Before you read this article, it would be helpful to understand what a consensus mechanism is and how Proof of Work functions. Check out our article on that here.
Consensus mechanisms provide the framework for computers across the network to agree on which transactions are legitimate. With a consensus mechanism, the network can agree on one version of the truth; securing the ledger and all funds.
Proof of Stake (PoS) is a popular alternative to the Proof of Work (PoW) consensus mechanism and aims to improve decentralization, scalability, and security. For users, PoS is faster and cheaper than using PoW. Importantly, PoS is much less energy intensive compared to PoW. Due to these properties, Proof of Stake has become the de facto consensus mechanism in the cryptoverse. There are many different types of Proof of Stake, but they all share the same fundamental ideas.
Let’s dive in to learn more.
Understanding Proof of Stake
Consensus mechanisms must ensure that bad actors do not flood networks. They do this by creating an environment where it is prohibitively expensive to do so.
In Proof of Work systems, miners prove they have capital at risk by expending energy.
In Proof of Stake, miners are referred to as validators. Validators confirm they have capital at risk by locking cryptocurrency in a smart contract. This capital, also known as their stake, acts as collateral which can be destroyed if the validator acts dishonestly or lazily. Validators who act in accordance with the rules earn transaction fees and other rewards when they are chosen to validate. This is a powerful economic incentive for validators to behave in the best interest of the wider network.
So, rather than providing computationally intense proofs, participants only need to prove that they have staked coins.
Validators are chosen pseudo-randomly from the pool of nodes. A common method for selecting validators is Coin Age Selection. Coin age is calculated as the product of the number of coins staked by the number of days the coins have been staked. Once a node has forged a block, its coin age is reverted back to zero. This prevents larger validators from having control over the network.
Validators receive new blocks of transactions, which are re-executed to check block signatures before marking the block as valid. Any transactions with an invalid signature are automatically declined. These transactions could be users trying to spend assets they do not have. Once the block has been checked, the validator signs it and sends their vote of attestation in favor of that block being added.
Validators earn transaction fees for validating the block and in some cases, they are given additional rewards. Misbehaving validators risk having their stake slashed which involves sending part of their staked collateral to an address where it cannot be recovered. If a validator would like to cease validating, its stake and rewards will be unlocked after a certain time period to ensure it has not added any fraudulent transactions.
To many, Bitcoin and Proof of Work are viewed as being detrimental to the environment due to the high energy requirements. With Proof of Stake, there is no need to purchase special single-use hardware and waste energy on arbitrary calculations. It is estimated that after the merge, Ethereum’s network will consume 99.95% less energy. For investors, this means Proof of Stake assets can be included within ESG portfolios which could allow for larger capital inflows.
Decentralization & Barrier to Entry
There is no need for high-powered hardware to join a Proof of Stake network. Instead, Proof of Stake allows users with traditional hardware to join the network. This opens up the door for more users to become validators, increasing decentralization.
On the flip side, many cryptocurrencies have a large minimum staking amount that can prohibit many users from becoming a validator on their own. Luckily, with delegated proof of stake, users with any amount of cryptocurrency can stake, earn rewards, and help secure the network.
Delegated Proof of Stake offers users the ability to stake their coins without becoming a validator. In this system, delegators stake their coin with an existing validator to increase the size of their stake. All delegators share the rewards with the validator taking a fee for running the validator.
One of the largest threats to a blockchain is a 51% attack. This is a situation where a bad actor controls 51% of the staked cryptocurrency to make their fork the canonical one.
Economic penalties for misbehavior make a 51% style attack extremely expensive for an attacker with Proof of Stake. In the case of Ethereum, this would cost the attacker around $15 billion. If this were to occur, honest validators could decide to continue building on the minority ‘honest chain’, ignoring the attacker’s fork. They could also remove the attacker from the network to destroy their stake.
Ethereum claims that this demonstrates that Proof of Stake is more economically secure than Proof of Work.
Ethereum 2.0 and ‘the merge’
Ethereum’s move to Proof of Stake, known as ‘the merge’ has taken many years of testing, research, and development.
Validators will need to deposit 32 ETH and must run three pieces of software: an execution client, a consensus client, and a validator. New validators must join an activation queue which limits the rate of new validators joining the network.
After the merge is complete, the issuance of new ether will be greatly reduced as less ether will be required to incentivize validators compared to miners. All eyes are on the Ethereum team to see if they can successfully transition from Proof of Work to Proof of Stake without any major hiccups.
Blockchains that use Proof of Stake
Proof of Stake has quickly become the most popular consensus mechanism for crypto projects. Here are a few of the major protocols which use Proof of Stake:
- Ethereum post-merge
- BNB Smart Chain
Proof of Stake has become the most popular consensus mechanism among projects as it improves upon Proof of Work with its scalability, decentralization, and barrier to entry. For users, it allows for faster, cheaper, and more complex transactions. For investors, the improvements in energy efficiency allow PoS assets to join ESG portfolios. Economic penalties make a 51% style attack extremely costly. The major drawback at this time is that the technology is less battle-tested than Proof of Work. Only time will tell.