KEYTAKEAWAYS
- PoS replaces energy-consuming mining with cryptocurrency staking, making it more eco-friendly than PoW.
- Validators in PoS are selected based on their staked tokens, enhancing security while reducing energy use.
- While PoS is efficient, risks like centralization and inflation remain challenges for blockchain projects.
CONTENT
Proof of Stake (PoS) is a consensus mechanism designed to improve energy efficiency in blockchain networks by allowing participants to secure blocks through staking cryptocurrency, rather than computational power.
WHAT IS POS?
Blockchain is a decentralized ledger technology (DLT) where every blockchain operates on a consensus mechanism, a protocol that ensures the authenticity of any encrypted transaction before it becomes part of the blockchain.
The Proof of Stake (PoS) mechanism, also known as staking or stake-based mining, was proposed in 2011 on the Bitcoin Forum as an alternative to the Proof of Work (PoW) mechanism. Its goal is to reduce the resource consumption caused by intensive computational processes.
In simple terms, a blockchain is a ledger maintained by a group of participants. The way this ledger is maintained is through validation. When validators reach a common consensus, the content is secured from being tampered with.
Initially, blockchains achieved consensus and validation by consuming significant amounts of electricity for computations (such as using large quantities of graphics cards for mining). This consumption is what PoW refers to.
Those participating in validation and providing Proof of Work are rewarded, but eventually, people sought to reduce this waste and maintain consensus without consuming excessive resources, leading to the invention of the PoS mechanism.
The term “stake” essentially refers to the amount of cryptocurrency one holds. The more cryptocurrency a validator has, the greater their ability to compete for the next block.
Therefore, PoS can be understood as a mechanism akin to shares in a company—those who hold more shares (or stake) receive more rewards, similar to dividends.
>>> More to read : 10 Biggest Crypto Exchange With Lowest Fees (2024)
HOW DOES POS MECHANISM WORK?
The Proof of Stake (PoS) mechanism does not consume large amounts of electricity or energy to obtain new blocks. Instead, it relies on the staking of a significant amount of cryptocurrency (money) to secure new blocks.
In other words, PoS replaces the computational power used by miners in Proof of Work (PoW) with the amount of cryptocurrency staked. Participants must purchase cryptocurrency and stake it in smart contracts to participate in block creation.
The operation of the PoS mechanism can be categorized into the following six steps:
- Staking by Participants: Participants must stake a certain amount of cryptocurrency in the blockchain network as proof of their involvement in the consensus process.
- Selection of Block Creators: Based on the amount staked, the consensus algorithm selects the next node responsible for creating a new block. These nodes are typically referred to as “forgers” or “validators.”
- Assigning Stake Rewards: The chosen forger is rewarded with incentives such as block rewards and transaction fees.
- Transaction Validation: The forger is responsible for validating new transactions, ensuring their legitimacy and accuracy, and then bundling them into a new block.
- Randomness and Stake Consideration: The consensus algorithm takes into account the amount staked to randomly select the next forger. It may also consider other factors such as the length of time a participant has been staking.
- Penalty Mechanism: If a forger violates the protocol rules or engages in malicious behavior, their stake may be reduced or frozen. This penalty system incentivizes participants to act honestly and follow the rules of the network.
This mechanism ensures that PoS can secure a blockchain without the energy-intensive requirements of PoW, while still maintaining network integrity and consensus.
>>> More to read : What Is ICO? Beginner’s Guide
POS ADVANTAGES AND DISADVANTAGES
Advantages of PoS:
- Energy Efficiency: Compared to Proof of Work (PoW), PoS does not require massive computational power or energy consumption. This makes it much more environmentally friendly and energy-efficient.
- High Security: PoS generally requires nodes to hold a substantial amount of cryptocurrency. For an attacker to compromise the network, they would need to own an immense amount of cryptocurrency, making such attacks highly costly and therefore less likely, enhancing network security.
- Faster Validation: Since PoS does not require heavy computational work, participants engage in the consensus process by holding tokens, making it more efficient than PoW. This leads to faster consensus and quicker transaction validations.
Disadvantages of PoS:
- Inflation Risk: In the event of a blockchain fork, where two chains are formed, staked tokens can earn interest on both chains. This could increase the token supply, leading to inflationary pressure and negatively impacting the value of the cryptocurrency.
- Centralization Risk: When a large amount of tokens is concentrated in a few nodes, it can lead to centralization. This concentration of power may undermine the original decentralized philosophy of blockchain, making it more susceptible to control by a few dominant players.
- Liquidity and Financial Risk: Staked tokens cannot be immediately withdrawn. If the price of the cryptocurrency suddenly crashes, stakers may find themselves earning interest but suffering from a significant loss of their principal. This increases the risk of staking, as token holders may face substantial financial losses.
PoW vs. PoS
ꚰ Proof of Work (PoW): Can be thought of as “mining through computational power.” Miners solve complex mathematical puzzles by consuming CPU power, electricity, and time. Only the successful solver of the puzzle can secure new blocks and receive rewards.
ꚰ Proof of Stake (PoS): Can be thought of as “mining through holding coins.” The more cryptocurrency someone holds (the more wealth they have), the greater their ability to secure new blocks and earn rewards.
Both mechanisms serve to secure the network, but they have distinct approaches to reaching consensus, resource usage, and decentralization outcomes.
>>> More to read : What Is Stablecoin ? Stable Virtual Assets
IS POS BETTER THAN POW?
PoS offers significant improvements over PoW, particularly in terms of energy efficiency and the potential for more diverse and innovative investment opportunities across blockchain networks.
However, when it comes to determining which consensus mechanism is superior, there’s no absolute answer—it largely depends on the specific needs and goals of a project.
PoS excels in reducing energy consumption, enhancing decentralization, and mitigating certain attack risks. Meanwhile, PoW, backed by years of real-world use, remains a cornerstone of blockchain security, with networks like Bitcoin relying on its proven robustness and reliability.
Ultimately, both PoS and PoW have their unique strengths, and many blockchain projects continue to explore and adapt these mechanisms to suit different applications.
Rather than viewing one as definitively better, it’s about selecting the right tool for the right purpose, as each consensus mechanism brings valuable advantages to the table.
