Proof of Stake, also abbreviated as PoS, is a consensus mechanism used by several blockchains. It is an algorithm devised in response to the various drawbacks of Proof of Work.
Within a network that uses Proof of Stake, there are validators that add new blocks to the blockchain. To become a validator, money in the form of cryptocurrency must first be put in. This is called the ‘stake’ and can be compared to a deposit.
How does Proof of Stake (PoS) consensus work?
In a Proof of Stake blockchain, the network consists of different nodes. Nodes are computers that have joined the network themselves and they can perform multiple tasks. For example, keeping a copy of the blockchain in order to better secure the network.
So-called validator nodes can validate transactions and add blocks to the blockchain.
Nodes can also verify if other validators are doing their jobs correctly.
It is always possible for a node to join the network, but in order to be a validator node, they must commit a stake.
Based on the size of the stake, a validator is chosen to add a block.
This validator first verifies all the assigned transactions. Once this is done a group of validators will check this work and if this is approved the new block will be created and added to the blockchain. For this, the validator receives a reward, which consists of the transaction fees paid by users, but often also of new coins. However, the latter is not always the case and can vary from blockchain to blockchain.
Safety
The other nodes in the blockchain network will check whether the chosen validator is doing its job properly. Should it be suspected that a validator is approving transactions wrongly, the network can vote on this. If at least 51% of the network agrees with this suspicion, the validator in question will be punished. This punishment can vary from blockchain to blockchain, but usually it is a fine.
This fine is paid from the stake that the validator has put in. It is possible that the entire stake is taken away from the validator, which will hit the validator hard financially.
The stake can therefore also be seen as a proof of creditworthiness. A validator can prove his reliability by betting a high stake. The higher the stake, the higher the amount of money a validator can potentially lose. Therefore, a validator will try harder when the stake is high. The network will prefer a validator that is reliable and therefore the chance of being chosen as a validator increases when the stake is higher. However, this is at the expense of decentralisation. This is because it will mainly be the rich who are allowed to add new blocks. Because only they receive rewards, the rich get richer. This can cause a gap between rich and poor that gets bigger and bigger, so that new blocks are added to the blockchain almost exclusively by the same validators.
The result can be compared to mining pools within Proof of Work. Here miners form groups of mining pools and thus join forces. The result is that new blocks are only added by the same mining pools and the network becomes increasingly centralised.
Outsourcing stakes
It is possible to set up a validator yourself, although you can also outsource staking to another validator. In that case, cryptocurrencies are sent to a validator, who then uses them as stake. This ensures that this validator has a greater chance of being elected. The validator will then share its rewards with the people who have outsourced their stake to that validator. This is also comparable to a mining pool within the Proof of Work network: proceeds from a mining pool are distributed among all participants of the mining pool.
However, this is not entirely without risks. If the validator makes mistakes, it can be punished with a fine. This fine is paid with the stake, which also consists of other users’ cryptocurrencies. So these users also lose their stake if this validator is penalised. That is why it is important to do good research before staking via another validator.
What are the Pros and Cons of Proof of Stake?
Proof of Stake is seen as the opposite of Proof of Work, because it has solved several problems of PoW in its algorithm. The disadvantages of PoW are often the biggest advantages of Proof of Stake, as can be seen below. However, the Proof of Stake algorithm also has some drawbacks.
Benefits
- Sustainable. With proof of stake, no proof of the computational work is required, only the proof of the staked assets. As a result, less energy is required for a proof of stake blockchain.
- Fast processing time. Compared to Proof of Work, transactions can be processed extremely quickly, while transaction costs are often lower.
- Scalable. The validators do not conflict with each other, making the network of a Proof of Stake algorithm much more scalable than, say, PoW. This ensures that transactions can still be processed quickly when the number of transactions increases.
- No special hardware required to participate. A validator does not need special, and therefore often expensive hardware. The validator is chosen on the basis of the stake that has been pledged.
Disadvantages
- The rich get richer. To be chosen as a validator, a high stake will have to be placed. Validators with a high stake will therefore receive rewards more quickly than validators with a low stake. This ensures that the rich get richer and richer.
