Proof of Stake Versus Proof of Work: Understanding the Differences

In an event that would change the course of blockchain, the Ethereum Merge marked the shift from a proof of work to a proof of stake consensus mechanism. The price of Ether soared in the summer months leading up to the Merge in September 2022. But the value of the shift goes far beyond money. According to the Ethereum Foundation, any transaction now consumes ~99.95 percent less energy than before. 

Although the difference between PoW and PoS might not be noticeable to the casual investor who has their eyes on price fluctuations, the consequences of the Merge continue to shape the technology that gives rise to the coins.

More on the MergeEthereum’s Merge: A Case Study in Risk

Why Do Cryptocurrencies Need Proof?

Difference Between Cryptocurrencies and Traditional Currencies

The U.S. dollar is a centralized currency, meaning it’s issued by a central bank and distributed to the wider public through branch banks. Technically speaking, no dollar is worth anything. The value of a dollar is determined not by whether you can eat it, drink it, or wear it, but by what you can get in exchange for it. For example, you might be able to buy a small snack for one dollar. One dollar is therefore worth one snack, two dollars are worth two snacks and so on.

Cryptocurrencies are similar in practice. Back in 2010, a Floridian programmer named Laszlo Hanyecz bought a couple of pizzas for 10,000 Bitcoin. Today, you could buy many more pizzas with this money. The point is, the value of Bitcoin is not determined by the technology itself, but by what you get in exchange for it.

The fundamental difference with currencies like Bitcoin and Ethereum is that they are not issued by a central bank. Cryptocurrencies are decentralized — no state or institution is in charge of printing and regulating the money.

Double Spend Problem With Decentralized Currencies 

There’s just one big problem with this approach: How do we prevent fraudsters from abusing decentralized systems? 

As an example, let’s assume that you have 100 Bitcoin. You see a nice house in Florida worth around $2 million dollars, equivalent to 100 Bitcoin. You decide to buy the house. A few months later, you see that the neighboring house is on sale for $2 million. You want this house but don’t want to give up your current house, so you just take the same 100 Bitcoin and buy the neighboring house as well.

This so-called double spend problem would destroy all confidence in a currency. If you can buy things worth 200 Bitcoin by spending the same 100 Bitcoin twice, then you might as well buy those things by spending one Bitcoin 200 times. In other words, you would be able to buy anything with tiny amounts of money. Everyone else would do the same, and before long you’d have endless quarrels about what belongs to whom. People would conclude that the currency isn’t worth anything because it results in fights

Regulating Cryptocurrencies With Consensus Protocols

With state-issued currencies, the double spend problem doesn’t arise much. States don’t just hand out money; they also have police who can arrest you if you commit fraud.

In decentralized cryptocurrency systems like Bitcoin or Ethereum, there are no police. There is no central authority to ensure justice. To avoid the double spend problem, one needs something else. A sort of proof that a transaction is valid and that no coin is being spent twice.

In crypto-speak, this kind of proof is generally called a consensus protocol.

What Is Proof of Work?

The oldest consensus protocol, proof of work validates transactions through a process called mining, where computers connected to the network race to solve complicated cryptographic puzzles. These are generally hard to solve, so they require a lot of electricity to complete. When a computer has successfully completed a puzzle, it sends the result, called a hash, to all other computers. These other computers can verify that the hash is correct.

Generally speaking, cryptographic puzzles used for PoW are difficult to solve but easy to verify. On the Bitcoin network, which uses PoW, these puzzles are solved about every 10 minutes — this means that every 10 minutes all new transactions are added to a block on the blockchain, encrypted, and hashed. Everyone can check and verify these transactions. So, if you wanted to spend the same Bitcoin twice, validators would notice and the community would take immediate action.

Through PoW, banks aren’t necessary. Miners keep mining and verifying the transactions because they receive coins as a reward for each transaction they verify. Every transaction is public, so the community can quickly spot and remove bad actors. 

What Is Proof of Stake?

Having coins on a network is called staking, and this process is integral to how proof of stake works — those who stake the most coins to the network get rewarded. Thus, those who have the most coins on a network get rewarded, rather than those who work hardest and fastest. The more coins you have, the more likely it is that you’ll earn a reward for validating the next transaction.

To keep the network secure, multiple validators are needed for each transaction. This is, of course, much more energy efficient because the work is no longer necessary. In addition, transactions might go through quicker, although this isn’t always the case with Ethereum. 

PoS also makes it easier for individuals to earn money. Since The Merge, anyone can buy some Ethereum and earn more over time as they validate more transactions. Bitcoin, on the other hand, requires massive server farms and maintenance costs that few can afford.

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Proof of Work vs. Proof of Stake

With a general idea of how PoW and PoS operate, here’s a closer comparison that reveals in more detail the benefits and downsides of each.  

Environmental Impact

PoW relies on crypto mining to verify transactions, which consumes lots of energy. According to the U.S. Energy Information Administration, crypto mining could make up as much as 2.3 percent of the country’s electricity consumption. And not only do the computers used in mining to solve complex problems consume electricity, but the mining infrastructure itself also relies on fossil fuels to function. 

PoS completely eliminates mining from the verification process, offering a more sustainable alternative to its PoW counterpart. 

Security

Although requiring computers to solve difficult calculations can drain resources, it also serves as a strong security measure against bad actors. Cryptographic problems make it time-consuming and costly for hackers to undermine transactions on a blockchain, making PoW a safe option. 

However, using validators to verify transactions is also a reliable method. By involving multiple validators for each transaction, PoS enables a community to quickly identify suspicious activity and punish the bad actors accordingly. As a result, both PoW and PoS offer reliable methods for keeping transactions secure. 

Scalability

PoS promises to deliver greater scalability since it often facilitates faster transactions than PoW. That’s because PoS avoids crypto mining and complicated cryptographic puzzles, opting instead to use staking and validators. The catch is that PoS has never been applied on the same scale as PoW, so the question of scale remains up in the air for now.  

Fairness

A major flaw with PoS lies in its use of staking. Under this system, users who already have coins on a blockchain have an advantage over newcomers, and they can stake more coins to increase their chances of earning rewards. In short, the rich get richer while the poor get poorer. 

Meanwhile, PoW rewards users who work harder and faster than others to solve complex problems. This method presents a more egalitarian approach and supports greater decentralization on a blockchain network.  

Future of Consensus Mechanisms

While the urgent need for energy-efficient blockchain networks will lead to wider use of PoS mechanisms, this doesn’t mean PoS will replace PoW entirely. PoS still has its weaknesses, so a possible solution could be to form hybrid systems that leverage the strengths of both PoS and PoW systems. 

Either way, consensus mechanisms will play a vital role in regulating transactions as the Trump administration pushes for greater investments in crypto. And if artificial intelligence becomes integrated into blockchain technology, PoS, PoW and other mechanisms will be required to monitor AI outputs and protect the integrity of blockchain networks.

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