Proof of Stake? Proof of Work? We explain the difference between two common consensus mechanisms that make blockchains tick.
If you have done your research on your favourite cryptocurrencies, chances are you have come across the terms Proof-of-Stake and Proof-of-Work. What exactly are they?
What is a Consensus Mechanism?
Simply put, a consensus mechanism is used by all cryptocurrencies for three purposes. They are used to verify the accuracy of all transactions on the blockchain, ensure the security of the system, and ensure all parties agree on and store the same information. Not sure how blockchains work? Click here to learn more.
Why do blockchains need a consensus mechanism? Let’s illustrate the issue with a simple children’s game – Pass The Message. A message is given to the first person, but by the time it reaches the last person the message rarely resembles the initial phrase. While it raises a chuckle or two in a play setting, it presents a major headache when hundreds of nodes need to store the same information simultaneously and accurately.
With a consensus mechanism in place, it ensures all parties involved in the network can agree on a data in a trustless environment. And such mechanisms come in the form of Proof-of-Work and Proof-of-Stake.
What is Proof-of-Work (PoW)?
In a Proof-of-Work consensus, participants involved secure the system and verify transactions by literally showing proof that they have done some kind of work. Taking Bitcoin as the main example, this is done by using a bitcoin mining rig made of computer hardware components like the CPU and GPU to participate in the mining process.
Instead of going at it with pickaxes like traditional miners, the participants join in an intense game of ‘Guess The Number’. Miners compete to be the first to verify a transaction block by guessing the target number, or hash, in a 64-character long string of numbers and words called a 64-digit Hexadecimal Number.
By generating a large number of nonces (A shorthand term for ‘numbers only used once’), the miners will eventually guess the right target hash and be rewarded with a certain amount of cryptocurrencies for their effort. The more mining rigs one has, it means more computers generating such numbers, and thus a higher chance of being first to reap the rewards.
Why would miners purchase all these rigs and go to such lengths just to mine some internet money? That’s because the rewards are rather attractive. Take Bitcoin for example – miners could earn 50 bitcoins per block when it first started. Even with the rewards halving every four years, miners can still earn 6.25 bitcoins per block every 10 minutes. Based on the prices of Bitcoin as of the time of writing, that could mean a whopping USD$250,000 per block!
What is Proof-of-Stake?
In a Proof-of-Stake mechanism, users need to have a large quantity of network tokens to prove that they have a staked interest in the blockchain. This allows the user to qualify as a block validator for the network.
Unlike the Proof-of-Work mechanism, there is no competition between computers or mining rigs to see who gets the block reward first. Instead, computers are chosen at random to validate the transaction block and earn the reward, and users with larger holdings have a higher chance of being selected.
Using a Proof-of-Stake mechanism also benefits users who has a smaller amount of tokens. By depositing their tokens into staking pools owned by these block validators, they can earn a portion of the rewards without having to own a large bag of tokens. This works in favour of the block validator too as they are chosen more frequently if more users deposit their tokens under them.
What are the pros and cons of PoS and PoW?
Proof-of-Work networks are considered secure as it takes a lot of effort and energy to validate transactions and discourages any malicious user from hacking the network based on sheer effort alone. Plus the competition from mining rigs to obtain the incentive ensures there are always validators securing the network. On the flip side, this leads to slower transaction validation times since validators need time to guess the target hash and leads to higher transaction fees as well.
Proof-of-Stake networks can process transactions more quickly thanks to the random validation process and low competition. This in turn leads to lower network fees and higher energy efficiency for the system. Plus, token holders can opt to delegate their tokens to users and play a part in securing the blockchain while earning a portion of the rewards. On the other hand, this could lead to security issues since this could lead to a small number of validators securing the network and could even lead to a 51% attack if enough tokens are deposited into a single validator.
What’s with the complaints about energy usage?
The energy usage of cryptocurrency mining is often a sticking point, and for good reasons. While different consensus mechanisms do require electricity to operate the computer hardware that supports the block validation, the Proof-of-Work mechanism has come under fire for being the most energy intensive.
But how much power do mining rigs draw when mining Proof-of-Work cryptocurrencies like Bitcoin? Based on the data from the University of Cambridge, Bitcoin currently draws about 126 Terawatt-hour (TWh) per year globally. While the power consumption is lower than countries like Malaysia, Thailand, and Vietnam, it is higher than countries like Norway, Sweden, and Philippines. That’s almost 2.5x higher than Singapore’s energy consumption of 50.7 TWh.
Just to give a comparison, Singapore’s southern islands like Sentosa is known for being one of the heaviest electricity consumers. Yet you could still power 10,000 landed properties in Sentosa for 2,866 years with that amount of energy.
Why does Bitcoin mining use so much energy? The answer is in the mechanism itself. The mining process is easier when lesser participants are involved, but as more people joined the mining process better equipment that could process calculations faster were essential to get the rewards first. Better equipment often draws more power (think of the energy needed to run computers that process games with better graphics or render animations), and this effect is compounded with more users joining in and buying their own electricity-intensive machines.
Combine this with slower transaction validation and higher fees, and it’s obvious why later blockchains like Polkadot and Cosmos opt for Proof-of-Stake instead. While there is a security trade-off for Proof-of-Stake, the lower energy usage and convenience outweighs its trade-off.
Currently, Proof-of-Stake and Proof-of-Work consensus are the norm for blockchains. But with the continued development of blockchain technology, we can see more alternative consensus mechanisms such as Proof-of-Authority and Proof-of-Burn in the future.