PoW (Proof of Work) and PoS (Proof of Stake) are consensus mechanisms needed to confirm transactions that take place on a blockchain.
When Satoshi Nakamoto was designing the first cryptocurrency in history, Bitcoin, he had to find a way for transactions to be verified without the need to use a third party (escrow). This was achieved when it created the Proof of Work system.
Essentially, PoW or Proof of Work is used to determine how the network can be sure that the transaction is valid and that someone is not trying to spend the same funds twice.
The Proof of Work is based on advanced mathematical formulas called “cryptography”. This is why digital currencies like Bitcoin and Ethereum are called “cryptocurrencies”.
Cryptography uses mathematical equations so difficult that only the most powerful computers can solve them. No equation is the same, which means that once solved, the network knows that the transaction is authentic.
Other blockchains copied the original Bitcoin code and also use the PoW model. Although PoW is an amazing invention, it is not perfect. It needs powerful computers that consume a lot of power and the number of transactions it can process at the same time is limited.
This factor resulted in the creation of other consensus mechanisms, one of the most popular being the Proof of Stake model. PoS was created in 2012 by developers Scott Nadal and Sunny King. At the time of its launch, the founders argued that Bitcoin and its Proof of Work model required the equivalent of $150,000 in daily electricity costs. This figure has since risen to millions of dollars per day.
In any case, the first blockchain project to use the Proof of Stake model was Peercoin. Initial benefits included a fairer and more equitable mining system, more scalable transactions and less reliance on electricity.
On Bitcoin’s network, the world’s most popular, each time a transaction is sent, it takes about 10 minutes for the network to confirm it. In addition, the Bitcoin blockchain can only handle about 7 transactions per second.
This has led transaction fees to increase significantly since the project began in 2009. For example, Bitcoin fees initially cost a fraction of a cent, which made the network useful for transferring small amounts. However, transaction costs have on several occasions exceeded $30. These exaggerated fees are higher than those of international transfers and make sending small amounts of money in bitcoin unprofitable.
The second most popular cryptocurrency in the world, Ethereum, also uses Proof of Work. Interestingly, the developers made some changes to the original code, which allowed the network to process transactions in just 16 seconds. While not the fastest in the industry, it is significantly faster than the 10 minutes Bitcoin takes.
On the other hand, some really popular cryptocurrencies now use Proof of Stake. One of them is Dash, which allows users to send and receive funds in just a couple of seconds.
The Proof of Stake model uses a different process to confirm transactions and reach consensus. The system still uses a cryptographic algorithm, but the purpose of the mechanism is different.
While Proof of Work rewards your miner for solving complex equations, in Proof of Stake, the individual creating the next block is based on how much he or she has “staked.” To simplify things, the bet is based on the number of coins the individual (or representative) has for the particular blockchain they are attempting to mine.
Therefore, in order to have the opportunity to validate transactions, the user must put his coins in a specific wallet. This wallet freezes the coins, which means that they are being used as staking to run the network. Most Proofs of Stake blockchains have a minimum requirement of coins needed to start staking, which of course requires a large initial investment.
However, assuming you have staked the minimum required, your chances of earning the reward (transaction fees) are tied to the total percentage of coins you own. For example, if you own 1% of the total coins in circulation and wager, you will have a 1% chance of winning each reward.
The most important theory supporting the Proof of Stake consensus mechanism is that gamblers will want to help keep the network secure by doing things correctly. If someone were to try to hack the network or process malicious transactions, they would lose all their stake. That’s why the model works so well. The more you bet, the more you win. But at the same time, the more you lose if you go against the system.
Advantages of Pos over Pow
Proof of Work blockchains reward people with the most powerful hardware, so people with more money have a better chance of winning the reward which has caused centralized organizations to buy thousands of devices (known as ASICs) that generate the most mining power. This type of operation is known as a “mining pool” and allows people to “pool” their resources to have the greatest chance of solving the cryptographic sum in the first place.
As a result, just four mining pools (of which most are located in China, where electricity is cheap) control more than 50% of the total Bitcoin mining power.
This is an unfair system, as it means that the average person has no chance of earning the mining bounty. This is where Proof of Stake is different. This model prevents groups of people from joining forces to dominate the network just to make a profit. Instead, those who contribute to the network by freezing their coins are rewarded proportionally to the amount they have invested.
The total amount of electricity required to keep the Bitcoin network functional is more than the amount of electricity used by all of Argentina. Not only is this bad for the environment, but it also slows the pace of cryptocurrency adoption in the real world. This is because electricity bills must be paid with fiat currency.
A 51% attack is used to describe the unfortunate case of a group or a single person gaining more than 50% of the total mining power. If this were to occur on a PoW blockchain such as Bitcoin, it would allow this person to make changes to a particular block. If this person were a criminal, they could alter the block to their advantage.
A recent example of a 51% attack occurred against the Verge blockchain, allowing the hacker to take 35 million XVG coins. At the time of the attack, this equated to a real value of $1.75 million.
When using a Proof of Stake consensus mechanism, it would not make financial sense to attempt a 51% attack. To pull it off, the malicious actor would have to stake at least 51% of the total amount of cryptocurrencies in circulation. The only way they could do this is to buy the coins on the open market.
If they decided to buy such a large amount, the real-world value of the coin would increase along the way. As a result, they would end up spending far more than they could gain from the attack. Not only this, but once the rest of the network realized what had happened, the individual would lose all their bets.
From all of the above what can we conclude? PoW or PoS?