- Validators do not spend their stake. A validator has more to gain from staking coins rather than spending them. This ensures that a large proportion of the coins do not circulate as they would in a normal and healthy economy.
- Has not yet been able to prove itself on a large scale. Proof of Stake is a fairly new algorithm that is not yet used by the largest and most proven blockchains. It therefore remains to be seen how this algorithm will work when used on a large scale.
- Indications of security problems. There are indications that there are problems with the security of this algorithm, which is why most blockchains using this algorithm are still taking measures to prevent these problems. Partly because this algorithm has not yet been able to prove itself on a large scale, there is not yet much knowledge about its security.
Proof of Stake vs. Proof of Work
Proof of Stake is often compared to Proof of Work. This is because these two algorithms are the most widely used consensus mechanisms. In recent years, Proof of Stake has been on the rise and is preferred by several blockchains over Proof of Work. Below are the main differences between Proof of Stake and Proof of Work.
- In Proof of Stake, it is validators who add blocks, while in Proof of Work, it is miners who create new blocks.
- Proof of Stake rewards validators on the stake they put in and with Proof of Work, miners are rewarded on the basis of the computing power they can provide.
- More energy is lost in a Proof of Work blockchain because many miners provide computing power that is ultimately not used. The Proof of Stake algorithm is therefore considered a more sustainable algorithm than Proof of Work.
- No special hardware is needed to participate as a validator in a Proof of Stake network. Validators are not judged on the computer power they can provide, but on the size of the stake they can put in. The costs that this saves can then be used as a stake.
Which blockchains use the Proof of Stake algorithm?
Whereas at first Proof of Work was the only choice for a blockchain, more and more blockchains are using the Proof of Stake consensus algorithm. The cryptocurrencies below are the most important blockchains that use the Proof of Stake algorithm.
Ethereum
Ethereum started with a Proof of Work algorithm, but since the upgrade to Ethereum 2.0 which started in 2021, it is transitioning to Proof of Stake. This is being done because Ethereum had many problems with scalability. Users pay high transaction fees which can amount to sometimes several hundred dollars, while it often takes a long time for a transaction to be approved.
Proof of Stake has yet to prove itself within Ethereum, as the blockchain has not yet fully switched over to this algorithm. The upgrade was expected to be completed within a year, but has been postponed several times.
Cardano
Cardano’s blockchain uses a consensus algorithm called Ouroboros, which is based on Proof of Stake. The team behind Cardano found it necessary to provide Proof of Stake with a number of modifications, in order to guarantee better security.
Algorand
Algorand’s blockchain uses the Proof of Stake mechanism, which allows up to 1,000 transactions to be processed per second. By way of comparison, Bitcoin’s blockchain can process up to 5 transactions per second.
Tezos
Tezos is an open-source blockchain that allows users to perform transactions quickly. The blockchain also offers support for smart contracts, allowing developers to create their own application (dApp) on the blockchain. It uses the Proof of Stake mechanism, which makes the blockchain very scalable.
Summary
Proof of Stake is a consensus algorithm used by several blockchains. For example, Cardano, Ethereum 2.0, Algorand and Tezos are projects that use this algorithm. There are several reasons why they do so.
In a Proof of Stake mechanism, validators within the network work to verify transactions and add blocks to the blockchain. Validators are selected in advance, based on the stakes they have invested. The higher the stake, the higher the chance of being chosen as a validator. If a validator then approves incorrect transactions in order to manipulate the blockchain, the network can proceed to penalise them. This punishment usually consists of a fine, which is paid with the stake invested by the validator. Thus, there is a lot at stake if a validator has a high stake. Therefore, validators with high stakes are more likely to be chosen than validators with low stakes, as they generally have a lot to lose. This makes them reliable validators.
However, this way of choosing validators ensures that the rich get increasingly richer. Validators who simply do not have enough money are less likely to make money from validating. Also, this algorithm has not yet been able to prove itself on a large scale. Ethereum will be the first blockchain to use this mechanism on a large scale.