Proof of Work vs. Proof of Stake
The Beginner’s Guide
Proof-of-work (PoW) and proof-of-stake (PoS) are the two most common consensus mechanisms used by public blockchain networks. These systems provide network security and incentivize a decentralized group of 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 how these networks operate. This means no one has direct control over popular blockchains such as Bitcoin, Ethereum, Dogecoin, or Monero.
That's because these technologies are decentralized. Like the internet, there is no one person or group responsible for their upkeep and maintenance. Instead, this responsibility is shared across thousands of individuals around the world. However, with decentralization comes some important questions:
- How do you create a robust, trustless system that's resilient to malicious agents?
- If anyone can join a network, how do you promote honest participation and dissuade bad actors?
- With no overarching manager, how do you pick who gets to propose, verify, and record data on the blockchain?
Here is where proof-of-work (PoW) and proof-of-stake (PoS), more generally known as blockchain consensus mechanisms, come into play.
Examples of proof-of-work blockchains
What is proof-of-work (PoW)?
Proof-of-work is a type of consensus mechanism that requires network users called “miners” to devote computing power to complete a task.
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 puzzle was an easy task. However, for a dishonest actor looking to send spam emails en masse, the amount of computational power required made the venture far more costly.
Bitcoin and proof-of-work
In January 2009, the pseudonymous author of the bitcoin white paper, Satoshi Nakamoto, 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 compete for the right to propose new entries in the ledger using their computers.
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 network regards the proposed block as valid, the miner receives a block reward for their efforts. If the network determines the block is 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
In return for their effort, successful miners earn newly minted bitcoin and any fees for the transactions they added to the new block. This reward is known as a block reward.
It’s possible for individual miners to combine their computing resources together using mining pools to increase their odds of winning the mining competition. Any block rewards earned are split proportionally among pool participants.
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, known as a Bitcoin Halving, tapers the issuance of new coins entering circulation over time.
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 massive amounts of computational power to execute.
Dishonest actors can only commit fraud if they control the majority, or more than 50 percent, of the network's computational 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.
PoW systems are hard to attack because they need specialized equipment and a tremendous amount of energy to exploit the network.
The amount of energy consumed by PoW-based blockchains, however, is a common criticism among crypto detractors. But, it’s important to note that this consumption is an intentional feature. In most instances, the greater the hashpower, the greater the network security.
To help separate the facts of crypto mining from the fiction, see our Busting Crypto Myths: "Bitcoin is Destroying the Environment" guide.
Ultimately, to maximize profits, PoW miners must keep their operating expenses as low as possible and source cheap, reliable energy. Many miners use a sustainable power mix to keep their costs down and mitigate environmental concerns.
What is a consensus mechanism?
Consensus refers to an agreement on a certain piece of information among a system or group of people.
Blockchain consensus is a state of agreement among a distributed network of computers on the order and validity of information stored on a shared database.
The Bitcoin blockchain and other blockchains that followed were revolutionary because they solved a long-standing problem called the Byzantine Generals problem.
The Byzantine Generals Problem is a classic problem in distributed computing that deals with the issue of trust. It is a problem of consensus among distributed platoons, where multiple generals are trying to coordinate an attack on a city. In the problem, the generals are unable to communicate directly with each other and some of the generals may be traitors sending false messages to the other generals.
In the context of blockchains, the Byzantine Generals Problem is a problem of consensus. In a blockchain network, there are multiple nodes that are trying to reach consensus on the state of the ledger. However, some of the nodes may be malicious, and attempt to send false information to the other nodes. The problem is that the other nodes must be able to trust the information they receive in order to reach consensus.
Blockchains solve the Byzantine Generals Problem by using a consensus algorithm to incentivize all participants in the network to agree on a single version of the truth. This is done by having each node in the network validate the transactions and reach agreement on the validity of the transaction. The system then records this consensus on the blockchain, thereby creating an immutable, secure and collectively shared source of truth. The consensus mechanism ensures that all participants in the network have the same version of the truth and that the transaction is valid.
