What is Proof of Stake and Its Working Principles?

Author: Iskander Ziyanurov
22.07.2022

Proof of Work (PoW) is used to precisely verify the history of all transactions in Bitcoin. However, it is energy-intensive and has a limited capacity for transactions. New consensus mechanisms that emphasize a less time and energy-consuming approach have consequently arisen, with the Proof of Stake (PoS) model being the most promising one.

In this article, you will find out what Proof of Stake is and how it works, how it differs from the first-ever mechanism Proof of Work, its upsides and downsides, the most popular crypto assets that use this method, and what are its future perspectives.

What Is Proof of Stake (PoS)?

A consensus mechanism is a technique for ensuring the security of a distributed database and verifying data. The database in the context of cryptocurrencies is referred to as a blockchain, and the consensus process was developed to protect this blockchain. A consensus mechanism for completing transactions and adding new blocks to a blockchain in cryptocurrencies is called Proof of Stake (PoS).

Proof of Stake decreases the quantity of computing work involved to validate blocks and operations that ensure the security of the blockchain and, consequently, cryptocurrency itself. The verification of blocks using coin owners' equipment is adjusted by Proof of Stake. The owners submit their currencies as collateral in exchange for the capability to verify blocks. Holders of coins who have decided to stake them are known as "validators."

The block is then validated by validators who are chosen randomly or by an algorithm. Instead of employing a competition-based process like Proof of Work, which is used the most, this approach assigns who gets to validate.

A coin owner must "stake" a certain number of assets to become a validator. For example, to become a validator on a certain network, he must initially invest 32 ETH, which must be staked. Many validators verify blocks, and when a certain number of these validators confirm that the block is correct, it is considered completed and locked.

Each Proof of Stake technique utilizes multiple methods for validating blocks. One day, when Ethereum, the second biggest crypto asset in the world, fully converts to PoS, shards will be used for transaction submissions. A validator will authenticate the operations and add them to a shard block, which must be attested to by at least 128 validators. After the shards have been validated and the block has been produced, the majority of the validators should confirm that the results are valid before the block may be closed for good.

Let's examine how PoS looks in practice and what the whole process involves.

The Proof of Stake method enables cryptocurrency holders to stake their crypto and establish their own validator nodes.

Staking crypto is the act of pledging your coins to be used for transaction verification. When you stake your assets, they are basically locked up. However, you can redeem them anytime you want and move them around.

Once a block of money transfers is ready for processing, the cryptocurrency's Proof of Stake mechanism selects a validator node to review it. The validator verifies that the activities inside the chain are legitimate. If this is the case, they add the block to the blockchain and collect cryptocurrency incentives for their efforts. Conversely, they will be penalized if a validator suggests adding a block with incorrect information. Penalized here means that these individuals will eventually lose a certain amount of their staked assets.

Let's check out how all of this functions with one of the widely used cryptocurrencies, Cardano (AいえsDA). This crypto asset is a significant crypto asset with a vast client base and a market cap utilizing Proof of Stake. Suppose you buy ADA. Once you possess Cardano, you will find out that it has the ability to be staked and create its independent validation node. When Cardano has to verify transaction blocks, its Ouroboros protocol chooses a validator. The validator validates the block, uploads it, and is rewarded with additional Cardano assets for his efforts.

Now, when it is more clear what PoS is, let's look at the main differences between Proof of Stake and Proof of Work.

PoS vs. PoW

Understanding Proof of Work and Proof of Stake lays the groundwork for comprehending the usefulness of blockchain technology, the advantages and downsides of various consensus mechanisms, and the present situation in digital currencies.

Bitcoin, the father of all crypto, utilizes Proof of Work. It is based on the "work" of mine workers, whose primary goal is to get the reward in crypto. The bonus is granted for mining the transaction block. The new transaction block is added to the blockchain and can be viewed by anybody on specific websites.

Miners must complete incredibly complicated math riddles to mine the next block and collect their prize. They want tasks to be solved as soon as possible; therefore, they use the most advanced machines that run 24/7. However, it is highly energy-consuming.

On the other hand, there are validators and staking cryptos. Basically, the goal of PoW and PoS blockchains is identical. They were just developed differently and allow users to enjoy other benefits. Validators, rather than miners, are participating in Proof of Stake blockchains. With PoS, there are no complex mathematical problems, yet there is still a prize. Validators, on the other hand, are earning the privilege to validate the next block of transactions by staking or "locking" their cryptocurrencies for a set period of time.

As already mentioned, the Proof of Stake consensus process chooses validators randomly. However, it is essential to remember that validators with the most assets staked for the longest time have a more significant probability of forging the next block. In the same way, miners with not-so-robust mining machines can pool their cryptos on PoW, and validators on PoS can pool their assets to compete with other validators who may have the higher block-creating capability. This activity is referred to as a staking pool.

As a matter of fact, each consensus (there are more) technique has its benefits and drawbacks.

Let's proceed and look at the pros and cons of the Proof of Stake method.

