Proof of Work
PoW’s mode of operations is based on miners competing to solve cryptographic puzzles, with the first one to solve it being rewarded with the blockchain’s underlying native cryptocurrency. The “puzzles” are tranches of transactions that miners compete to validate.
Each answer to a puzzle constitutes a hash. In addition, these transactions attract a fee. Therefore, the higher the hash rate for the miner, the faster it solves a puzzle. However, due to the complexity of the cryptographic puzzles, it takes large computational power to solve them, consuming a lot of electricity.
The PoW mechanism operates as follows:
- A blockchain network provides a transaction to its ecosystem.
- The thousands of computers connected to the network (known as miners) compete to validate the transaction by generating the required hash.
- The miner that validates the transaction first (and hence is the first to solve the “puzzle”) gets a cryptocurrency token.
- The network generates another block, with the previous transaction forming part of its structure. This is replicated severally, hence the term “blockchain.”
By incorporating part of the previous transaction, the network creates a signature, ensuring that no fraudulent transactions are added to the network. The leading network in Proof of Work transactions is the Bitcoin network, followed by Ethereum.
On average, the Bitcoin network generates a block every ten minutes. The Ethereum network is faster, churning out a block after every sixteen seconds, on average.
The higher the number of nodes connected to a network, the harder it is to solve the puzzles presented. Therefore, it is more difficult to get a token from popular networks like Bitcoin and Ethereum.
Proof of Stake
Proof of Stake (PoS) was created as a solution to the high amount of energy consumed in the PoW mechanism.
PoS validates transactions based on the number of tokens owned by a node. This number of tokens is what constitutes a “stake.” You can think of it as having shares in a company. The more shares you hold, the stronger your influence in the company.
In PoS networks, the number of tokens is pre-determined by the network creators, meaning that only transaction fees are generated. However, the network works to validate transactions, which is the same as PoW.
Because the network does not reward transaction validators based on their ability to “mine,” it selects them depending on their stake. For example, if you have an equivalent of 5% worth of tokens native to the network, you can only validate 5% of transactions per block.
The influence of mining pools
Due to the rise in the popularity of blockchain technology and cryptocurrencies, in particular, it became increasingly difficult to make a significant profit when mining using a single or a few computers.
To tackle this problem, it has become more profitable to create groups of computers with high power to synchronize their mining abilities. Consequently, there has been an upsurge of mining firms operating factory-scale mining activities, with thousands of workers employed and millions of dollars invested.
Mining pools have been criticized because of the belief that they increase the potential for 51% attack. This kind of attack refers to a situation where more than 50% of a network hash power is controlled by a group of nodes controlled from a central location. This is an existential threat to the Bitcoin and Ethereum networks because there are very few mining pools controlling more than half of their hash power.
The other criticism against mining pools is that they are seen as a contradiction of the essence of the decentralization concept, which is the backbone of blockchain technology.
Due to its technical setup, it is not possible to launch a 51% attack on a network running on PoS. This is because the attacker would have to own more than half of the currency available on the network.
As of now, nobody owns that much currency on any of the leading PoS networks. The only way to own that much Ether, for example, would be to buy billions of dollars worth of ETH. Such a move would inevitably lead to a spike in demand, with the price rising to astronomical highs. That would render such an attack unprofitable.
Why is PoS more efficient than PoW?
(1) The PoW ecosystem is not based on rewarding computational power. It is not possible to centralize a blockchain based on PoS. On the other hand, PoW networks are facing the threat of centralization from mining pools.
(2) Perhaps the most controversial aspect of PoW is its high energy consumption. Due to the struggle for computational power, it takes high-capacity computers to mine. In fact, last year, it was estimated that if Bitcoin was a country, it could have been the 12th largest energy-consuming country in the world!
(3) Because of the requirement that the validation capacity in PoS is proportional to the currency/tokens owned by the validator, PoW is considered deflationary. For each transaction validated, a proportional number of coins are withdrawn from circulation. This ensures that the network does not suffer from an oversupply of currencies. PoW coins are mined and added to circulating currencies.
Proof-of-stake and Proof-of-Work are the standard networks in the blockchain ecosystems and the basic terms you should know when learning about cryptocurrency. They are interrelated but different in their rewards to validators. However, PoS is an improvement on PoW and is more efficient in energy consumption, and is safer from 51% attacks and centralization.