devote computing power to complete a task. People who do this are called "miners."

The proof-of-work (PoW) consensus mechanism debuted in the early 1990s as a system for preventing email spam. The method required users to solve a cryptographic problem before being able to send an email.

For legitimate users sending only a handful of emails, solving this single cryptographic proof was an easy task. However, for a dishonest actor looking to send spam emails en masse, the increased amount of computational power required makes the venture far more costly.

Bitcoin and proof-of-work

In January 2009, the pseudonymous author of the bitcoin white paper, Satoshi Nakomoto, launched the Bitcoin protocol. This peer-to-peer electronic cash system featured an adapted version of the PoW mechanism to solve the aforementioned Byzantine Generals problem.

The PoW consensus mechanism used in the Bitcoin protocol incorporates a cryptography-based competition. Users interested in becoming miners compete using their computers to win the right to propose new entries for the ledger. 

Through the bitcoin mining process, miners generate random, fixed-length codes called hashes. They create these hashes by running inputs at random through a cryptographic hashing algorithm. Doing so produces unique, 64 hexadecimal codes (codes only containing numbers from 0-9 and letters A-F). 

Miners generate hashes at random until one has the same or more zeros at the front compared to the target hash.

The target hash is a number set by the difficulty adjustment algorithm of the blockchain protocol.

When a successful miner beats the target hash, they gain the right to propose a new block of transactions to join the blockchain. If the proposed blockchain is found to be valid by the network, the miner receives a block reward for their efforts. If it is found to be invalid or fraudulent, nodes reject the block and the miner’s effort is wasted.

If you are interested in learning more about the cryptography behind cryptocurrencies, you can check out our beginners guide to how cryptocurrencies use cryptography.

Incentives and reward distribution

As a reward for winning and using computational energy, the miner gets newly minted bitcoin and any fees for the transactions they added to the new block. This reward is known as a block reward.

Block rewards usually adhere to a strict, pre-defined monetary policy where rewards are systematically reduced over time. Bitcoin, for example, cuts the number of newly minted coins awarded per block by half every 210,000 blocks (approximately once every four years). This reduction tapers the issuance of new coins entering circulation over time.

This event is known as the Bitcoin Halving. 

You can read more about Bitcoin Halvings in our Kraken Intelligence report, The Halving: Trends & Implications of Bitcoin’s Supply Inflation Mechanism.

Verification and issuance

Once a new block of transactions has been proposed by the winning miner, the remaining miners in the network then independently verify those transactions. Once they reach consensus regarding the validity of information stored in the block, the block permanently joins the blockchain.

By requiring all users in the network to independently confirm proposed transactions before they are finalized, it's nearly impossible to double-spend one's balance. The potential to spend the same coins twice only becomes a threat if 51% or more validators are dishonest. However, this type of attack becomes exponentially harder to complete as the blockchain network grows..

After the mining competition for each new block ends, it then starts all over again based on the block time each protocol is programmed to follow. For Bitcoin, new blocks are discovered roughly every 10 minutes, but block times vary between cryptocurrencies. Other cryptocurrencies such as Litecoin and ZCash,create new blocks every 2.5 minutes and 75 seconds, respectively.

This feature not only keeps the network secure, but also makes sure new units of cryptocurrency are released into circulation at a fixed, predetermined rate.

Pros and cons of PoW

An advantage of using a PoW system is security. Fraudulent transactions on established PoW blockchains require huge amounts of computational power to execute.

Dishonest actors can only commit fraud if they control the majority, or more than 50%, of the network’s computation power. This sort of vulnerability is known as a 51% attack. If someone could control over 51% of the network, they could reorder transactions, double-spend balances, and block certain inbound payments. This type of attack would destroy trust in the underlying blockchain ledger.

PoW systems are hard to attack because they need expensive equipment and a tremendous amount of energy to conduct an attack.

A major criticism of this computational power-driven security is that a significant amount of energy involved in the mining process is wasted. Only one miner can propose a new block every 10 minutes. This factor means most of the energy involved in mining does not go toward producing new blocks.

Beyond PoW's energy use lies e-waste that results from mining rigs malfunctioning or simply becoming obsolete. But if you are worried about the amount of energy proof-of-work uses, you can check out our article Busting Crypto Myths: “Bitcoin is Destroying the Environment.”