Pros of PoS

Energy-efficient solution

One essential difference from PoW is that PoS does not demand the use of expensive computers and the usage of enormous amounts of resources.

A variety of research studies have been conducted to examine how PoW-based blockchains use energy. A 2021 follow-up study, for example, revealed that the energy usage of Bitcoin mining had climbed to 121.36 TWh per year. In one year, the mining of Bitcoin consumes more electricity than Switzerland, Argentina, the Philippines, and the Netherlands combined. Many criticize PoW mainly because of this.

The high power consumption of the Proof of Work consensus algorithm is the main contributor to the ecological concerns of PoW-based blockchain networks. The fact is that power generation is still reliant on fossil fuels.

Besides being more energy-efficient, PoS also has some other unique advantages.

Utility and scalability

A further benefit provided by Proof of Stake is that it secures the blockchain by promoting correct confirmations and discouraging incorrect ones. Validators, as previously stated, earn a share of the processing fee and will lose stake if they try to cheat in any way.

PoW is constantly raising scalability problems. Utilizing a Proof of Stake blockchain is more scalable because it is even more decentralized and enables more participants to use it. Also, when comparing Proof of Work to Proof of Stake, PoW is undeniably slower when it comes to handling transactions.

The use of energy-efficient blockchains extends beyond cryptocurrencies. For instance, the Ethereum and Cardano platforms were launched to support their native digital currencies and other digital assets, as well as applications including the creation of non-fungible tokens (NFTs), DeFi, blockchain games, etc.

Cons of PoS

It might sound like an ideal solution, but unfortunately, it is not. There is another side to the coin, and it includes:

Limitations to access

The most significant barrier to participation is that those interested must possess the specific PoS-based blockchain platform's native currency. These cryptocurrencies can be acquired via fiat currency or by exchanging cryptos for the native cryptocurrencies that work with them.

Frankly speaking, PoS is not always easily accessible. The technological and technical challenges associated with owning cryptocurrency and comprehending blockchain may discourage people from using the network.

Unfairness

Then there is a "rich get richer" conundrum. The more assets one gets, the more one can stake and earn cryptocurrencies. Many criticize this method due to the fact that it involves staking crypto to engage and also because the larger the capital, the better odds of becoming the chosen validator and profiting from it.

Similar to PoW, the more capital a person or entity has, the more powerful the equipment he can buy.

51% Attack

Proof of Stake vulnerability to 51% attack is by far its most considerable drawback. Such an attack occurs when someone has control over the blockchain and owns more than 51% of the verification capacities.

Bear in mind that a 51 % attack can target both PoW and PoS. A person or group of people might buy enough cryptocurrencies on PoS-based blockchain systems, particularly those with newer and lower valued cryptocurrencies, to obtain an advantage over other users and raise their chances of being selected as a validator.

Moreover, the fact that Proof of Stake is still relatively young compared to Proof of Work is one of its main drawbacks. Therefore, its safety is not as established as PoW. Proof of Work offers a more reliable consensus process because it requires hardware power.

The most profitable PoS cryptocurrencies

1) Ethereum (ETH)

In the past few years, Ethereum has become the most popular blockchain network. More than 2800 decentralized applications are built on it.

As of now, Ethereum is a Proof of Work network, but its upcoming major update, Ethereum 2.0, which would change it into a Proof of Stake network, is intended to address its scalability problems. By doing so, the network would be optimally scaled and secured, leading to more creative Decentralized Applications that might be created.

2) Tezos (XTZ)

Another PoS multifunctional blockchain with on-chain governance is called Tezos. Staking Tezos (XTZ) will allow you to generate passive revenue. It's worth noting that Tezos is the first Proof of Stake crypto asset to be accepted for staking by all of the major exchanges. Using any reliable crypto platform is the most straightforward method for staking cryptos like Tezos.

3) Akash (AKT)

The Akash Network is a promising project that was created on Cosmos Hub and employs the native utility token Akash (AKT) as a method of governance, security, and trade. By staking the Akash token, one can receive an APR of up to 58%. The staking earnings for this asset are among the highest in the market.

Conclusion

Cryptocurrency enthusiasts often wonder whether Proof of Stake will expand cryptocurrencies and change the way money is used in the future.

Well, most indicators point to the rising demand for a cryptographic infrastructure that is scalable, secure, and effective, which Proof of Stake certainly is. Staking cryptos will most likely increase accessibility to blockchain networks and speed up widespread adoption. Faster transactions would be encouraged by Proof of Stake cryptocurrencies, which would persuade more companies to accept crypto.

Proof of Stake helps both cryptocurrency users and investors thanks to its functions. PoS-based cryptocurrencies can execute transactions rapidly and inexpensively, which is essential for scaling, and сryptocurrency stakes allow investors to earn awards and generate additional income.

Despite several weaknesses, Proof of Stake is still one the best candidate for cryptocurrencies' future, especially when we take into account that crypto intends to become broadly recognized, ecologically friendly, and scalable to fit more users.

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