What is Proof of Stake (PoS)?

Investing
Updated: 8th Oct 2021
Written by Andrew
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October 8, 2021
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Crypto mining has historically relied on computers to solve complex math problems. However, new ways of generating coins and validating transactions have arisen in the industry.

A popular alternative to the proof of work consensus mechanism is proof of stake. But what is it and how does it work?

What is Proof of Stake (PoS)?

In a proof of stake system, the person or node that holds the most cryptocurrency decides who is allowed to validate a block in the blockchain.

In other words, the concept’s core is that those who have invested the most in the integrity and security of the currency are rewarded for validating said integrity and security.

Validators “stake” a certain amount of crypto to essentially vouch for their mined block. If the network rejects their block, the validator forfeits the crypto they staked.

Understanding Proof of Stake

By maintaining a record of the existence and use of each coin, blockchains help prevent counterfeiting and theft by tracking how coins move in the network, although you can’t tell where it is or who holds it, just the wallet address.

The blockchain is composed of chunks of data called blocks that record coins and their movement. Because they’re verified and checked before being added to the chain, users can verify whether or not transactions have taken place.

Because the accuracy of blockchain is crucial to the system’s integrity, one key feature of all cryptocurrencies is that they ensure accuracy.

And since cryptos also want to avoid a centralized network and fiat currencies, they rely on rewarding people for checking the blocks.

Proof of stake is just one way to go about this process.

>> More: Best Crypto Exchanges

How Does Proof of Stake Work?

The mechanics of PoS can get complicated – but the underlying concept is rather straightforward.

Cryptocurrencies depend on secure, accurate blockchains to function. In turn, blockchains rely on a network of computers, or nodes, to verify transactions and secure the blockchain.

PoS chooses who checks the blocks by rewarding those who own a lot of the given currency.

In order to check a block and receive your reward, you have to put currency into a digital wallet, and then the algorithm underlying PoS has to select you from a group of qualified hopefuls.

The more you put in, the greater the chance you’ll be chosen to check the blockchain.

By definition, proof of stake systems ensure that the only people who can check – or change – the blockchain are those who would be most damaged by fraudulent activities.

When combined with myriad computational protections, PoS makes larger investments in currencies more rewarding while ensuring the security of the blockchain.

Proof of Stake Concepts: Validators, Staking, and Security

Because crypto involves solving old problems in new ways, the space is filled with new terms and mechanisms as well. If you want to understand proof of stake, starting with the language is key.

Validators

A validator is anyone who has staked the minimum required amount into a proof of stake system. Once you’ve done that, the algorithm can choose you to propose a block or check and attest to a proposed block.

Either role comes with the opportunity for a currency reward.

Staking

Staking is the act of placing cryptocurrency – usually a substantial sum’s worth in fiat currency – into a digital wallet to become a validator.

Depending on the currency, stakes may be weighted, for instance to favor long-term investors. But even if you’re not selected, you’ll still typically receive interest on your stake.

Additionally, any bad behavior will result in deducting currency from your stake in proportion to the seriousness of the offense.

For example, you might face a small loss if you’re chosen but fail to play your role in proposing or attesting.

But if you attempt to alter the block, you may find your entire stake confiscated.

Security

A blockchain attack is always a possibility, and PoS is no exception – but it does come with some real strengths.

For all but the newest systems, staking enough to alter the blockchain would mean investing billions of dollars.

If the nefarious actor outvoted the validators to alter the blockchain, the public would notice immediately, and the value of the currency staked by the malicious actor would likely be destroyed.

Because the PoS only gives leverage to those who would suffer the most severe consequences as a result of malpractice, such an attack by those same individuals is extremely unlikely.

Does Ethereum 2.0 Use Proof of Stake Consensus Mechanism?

Up until now, Ethereum has worked on a proof of work system, but they’re currently transitioning to proof of stake.

What are the Advantages of Using Proof of Stake?

Proof of stake requires less computational energy than proof of work. Additionally, PoS can scale better than PoW, which enables high transactional throughput.

What are the Disadvantages of Using Proof of Stake?

One of the main problems with proof of stake is centralization. Individuals with the most Ether, for example, have massive control on the network. This makes proof of stake currencies more vulnerable to censorship.

Differences Between Proof of Work and Proof of Stake

Proof of work systems are built on arbitrary complex problem solving using computers to decide who will receive newly minted currency, thus “showing work” to mine and achieve consensus.

Instead of providing computational energy, proof of stake systems put their money where their mouth is and attest to the validity of a block by putting their crypto up as collateral.

Is Proof of Stake Secure?

Proof of stake is a decentralized mechanism to reach consensus on the blockchain. It is as secure as the encryption that the given protocol uses. However, some PoS systems are more centralized than others, and therefore more vulnerable to censorship.

Energy and Proof of Stake

One of the main reasons PoS has gained steam is it’s allowed miners to overcome the energy requirements of using a PoW system.

As the value of cryptocurrency has risen, the incentive to create enormous computing networks has increased in the pursuit to solve cryptography puzzles and mint new coins.

These systems use large amounts of electricity. PoS attempts to sidestep energy expenditure by removing difficulty in mining. PoS is more interested in how much you have than how hard you try.

Pros and Cons of the PoS Consensus Mechanism

Proof of stake comes with its own strengths and weaknesses:

Pros:

  • More environmentally friendly than PoW systems
  • Better scalability on layer one blockchains
  • More transaction throughput

Cons:

  • More centralized as the participants with the most crypto control the network
  • More vulnerable to censorship than PoW systems like Bitcoin

Bottom Line: What is Proof of Stake?

Proof of stake systems allow blockchain-based cryptocurrencies to use algorithms and validator staking to decide who gets to make and verify blocks in the chain.

Proof of stake is an alternative method to proof of work that is increasingly being adopted by new cryptocurrencies.

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Andrew
Andrew
Andrew is an editor-writer living and working in Southern California. While he’s previously focused on editing for financial publications, he’s now dabbling in the writing pool as well. Hobbies include listening to podcasts, and learning about all things financial. (Just don't ask him about logarithms.)