I imagine that there are a few people who haven’t heard about Bitcoin and the miners who labor to mine new bitcoins. But few of you might know that Bitcoin uses a proof-of-work algorithm to validate transactions. Do know how it works? If you don’t, we’ll get back to it. More importantly, do you know that there is another possible algorithm?
You might have heard recently about the launch of a new cryptocurrency platform Cardano. It’s an ambitious project, which relies on an algorithm, called proof-of-stake. It’s not the only cryptocurrency to use proof-of-stake and probably won’t be the last.
It’s natural to wonder what proof-of-stake is and why Cardano has chosen it instead of proof-of-work. What’s the different between them?
To help you gain an understanding of the matter, today we’re going to talk about the difference between proof-of-stake and proof-of-work and their advantages and disadvantages. Keep on reading if you’re interested in learning something new about cryptocurrencies.
#1. What’s the history behind the algorithm?
The proof-of-work algorithm dates back to 1993. Cynthia Dwork and Moni Naor developed it first as a way to prevent email scams and DoS attacks. Later in 1999, Markus Jakobsson and Ari Juels named the method Proof-of-work (PoW) in their paper.
However, the algorithm gained popularity with the invention of Bitcoin. Satoshi Nakamoto, the mysterious creator of Bitcoin, saw in this algorithm the solution he was looking for to create a secure blockchain and allow nodes to reach a consensus.
On the other hand, proof-of-stake (PoS) is a relatively new idea. Sunny King and Scott Nadal first introduced it in 2012, but some point out that it was first mentioned by a forum user named Quantum Mechanic a year before that.
The primary incentive for the development of the PoS is to provide an alternative to POW, an alternative, which you be cheaper and more efficient, but would still be secure enough to validate transactions.
As a new concept, it’s still in development and experts are still g trying to come up with a solution to potential problems. More about that later one. Currently, it’s been employed and by cryptocurrencies like Peercoin, Blackcoin, Cardano, and Ethereuim. It’s very probable that we would see a lot of development in the future years.
#2. How does the proof-of-work algorithm work?
The proof-of-work algorithm is a complicated mathematical puzzle, which requires a significant computing power to solve it. The puzzle shouldn’t be too hard because, otherwise, generating a block of transactions would take forever. On the other hand, it shouldn’t be too easy because the network would be vulnerable to spam or DoS attacks.
Bitcoin, for example, uses hash functions, which get more difficult with time. Explained simply, you have to find the output if you know the input, and it has to start with a certain number of zeros. It might sound easy, but it’s quite the challenging because you have to make hundreds of guesses until you reach the correct answer.
So, if you want to add a new block of transactions on the blockchain, you have to solve the puzzle. This process is called mining, and the people, who do it are miners. They are “miners” because the process of validating transactions and adding blocks to the blockchain creates new bitcoins, which the miners received as a reward for completing their job.
The newly created bitcoins are also an incentive for the miners to try solving the equations. Here comes of the future problems that may arise. Bitcoin’s supply is limited, and bitcoin creation will stop around 2140. After that, miners will have to rely only on fees they receive, which might discourage some people from participating.
Everyone can be a miner as long as he has a computer with enough power to solve the mathematical problems. However, he is going to compete with the rest of the miners to find the solution to the puzzle first, because the first to succeed gets to add the block and receive the rewards. There is no reward for finishing second or third or even a consolation prize.
In reality, what happens is that a lot of people are solving the same problem at the same time. It might not be such a problem if mining doesn’t require a significant amount of computing power and electricity.
In fact, it’s so energy-consuming that bitcoin miners use as much electricity as a country like Hungary or six million USA household – over 66 TWh. If you want another comparison - experts estimate that the mining of a single bitcoin takes as much electricity as you’d need to power your home for a week. And the estimated global mining costs are over $3 million.
What’s more, mining is not for everybody. It favors those with better equipment – computers with a lot of CPU to carry out the complicated mathematical equations. If your computer is weak, you have no chance of solving the problem first, and you’ll only end up with a damaged computer after a while because mining wears out the hardware quickly.
That’s why people some people have created mining farms – professional grade computers with effective cooling systems, whose purpose is to mine the next bitcoin. Another solution to the cost problem is mining pools – people gathering and pooling together their computer resources to increase their chance of being the first.
All the people in the mining pool divide the reward between themselves based on their contribution. What could be the bad thing about this, you might ask?
As you might know, one of the main principles of the blockchain is decentralization – e.g., no intermediary, no central institution to control or supervise. However, these mining pools are growing larger and larger, and fears exist that they might influence the way the blockchain works and functions if they gather enough influences.
It’s entirely possible for a group which controls more than 51% of the network to reverse transactions, monopolize the system, and carry out what’s known as a 51% attack.
