If you’re currently invested in the cryptocurrency market, then it’s important to gain a perspective on how cryptocurrencies work “under the hood”. If you’re a newer cryptocurrency investor and have begun to take a look at some of the various information resources regarding how digital currencies work, then you’ve probably come across one or both of the following terms:
- Proof of Work (PoW)
- Proof of Stake (PoS)
“Distributed consensus simply means a large pool of people who are geographically segregated agreeing on something. In cryptocurrencies like Bitcoin, ‘something’ here means agreeing on which transactions or blocks are valid and which are invalid to be added/rejected to the blockchain.”
Consensus methods are extremely important in the world of cryptocurrencies. It’s essential for cryptocurrency investors as well as technical users to understand the mechanisms that drive digital currencies.
In this article, we’ll break down the difference between Proof of Stake and Proof of Work and explain how they function to help you gain a greater understanding of how cryptocurrencies work.
Many newer cryptocurrency investors become frustrated when attempting to understand the meaning of these terms, as explanations are often needlessly complex. In reality, however, these terms are relatively simple to understand if explained correctly.
Both Proof of Work and Proof of Stake are two different kinds of computer algorithms that are responsible for the extreme success of digital currencies such as Ethereum and Bitcoin. Essentially, these two cryptocurrencies are the most popular and valuable in existence today due to these two different algorithms. These algorithms are used to achieve what is referred to in the cryptocurrency world as “distributed consensus”
What Is Proof Of Work (PoW)?
Proof of Work, or PoW, is a computer algorithm that is used by a number of different cryptocurrencies to reach agreement. Proof of Work is used by cryptocurrencies such as Bitcoin, Ethereum, Litecoin, and others, and is designed to create decentralized agreement between different nodes around adding a specific block to the blockchain.
Hashcash (SHA-256) is the Proof of Work function that is used by Bitcoin. This digital currency forces miners to solve extremely complex and computationally difficult mathematical problems in order to add blocks onto the blockchains. This function of Hashcash produces an extremely specific kind of data that is used to verify the fact that a substantial amount of work has been carried out.
Proof of Work can be considered as a lengthy endeavor that eventually produces a single piece of data that fits within the Bitcoin protocol. This process is time consuming and extremely energy intensive. To understand how Proof of Work functions in a deeper sense, we’ll need to take a look at the workflow that is followed by miners.
In order to successfully mine a block, miners need to hash the block’s headers in a manner that is less or equal to the “target”. The target, and the time of this report, is that the SHA-256 hash of a block’s header must be a 256-bit alphanumeric string. This hash must start with 18 zeros. This target changes as the difficulty changes, which occurs every 2016 blocks.
Miners are able to arrive at this particular hash, or target, by varying an extremely small portion of the block’s header. These small portions are called a “nonce”. A Nonce always starts with “0” and is then incremented every time for obtaining the required target, or hash.
As the process of varying a nonce is hit and miss, the odds of achieving the specific target required, which begins with many zeros, are extremely low. As such, many attempts must be made consecutively, with each miner varying the nonce over and over. This requires a significant amount of work on the miner’s behalf.
This process requires a massive amount of processing power, hardware sources, and energy in the form of electricity, which thus proves that a large amount of work has been performed before mining any individual block. This is why this process is referred to a “Proof of Work”.
Using this method, any miner that first obtains the correct Bitcoin Hash wins the mining reward, which is 12.5 BTC in addition to fees.
What Is Proof Of Stake (PoS)?
Proof of Stake is an alternative consensus method, or a way for different nodes to reach agreement. The Proof of Stake consensus method was first proposed by a Bitcointalk forum user in 2012 because POW required too much electricity and energy to perform. At the time, miners felt that mining a single block was a waste of time and effort.
Many studies have indicated that the electrical cost of running and maintaining Proof of Work networks like Bitcoin is as costly, if not more so, than powering millions of homes across the United States. Proof of Stake, however, uses far less power, and is therefore far more environmentally and user friendly than Proof of Work.
In the Proof of Work consensus model, the number of individual digital currency tokens each user holds in the currency in question is important. The larger the “stake’”, or amount of tokens owned, by a user, the higher the chance that they won’t breach the system. This follows the logic that the more heavily invested an individual is in a cryptocurrency, the more likely it is that they would want it to perform in an optimal manner.
Proof of Stake blocks, unlike Proof of Work blocks, are not mined. Instead, Proof of Stake blocks are forged, or minted. Participants that possess a significant stake in Proof of Stake systems are selected on a pseudo-random basis for forging blocks and adding them onto the blockchain.
The pseudo-random selection process used by Proof of Stake systems occurs after the system analyzes several different factors in order to ensure that only individuals with a large stake are selected, but others with lower stakes are also selected. Some of the factors assessed by the system are randomized block selection, masternodes and coin age-based selection.
Proof of Stake is typically applied to cryptocurrencies that are pre-mined in order to provide user with access to them for staking. This means that the overall supply of Proof of Stake cryptocurrencies are fixed from the start, and that there is no reward for block mining or forging, as their is in Proof of Work systems. The only incentive applied to Proof of Stake forging is the transaction fees associated with the specific block being minted.
PoW vs. PoS
Both Proof of Stake and Proof of work possess their own unique strengths and weaknesses. There are a range of other alternatives to these two popular consensus methods, and computer scientists and cryptographers are working every day to find newer, more efficient solutions for achieving consensus on the blockchain.
Proof of Stake can be considered to be the most environmentally friendly and cost-effective consensus method, but has a number of drawbacks that pioneers such as the Ethereum development team are attempting to solve.