With the upcoming Merge upgrade to Ethereum getting ever closer, you may have heard the terms “Proof-of-Work” and “Proof-of-Stake” being used to describe the upgrade. The upgrade will result in Ethereum combining its PoW and PoS consensus mechanisms.
But what does that actually mean?
What is Proof-of-Work?
Proof-of-Work (PoW) is a consensus method, by which blocks in a blockchain are authenticated. Bitcoin mining is an example of this.
PoW involves solving complex mathematical problems (work), with the first person to do so being rewarded with newly minted crypto. This is how cryptocurrencies such as bitcoin, that work on a PoW basis, emit more of their currency. In this way, Proof-of-Work is like a digitalisation of mining precious metals – it’s not that all gold has been mined, but it will require extra work to mine and refine the gold that is left. Gold maintains its value, in part because the cost (work) required to mine more gold is significant.
What is Proof-of-Stake?
Proof-of-Stake (PoS) is an alternative consensus method. Rather than having to solve mathematical problems to authenticate a block and earn the crypto reward, validators stake the native crypto of the network. In this way, if someone tries to manipulate the blockchain they lose their stake. Validators are then generally selected by how much crypto they’ve staked, plus how long they’ve had it staked for (although this can vary, depending on the project). The chosen staker then validates that block in the chain.
Proof-of-Stake was originally intended to tackle the growing energy consumption required by miners. Proof-of-Work is competitive and only a single ‘winner’ is rewarded – all other work is wasted energy. Proof-of-Stake doesn’t require validators to do work and thus eliminates the energy requirements.
What are the advantages and disadvantages of each?
Both methods reward participants for validating or mining the network, and punish those who attempt to abuse it. As a result, both PoS and PoW have good incentives for authenticating the network fairly, while keeping it decentralised. However, each method has its own separate advantages and disadvantages.
PoW has a proven track record of being a secure method for a decentralised network to run on, and is the original consensus method. As a cryptocurrency becomes more valuable, more miners are attracted, meaning that security grows in line with value.
However, it requires huge amounts of energy and special equipment to become a miner for a large cryptocurrency such as Bitcoin. While not very environmentally sustainable, it’s beneficial for network security. For a block to be altered, it needs the consensus of a majority of miners. Theoretically, it is possible to steal all the Bitcoin in the world by orchestrating something called a 51% attack. If someone controlled a majority (50%+) of the network, they could always reach consensus and edit the blockchain in their favour. But thanks to the large energy requirements to be a miner, it becomes infeasible to corrupt a block on the chain. With current network power, it would require a large country to direct all of its energy to do this!
PoS requires much less energy than PoW. But while this massive energy consumption adds to the security of the PoW method, the low energy consumption of PoS does not mean a reduction in security to the network. PoS is still vulnerable to a 51% attack, but would require someone to buy 50%+ of the tokens for a network. In this way, PoS would have a high financial cost to corrupt, compared with PoW having a high energy cost. This makes PoS a much more energy efficient method.
As well as being more energy efficient, PoS could be more desirable as there is no requirement for special equipment to participate, making it more accessible. Plus, transactions tend to be faster and cheaper, which benefits everyone on the network.
Having said this, PoS hasn’t got as long a record as PoW for security. It’s also possible for validators with exceedingly large stakes to have an overwhelmingly large influence on validating transactions, which can lead to arguments of how decentralised the consensus method is.
So which is better?
At the moment, it’s hard to say that one is overall better than the other. PoW has a great track record, despite the fact that it’s slower and less energy efficient . Since Bitcoin uses this method, it’s unlikely this method is going to be replaced anytime soon.
Disclaimer: Nothing within this article should be misconstrued as financial advice. The financial techniques described herein are for educational purposes only. Any financial positions you take on the market are at your own risk and own reward. If you need financial advice or further advice in general, it is recommended that you identify a relevantly qualified individual in your Jurisdiction who can advise you accordingly.