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

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

Table of Contents

Introduction

According to Digicomonist, Bitcoin’s energy consumption is comparable to Thailand while the power consumption of a single Bitcoin transaction is equivalent to that of an average U.S. household over almost 73 days. On the other hand, Cardano only uses 0.6 kWh per transaction which is 3,517 times less than Bitcoin.

But, why are they so different?

Consensus algorithm

In a centralized environment, a single entity is responsible for coordinating everything while in a decentralized setup, members run the whole system. But how do they do that?

Members need a mechanism to agree on different matters concerning the system. In blockchain networks, this mechanism is called a Consensus Algorithm. Let’s say we are a group of 10 and want to add another member to the team. According to our rules, a new member can join the team, only if more than 50% of the team members (at least 6 members) approve of the new member.

This is our consensus mechanism, the way we reach an agreement on recruiting new members. For a cryptocurrency, the consensus mechanism is for verifying users’ transactions before adding them to the history of transactions (ledger).

Think of a transaction as a message we broadcast to the network, announcing that we are transferring a specific amount of crypto to another user. Therefore, Transactions can be used as a way to confirm the ownership of digital coins because as we send our coins to another user, the ownership changes.

Every participant (node) within the blockchain network keeps a copy of the ledger so no single entity can change or alter transactions on its own.  Simply put, the ledger is used by every node to confirm the ownership of coins.

Double Spending

Cryptocurrencies are essentially digital data and like any other data, you can duplicate them! Think about our last example where 50% of team members had to approve the new member. Now let’s consider the same scenario in a blockchain network: what happens if a single entity somehow manages to take control over more than 50% of the power within the network?

We call this a 51% Attack which allows the attacker to alter previous transaction history stored on the blockchain. By removing or altering the transactions, they’re actually modifying the ownership of the coins.

To prevent users from this kind of malicious activity, consensus algorithms are based on game theory which focuses on rational decision-making. In order to earn rewards, users have to put some skin in the game (stake). Using rewards and punishments, the system incentivizes its members to act honestly because if they don’t, they may lose their stake and membership.

Different consensus algorithms were developed throughout the years but two of them are the most wildly used within the space: Proof of Work (PoW) and Proof of Stake (PoS).

Proof of Work (PoW)

Proof of Work is the first and probably the most recognized consensus algorithm. It was introduced by Satoshi Nakamoto, the creator of Bitcoin, in the project’s whitepaper.

Transactions are stored in blocks and are considered verified after the block is confirmed. We call this process mining which allows participants to earn rewards for verifying transactions and keeping the system running.

To become a miner, users have to buy expensive machines that use huge amounts of electricity. Expensive machines and maintenance expenses are the stake PoW asks its users to put in order to make cheating expensive.

So PoW is the main reason behind bitcoin’s energy consumption which is one of the main concerns. For now, green energy seems like the best way to reduce the currency’s huge footprint on the environment.

Proof of Stake (PoS)

Proof of Stake was proposed to address the Proof of Work’s issues. In this mechanism, instead of buying expensive mining hardware, users can lock a specific amount of coins as their stake to become validators. Validators are like miners and can verify the transactions to earn rewards. As a result, the energy consumption is significantly lower as we saw with Cardano.

Based on the required initial stake, many users may get a chance to participate in the network and earn rewards which can make the network more decentralized. That way, by allowing users to stake their tokens, PoS blockchains make it possible for every token holder to earn rewards.

However, Proof of Stake has its own weaknesses.

The value of a cryptocurrency and the amount required for staking play an important role in the overall network’s security and success. If the market capitalization of a coin is too small, the probability of a successful 51% attack would increase as it becomes less expensive for an attacker to hold more than 50% of the tokens.

Nevertheless, after Ethereum, many of the modern blockchains chose PoS as their consensus mechanism. Ethereum is also upgrading its network to become a PoS blockchain to improve its scalability, sustainability, and security.