Computer scientists conceived of this problem in the 1980's, but its underlying concepts draw from an older field of economics called game theory. Mathematicians John Von Neumann and Oskar Morgenstern pioneered game theory 30 years before the Byzantine Generals problem. Their research analyzed the outcomes of games based on the individual behaviors of players, payoffs, and punishments.
Blockchain consensus mechanisms incorporate these theoretical principles. Players participating in a blockchain network are incentivized to act honestly for both themselves and for the greater good of the network. Malicious actors, on the other hand, face penalties for dishonest behavior.
What's interesting is how PoW and PoS systems achieve trustless consensus in entirely different ways.
What is proof-of-stake (PoS)
Unlike the outright competition of proof-of-work, proof-of-stake (PoS) uses a different set of incentives to make sure that network participants behave honestly.
Three years after the launch of Bitcoin, two developers named Scott Nadal and Sunny King created the PoS consensus mechanism. Their main goal was to produce a more energy efficient system than proof-of-work.
With proof-of-stake (PoS), network participants purchase and lock away a protocol's native tokens to validate new blocks of transactions. In return, they can earn staking rewards (usually paid as interest on their staked assets).
Many leading PoS blockchains such as Ethereum, Cardano, Algorand, and Polkadot employ their own selection algorithms to choose which stakers earn the right to propose new blocks.
Participants with more tokens staked are generally more likely to validate new blocks, but there is a degree of randomness programmed into these particular algorithms.
This randomization is designed to improve fairness and means all staking participants have a chance of earning rewards.
Ignite (formerly Tendermint) is another popular PoS-style consensus mechanism whereby validators place prevote, precommit, and commit votes for new blocks joining the blockchain. Blocks with a ⅔ majority vote are committed to the blockchain.
PoS uses a similar approach of incentivizing honest behavior as PoW by requiring validators to invest their own money. Likewise, this cost varies greatly across protocols, including costs to run validator nodes.
PoS validator node equipment is often far less expensive overall compared to the equipment needed to profitably mine popular PoW cryptocurrencies like bitcoin (BTC).
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.
People without the technical expertise or minimum asset requirements to become a standalone PoS validator can combine their funds with other investors.
In this case, multiple smaller investors can pool funds together to form a single staking unit. Elected individuals or groups of people with the specialist knowledge maintain and operate these staking pools. Investors then divide the rewards proportionally among themselves and stake pool operators.
Just as PoS consensus mechanisms incentivize validators to behave honestly, they can also punish them for behaving outside the rules of the protocol. If a validator or delegated staking pool operator acts fraudulently, some protocols can partially or completely confiscate their staked assets. Known as "slashing," this mechanism further incentivizes good behavior on the network.
Verification and issuance
To participate in the staking process, most PoS blockchain protocols require users to first lock away a minimum amount of tokens to qualify.
For Ethereum's new PoS blockchain, 32 ether – the blockchain's native cryptocurrency – is 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, the network must independently verify newly proposed blocks of transactions on PoS blockchains before they can join the blockchain.
PoS chains also follow a transparent issuance schedule that allows the whole network to see how new coins enter circulation.
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 using costly equipment, they use less energy.
The main downside of PoS consensus mechanisms is stake centralization issues.
In PoS blockchains, the amount of tokens a person stakes primarily determines their likelihood of being selected to validate blocks of transactions and earn rewards. Because of this, PoS systems could favor those with more tokens over those with fewer staked assets — which some feel leads to centralization of the network.
Because of this flaw, 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 ends. This problem reduces the market liquidity of the underlying cryptocurrency and prevents investors from being able to access their staked funds during critical market movements.
Both of these consensus mechanisms solve the Byzantine Generals problem, but in very different ways. The PoW consensus mechanism is a battle-tested system that can provide incredibly high levels of security. On the other hand, PoS consensus mechanisms are becoming increasingly popular as a more energy-efficient, scalable alternative.
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