Some might say that the proof-of-work algorithm is not fair, although “fair” is a relative term here. Because the equations get harder and harder, you need more and more CPU. While at the beginning it was possible to mine bitcoins with a laptop, now the competition is such that you don’t stand a chance if you don’t have high-grade professional equipment worth thousands of dollars.
Although proof-of-work is a solid algorithm, there are a couple of things that make it inefficient – high cost, wasting resources, and possible centralization are the main ones.
#3. How does proof-of-stake work?
Since proof-of-work requires so much electricity, people have been searching for a cheaper and more effective way to validate transactions. That’s where proof-of-stake emerges into the spotlight. Although there are still some security concerns with proof-of-stake, Cardano’s Ourborous seems promising. So, let’s explain the mechanism behind proof-of-stake.
Unlike Bitcoin’s proof-of-work, which requires miners to compete with one another, the proof-of-stake algorithm takes another route. Instead of everyone wasting electricity and CPU trying to be the first one to solve the equation successfully, the proof-of-stake chooses a single person, who would be responsible for adding the new block.
This person is called a “minter” or a “forger.” His sole task is to make sure that all the transactions in the block are possible and valid and add the block to the blockchain. The process doesn’t create new coins, unlike Bitcoin. Instead of brand new coins, they get fees as a reward.
The question here is how the forger gets chosen, right? Well, it depends on his stake. For example, you want to part of a proof-of-stake blockchain. You have to put in your stake – e.g., part of the cryptocurrencies you own. For example, $100. Your friend, on the other hand, puts $3000. The one with the bigger stakes – in our case your friend – has a higher chance of being elected as a forger.
Think of your stake as the money you put in a safe deposit box. If you your job correctly – you validate and add only proved transactions and reject fraudulent ones, you’d get your money back plus the transaction fees. However, if you cheat, you’ll lose some of the money you’ve invested. So, as long as what you get is more than what you spend, it’s not in your interest to cheat the system.
Once a forget stops being a forger, his coins – the stake and the collected fees would be released back to him after a certain amount of time has passed to make sure that there are no fake transactions included in the blocks.
In addition to this, PoS blockchains are easier to join because you don’t need expensive equipment to set up a node. That’s excellent since it encourages decentralization and allows more people to be part of the blockchain without spending a fortune on machines.
However, don’t think that proof-of-stake blockchains don’t have any flaws. Can you guess one of the problems? Yes, that’s right.
Certain people might invest much more than others, which would guarantee them a place as forgers. As a result, they will collect more fees, get richer and increase their chances of being selected again. It might turn into a closed cycle, which won’t allow anybody with few stakes to join and might allow the richer one to dictate the rules.
That’s why the selection of the forgers should not rely only on their stake in the cryptocurrency. Some propose the introduction of the coin age factor, which would prevent users with large stakes from dominating the blockchain. However, it remains to be seen how effective it would be or if it will work at all.
Another potential issue would be what happens when the forger is not online to do his job. Would there be substitute forgers? Possible, every cryptocurrency will come up with individual solutions when they implement the algorithm.
It’s worth mentioning that PoS based blockchains are not so vulnerable to 51% attacks. Why? What would prevent a group of people from taking over the system? Can’t they buy over 51% of existing coins? Very unlikely. For example, if Bitcoin were to exchange algorithms, acquiring over 51% of the network would cost a fortune – more than 79 billion.
So, in a sense PoS, is much less to experience a 51% attack than POW, but it’s still possible if the value of the cryptocurrency is low.
#4. Purpose of PoW and PoS algorithms
Some of you might be wondering if we really need such algorithms and what their purpose might be. The simple answer is yes. We need these algorithms. Without them, there is no way to make sure that miners/forgers are doing their job as they should. Someone could quickly send himself thousands of coins and get rich on others behalf.
For those of you struggling to understand the purpose of both algorithms, let me explain it further. Back at the beginning, Nakamoto needed a way for miners to validate transactions and produce new blocks for the blockchain. What’s more, it had to prevent people from creating hundred or thousand fake pieces, which would undermine the whole network.
That’s what these algorithms are for. PoW requires too much power and time for someone to try and fake blocks because the other nodes would probably reject the transactions and the cheater would have wasted his time and resources. PoS, on the other hand, makes sure that you lose your stake if you validate fake blocks, so you’d probably lose more than you’d gain.
Another thing that you have to consider is that transactions on the blockchain are irreversible. Once you send somebody coins, there is no going back, and you can’t appeal to anyone for a refund. That’s why it’s imperative that the added transactions are correct, or there would be chaos.
#5. Proof of stake vs. Proof of work
Let’s summarize the main differences between the two algorithms:
The bottom line is that proof-of-stake and proof-of-work have their pros and cons, but they are both solid algorithms, which have proven their worth in the cryptocurrency community. The Ouroboros proof-of-stake algorithm is the first scientifically based one, so we will keep an eye on it to see how it would develop and prosper.
What do you think about proof-of-stake vs. proof-of-work? Which one is better according to you? Share your thought in the comment section.