What is Proof of Stake?
“Honesty is the best policy. If I lose mine honor, I lose myself.”
~ William Shakespere
With Ethereum 2.0 and all its game-changing scalability solutions just around the corner (although our proximity from that corner seems to change like a school assignment submission deadline), everybody in crypto is talking about Proof of Stake. Is this really the right scaling solution? Is proof of stake the holy grail of consensus mechanisms? What the hell is a consensus mechanism even? In this article, we’ll try to answer all of these questions, and give you a breakdown of what the future of crypto might look like.
What is a consensus mechanism?
Consensus mechanisms are the backbone of all cryptocurrency and blockchain systems, and are what make them secure, with decentralization at the heart of this technology. The data and transaction history of a blockchain are managed without the need for a central gatekeeper, as the network instead relies on a large number of users to approve incoming transactions and add them as new blocks to the chain.
In a blockchain, distributed nodes come to an agreement on a single network state through a consensus method, which is fault tolerant. These protocols ensure that all nodes are in sync with one another and that all transactions are valid and added to the blockchain. They have the responsibility to guarantee the legitimacy and authenticity of the transactions.
Simply put, consensus is the process by which a group of peers, aka nodes, on a network determine which blockchain transactions are valid and which are not. Consensus mechanisms are the methodologies used to achieve this agreement. These sets of guidelines aid in guarding networks from bad behavior and hacker attacks.
Proof of Work (PoW), used by Bitcoin and the current version of Ethereum, and Proof of Stake (PoS), used by Cardano, Polkadot and Avalanche, are the 2 most popular consensus mechanisms used in blockchain technology, with others including practical Byzantine fault tolerance (PBFT), proof of capacity (PoC), proof of activity (PoA), proof of publication (PoP), proof of retrievability (PoR), proof of importance (PoI), proof of burn (PoB), proof of elapsed time (PoET), and proof of ownership (PoO). Given that most of these are still experimental at best, and are yet to prove themselves at scale, only PoW and PoS will be within the scope of this article.
What is Proof of Work?
To understand Proof of Stake, and why Ethereum is moving towards it, we first need to understand Proof of Work. Let us take the example of Bitcoin, as it was the first cryptocurrency , and used this consensus mechanism.
Mining and Proof of Work are concepts that are closely related. The network demands a significant amount of computing power, which is why it is termed "Proof of Work." Each miner is constantly engaged in a race of sorts, working to solve a difficult problem (to discover the SHA-256 hash of the block they are trying to create, that will have a certain characteristic), in order to add the next block to the blockchain. In addition to newly minted Bitcoins (6.25 Bitcoins as of this writing), the first miner to complete this proof-of-work gets rewarded with the total transaction fees for the transactions contained in the block being created. The miner’s goal, the problem that must be solved, is to generate a hash output that is below a certain value. The first miner to compute a value having this characteristic wins, and his version of the block will, after validation by the other miners, be added to the block chain.
Particularly for a relatively simple but highly valuable cryptocurrency like Bitcoin, Proof of Work has several significant advantages. It's a tried-and-true method for keeping a decentralised blockchain safe. As a cryptocurrency's value rises, more miners are motivated to join the network, boosting its strength and security. It becomes close to impossible for any person or group to interfere with the blockchain of a valuable cryptocurrency because of the amount of computing power it would require.
On the other hand, it's a resource-intensive process that would have difficulties scaling to handle the enormous volume of transactions that blockchains that support smart contracts, like Ethereum, can produce. It’s a huge waste of time and energy for every node to work to add every block, when only one is successful, and is rewarded. Besides this, because Proof of Work mining requires so much expensive computing power, it tends to consolidate miners down to the few who can afford the equipment. It also tends to pull computing resources into locations where electricity is cheap. The result is a consolidation of miners, and geographic consolidation: the antithesis of the aspirations of true decentralization. Thus, alternatives have been created as a result, with Proof of Stake being the trail blazing solution.
What is Proof of Stake?
Staking in a Proof of Stake system performs a similar function to mining in a Proof of Work system, in that it selects a network participant to add the latest batch of transactions to the blockchain and receive block rewards and transaction fees in return.
The specifics vary depending on the project, but generally speaking, Proof of Stake blockchains use a network of validators who pool in, or "stake", their own cryptocurrency in exchange for the opportunity to potentially validate new transactions, update the blockchain, and earn rewards. The network selects a validator based on the amount of crypto each participant has in the pool and the length of time they’ve staked it there, thereby literally rewarding the most invested participants. Once the winner has validated the latest block of transactions, other validators can check that the block is accurate. When a predetermined number of attestations have been made, the network updates the blockchain. A reward in the native cryptocurrency is given to all participating validators, and it is typically distributed by the network in proportion to each validator's stake.
Given that the network selects the winning validators and that there is no contest to be the first to add a block to the blockchain, proof of stake uses significantly less energy than proof of work, and widely distributes infrastructure, potentially strengthening a blockchain system. Because proof of stake eliminates the need to purchase expensive computing systems and use a significant amount of electricity to validate transactions, more people can participate as validators, thus increasing a blockchains innate decentralization. Proof of stake blockchains may also have the advantage of being more scalable than proof of work blockchains in the future, because they can theoretically support more simultaneous transactions without sacrificing security or decentralization.
However, there are some caveats. As was alluded to with the opening quote from Shakespere, in PoS, validators are punished for being dishonest. Validators risk losing some of their stake through a process known as slashing if their node goes offline or if they try to validate a block of transactions that is deemed to be "bad". Although PoS doesn’t require participants to buy large amounts of powerful computing equipment, a significant amount of responsibility and technical expertise are needed to become a validator. For ETH 2.0, the required minimum stake is 32 ETH. This is not a small sum of money for most people.
But even if that sounds like too much responsibility, or too much money to put up yourself, you can still participate in staking by joining a staking pool run by someone else, and earn rewards for crypto that would otherwise be sitting around. This process is often referred to as delegating.
What is Delegated Staking?
Delegation is a process allowed by certain PoS protocols, whereby a holder of a particular network’s tokens can earn block rewards by contributing their crypto assets to the staked token pool on someone else’s node. In doing so, a delegator receives a portion of the block rewards received by the validator, without needing to set up and manage their own node. Meanwhile, since having more tokens staked to a node increases the likelihood that it will be selected to perform work and earn rewards, delegation increases a PoS validator’s reward-earning potential, thus leading to a win-win situation. So if you’re a crypto HODLer, but you don’t necessarily have the resources or technical know-how to operate validator nodes yourself, you can still earn rewards by choosing to delegate, and platforms like Pilllow can make it simple and seamless.
So what are you waiting for? I think the consensus is pretty clear. Go to your app store and download Pillow right now, so that you can start earning returns on your crypto today!