Ultimately, PoW miners are incentivized to keep their costs low and find the lowest cost energy possible.  Despite the fact that PoW uses more electricity than some countries, the majority of miners are using a sustainable power mix in order to keep their costs as low as possible.

Unlike the outright competition of proof-of-work, proof-of-stake uses a different series of incentives to ensure that network participants behave honestly. Proof-of-stake (PoS) is essentially a lottery-based system, where network participants purchase and lock away a protocol's native tokens for the chance to receive rewards for validating blocks of transactions.

A selection algorithm chooses which participants with staked tokens are able to propose new blocks. Though participants with more tokens staked are more likely to be chosen to validate a new block, there is a degree of randomness programmed in to ensure all staking participants have a chance.

Three years after the launch of Bitcoin, two developers known as Scott Nadal and Sunny King developed the PoS consensus mechanism. Their main goal was to address the energy inefficiencies posed by the proof-of-work system.

Think of this like buying multiple lottery tickets. You increase your odds with the more tickets you have, but more tickets are still not a guarantee that you'll win. The network may select a person who only bought one ticket over someone with many tickets. Or, in this scenario, staked native crypto tokens.

 

PoS uses the same principle as PoW by requiring validators to invest their own money to ensure honest behavior. However, PoS removes the need to run specialized, energy-intensive machines and replaces that with a different form of incentives and rewards than PoW.

Incentives and reward distribution

Within most PoS blockchains, network validators are nominated to verify blocks of transactions, rather than pitted against one another to propose new blocks. In return, validators earn rewards, sometimes in the form of fixed annual interest, for helping to secure the network.

For blockchain users that do not want to maintain their own PoS validator node, they can choose to delegate their tokens to an existing validator node instead. Here, multiple investors pool their funds together to form a single staking unit. Elected individuals or groups of people with the specialist knowledge maintain and operate these staking pools. Rewards are usually divided proportionally among investors and stake pool operators.

Just as PoS validators are incentivized to behave honestly, they are also punished for behaving dishonestly. If a validator or delegated staking pool operator acts fraudulently, the protocol can penalize them by automatically confiscating part or all of their staked assets. Known as "slashing," this system further incentivizes good behavior on the network.

Verification and issuance

To participate in the staking process, most PoS blockchain protocols require users to first deposit a minimum amount to qualify. This deposit acts as collateral – motivating stakers to behave honestly and in the best interest of the network. For Ethereum's new PoS blockchain, 32 ether – the blockchain's native cryptocurrency – was initially required to become a validator. However, liquid staking protocols have emerged to dramatically reduce this high barrier to entry.

On Polkadot's PoS blockchain, the minimum stake requirement can be as low as 10 DOT or as high as 350 DOT. DOT is the native cryptocurrency of Polkadot.

Like PoW based blockchains, new blocks of transactions on PoS blockchains must be independently verified by others in the network before they are committed to the blockchain. 

PoS chains also follow a transparent issuance schedule that allows the whole network to see how new coins enter circulation as a reward for correctly validating new blocks.

Pros and cons of PoS

The main benefit of proof-of-stake blockchains is that they are significantly more energy efficient than PoW protocols. Because PoS validators are nominated to validate blocks rather than compete with one another using costly equipment, less energy is used.

Delegated staking pools have the added advantage of letting users with little to no specialist knowledge get involved in the validation process. In fact, people can now stake their assets using centralized exchanges and other third party platforms via a laptop or mobile phone.

In comparison, successful mining requires a deep, technical understanding of the required software and hardware. Not to mention, mining rewards are not guaranteed while stakers can sometimes receive fixed annual returns paid in newly minted, native cryptocurrency tokens.

The main downside of PoS consensus mechanisms is stake centralization issues.

In PoS blockchains, the likelihood to validate a block of transactions (and thereby earn the reward) is primarily determined by the amount that has been staked. Because of this, PoS systems are seen by many to favor those with more tokens over those with fewer staked assets. 

Many feel that a small number of large staking pools and whale investors could gain centralized control over block validation. This factor goes against the core principles of cryptocurrency and reduces overall network security.

Another issue for some PoS blockchains is illiquidity. Sometimes, users cannot access their staked assets until a lockup period called a bonding period ends. This problem reduces market liquidity of the underlying cryptocurrency and prevents investors from accessing their staked funds during critical market movements.

Now that you have learned all about the difference between proof-of-work and proof-of-stake, are you ready to take the next step in your crypto journey? Click the button below to buy cryptocurrencies on Kraken today!