Proof-of-Work and Proof-of-Stake: what’s the difference?
If you've been investing in cryptocurrency for a while, you've heard the terms proof-of-work and proof-of-stake before. They represent two different approaches to achieving the same goal.
Bitcoin is the first viable proof-of-work peer-to-peer payment system to ever exist. In order to understand how a proof-of-stake consensus algorithm differs, we must first put the idea of reaching consensus in context.
What is a consensus algorithm, and what does it mean to reach consensus?
A consensus algorithm is a procedure that ensures all peers participating in a given blockchain network reach an agreement about the present status of the distributed ledger. It's a way to establish trust and reliability between parties that don't know each other.
A good consensus algorithm makes sure that every block added to the blockchain represents the only version of the truth as agreed upon by all nodes (computers) securing the blockchain. Proof-of-work and proof-of-stake are core inputs into two approaches to achieving consensus in distrusting distributed networks.
What is a proof-of-stake consensus algorithm?
Proof-of-stake aids consensus by entrusting nodes that are selected as validators to validate the next block of transactions. The reason it's called ‘proof-of-stake' is that for a node to be selected as a validator, it must stake tokens back to the network.
The size of the node's stake increases its chances of being selected as a validator for the next set of transactions. This means that nodes that can afford to stake a higher number of tokens have a better chance of being selected as a validator.
That may not seem fair, but it's an alternative approach to miners taking advantage of economies of scale the way they would in a proof-of-work-driven network. In addition, many projects using a proof-of-stake approach will randomly select the next validator, giving someone with less to stake a better chance of being selected.
Ethereum currently runs on a proof-of-work consensus algorithm but is planned to move to proof-of-stake in 2022 once the ETH 2.0 upgrade is complete.1
Bitcoin has no plans to transition away from proof-of-work, as many in that community argue expending energy is the best way to maximize the security of the network.
4 key ways proof-of-stake differs from proof-of-work
When it comes to consensus algorithms, both proof-of-work and proof-of-stake maintain reaching consensus within a trustless, decentralized environment as their main goal. They both reach that same goal but in different ways.
Security. A proof-of-stake environment uses stake currency as a way to grant participants permission to mine. This makes it expensive to engage in any sort of attack and makes participants more likely to stay invested in keeping the blockchain secure.2 Any malicious behavior can be pushing by “slashing”, taking away some of the funds that have been staked.
A proof-of-work environment maintains its security because miners need to commit resources to the network, namely computing power and the electricity required to run it, to have a chance of earning a reward. Anyone who wants to attack the network by double-spending coins would need to control more than half of the network's hash power, which is possible but very difficult and costly to achieve.2
Energy. Using proof-of-work requires more energy than proof-of-stake.3 Mining difficulty tends to increase over time as the amount of mining increases, which means more equipment, electricity, and cooling systems are required to keep mining cryptocurrency. Since a proof-of-stake environment relies on staking currency, not as much power is needed.4 The security of proof-of-work blockchains is a function of how much energy is expended to secure it.
Algorithm. A proof-of-work environment makes mining a competition. Competing for a reward is what keeps it secure. This means that the two algorithms aim to achieve the same sense of security in two different ways. One is not necessarily better than the other. Both make sacrifices in exchange for different advantages.
Decentralization. Both proof-of-work and proof-of-stake approaches have challenges to avoiding centralization. There are economies of scale to proof-of-work which leads to large mining facilities operated by single companies. However, proof-of-stake also rewards the richest participants, which they can then use to stake, compounding their position in the network.2
While both offer their share of advantages and disadvantages, it's clear that both proof-of-work and proof-of-stake consensus algorithms have a place in the world of cryptocurrencies.