With crypto developing at an incredible rate, it can be difficult to keep up with all the latest news and technology. Here I go back to basics and lightly talk about Proof of Work (POW) and Proof of Stake (POS) consensus mechanisms in order to recap on some fundamentals.
Bitcoin was born on the back of the 2007/08 global financial crisis, created by an anonymous entity using the pseudonym Satoshi Nakamoto who was frustrated by archaic and flawed global monetary systems. It was in essence, an experiment to see if it could provide a better global monetary standard. The underlying technology that is the blockchain, is a ledger of accounts, recording every transaction made, which is cryptographically immutable that can be verified by anyone.
An important remit for the blockchain was to ensure it was decentralized, meaning no central authority, entity or third party could control things. If no governing body was to process the data, it needed to be done somehow in a fair way. This was achieved by a collaboration of many people around the world acting as node operators, using their computers linked through the internet, each validating transactions and powering the network. The parameters in which the transactional data is shared, processed and agreed upon in a fair and decentralized way is referred to as the ‘Consensus Mechanism’. Two popular types of consensus mechanisms include POW and POS.
Proof of Work
The first blockchain Bitcoin was created using a POW consensus mechanism. Node operators, also referred to as miners, compete with other node operators around the world to validate the latest block of transactions by using their computer power to solve complex mathematical equations. Their incentive being that the winner gets a predetermined amount of bitcoin as a reward. The large amount of computer processing power that contributes in validating a block is what the term ‘Proof of Work’ refers to.
Bitcoin is a deflationary asset meaning that there is a predetermined number of bitcoins which will never increase (21 million). Every 4 years a halving occurs where the amount of Bitcoin miners can earn by the protocol is halved. This, as historical data suggests, creates a supply shock, increasing the price of the asset incentivising more people to join the network further maximizing its security. POW is a very powerful model which has stood the test of time. Bitcoin, over the last 12 years since inception, has grown into a fierce and competitive industry worth billions of dollars.
A couple of drawbacks of POW is that it is mathematically limited in terms of scaling. In order for POW to operate securely, the block size must be limited, restricting how many transactions per seconds (TPS) the network can process. This severely constrains the blockchain in terms of practical applications. Another concern is the collective power consumption required to power the network by the miners. It has been estimated that this equates to on average about 127 terawatt-hours, equivalent to what certain nation states such as Norway may use annually. Over the years the concern surrounding the miners energy consumptions has put pressure on to improve techniques and methods, with many mining setups now using green renewable energy.
Proof of Stake
POS is a consensus mechanism that attempts to resolve the problems of scaling and the high energy consumption of POW blockchains. POS was first introduced by Sunny King and Scott Nadal, founders of Peercoin, the first cryptocurrency to use the POS consensus mechanism in 2012.
In a POS consensus protocol, staking your cryptocurrency serves as a similar function to POW mining. Network node operators get selected, in a lottery based system, to validate and update the network and be rewarded. The more crypto staked in your staking pool, the higher the chance of being selected. Depending on the blockchain, the parameters in how POS work may vary, but in general terms participants' rewards are greater the longer and more that is staked. This model is again powerful in that it incentivises people to contribute more, further securing the network. Individual crypto holders who do not operate a staking pool (Node), can delegate their crypto to a staking pool of their choice to help secure the network and increase the chances of that pool being selected for blockchain validation.
Although POS has been developed to improve upon the limitations of POW, there are new blockchains that still prefer to use the POW consensus mechanism. Nervos Network is one such blockchain that has decided POW is a better fit for their blockchain model and what they want to achieve. Nervos is leveraging advancements in blockchain technology and building solutions to the limitations of POW.
It is argued that some advantages of POW over POS include:
- With POW, long term monopolization is difficult because changes of external factors such as technological advancements, regulation and energy consumption affects mining. This results in the necessity of continued reinvestment of time and resources to be competitive; a desired characteristic of a decentralized blockchain.
- POW is a simpler model resulting in fewer potential security holes.
- POW is fairer towards participants to a system. In POS systems, it is difficult to compete with early participants because rewards are deterministic. Simply put, early and wealthy participants have less competition from later participants.
- Governance with POS has some issues.The more tokens one has, the more they can change the rules of the network.
Some arguments for POS over POW include:
- POS is Incredibly cheap to operate in comparison to POW systems with minimal hardware required.With POS, mobile phones can have sufficient power to operate as a node. Although phones are not designed to run 24 hours a day, this demonstrates the small power consumption required with potential long term implications catering for mass adoption.
- In POS, individual stakers increase the decentralization of the network.
- Transactions are faster and cheaper.
The above comparisons are broad generalizations. There are about 1000 blockchains being constantly developed, with technology and the solutions they bring, evolving all the time.
It can be argued that in the fiercely competitive and fast-paced industry of blockchain, the pros and cons of any type of consensus mechanism are continually shifting, depending on what the blockchain protocol is trying to achieve. An example of this is that POS wasn’t considered as secure as POW, however with the development of the Cardano blockchain, Cardano is now considered one of the most secure networks in the industry. Whatever your thoughts and preferences, blockchain technology is dynamic and the applications endless. Having multiple goals and solutions all contribute to the decentralization ideology that originally sparked this industry.
The opinions shared within this article are those solely of the MELD Ambassador. Note that the content within should not be considered financial, legal, or tax advice. Neither the author nor MELD Labs PTE Ltd. are financial, legal or tax advisors. None of this content should be used to make any form of financial, tax, or legal decisions. Do your own research and consult professionals as needed for official policies, restrictions, and requirements in your jurisdiction.
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