Proof of Stake (PoS) Explained

Cryptocurrencies require a transaction verification system because they are decentralized and independent from traditional banking systems. At the time of writing, there are a half-dozen consensus mechanisms used to ensure the integrity of blockchain transactions. "Proof of Stake" is one such system.

This technique was designed as an alternative to the Proof of Work consensus mechanism — the original cryptocurrency consensus mechanism. As concerns about the environmental impact of cryptocurrency mining have grown, so has the use of PoS protocols. Investors in cryptocurrencies would be well to familiarize themselves with the Proof of Stake protocol, especially as more cryptocurrency networks look to utilize the consensus mechanism. Learn more about how it functions, its advantages and disadvantages, and some real-world applications in this handy guide.

What is Proof of Stake and How Does It Work?

In a nutshell, blockchain networks employ Proof of Stake (PoS) as a consensus mechanism for authenticating and securing transactions. Proof of Stake (PoS) is an alternative to Proof of Work (PoW) that does not necessitate a large amount of computing power to solve mathematical problems but instead requires users to keep and “stake” some of the network’s native cryptocurrency in order to take part in the validation process. In Proof-of-Stake (PoS), validators are selected to validate transactions and produce new blocks based on the amount of cryptocurrency they own and “stake,” as opposed to miners trying to solve complicated mathematical problems. With this staked sum at stake, validators have a monetary incentive to verify transactions fairly. PoS has quickly become a popular alternative to PoW in the blockchain community due to its higher security and quicker transaction times.

Goals of the Proof of Stake Consensus Mechanism

Find out the goals of the Proof of Stake mechanism here

As safety and decentralization are the main pillars of Web3, Proof of Stake seeks to continue to uphold Web34 values through its consensus mechanism. With that said, here are the main goals of the utilization of Proof of Stake:

1. Transaction validation

Proof of Stake technology is used to confirm blockchain network transactions, guaranteeing the veracity and reliability of the blockchain and its contents.

2. Increase efficiency

In comparison to Proof of Work, Proof of Stake requires less processing power to verify transactions and keep the network safe. This improves the network’s performance while decreasing its ecological footprint.

3. Increase scalability

With PoS, transaction times can be reduced in comparison to PoW, allowing for a greater capacity to process more transactions and a more scalable network.

4. Foster decentralization

When compared to PoW, the entry barrier for PoS is lower, allowing for a more distributed network in which more people can take part in the validation process.

5. Network security

PoS is implemented to strengthen network security by obstructing potential points of attack. Staking a network’s native cryptocurrency provides financial incentives and the possibility of fines for bad activity, which together serve as a deterrent against attacks on the network.

Proof of Stake in Action (Example)

Learn how Proof of Stake works with this example

Different proof-of-stake protocols use various methods to select validators. It’s not uncommon for validators to be chosen randomly, and other considerations, like how long they’ve been staking the cryptocurrency, may also come into play. To get a better idea of how PoS works, let’s look at a generalized example using a fictional blockchain network that employs PoS. Let’s say that there are ten validators in Network X and that each of them has 100 of the network’s native cryptocurrency. Network X uses a random selection process that takes into account the amount of cryptocurrency each validator has to determine which of them will validate a new block when it is added to the blockchain. Let’s narrow that down to two people — Validator A and Validator B. Since Validator A owns 120 units of Network X’s native cryptocurrency, it has the greatest chance of being chosen to validate the block. With 110 units, Validator B has the second-highest probability of getting chosen. This procedure will keep repeating itself until a validator is chosen. After a validator is chosen, they are responsible for verifying the new block’s transactions before adding it to the distributed ledger. In exchange for their honest behavior and accurate validation, validators are given a cut of the transaction fees made from the confirmed trades. A validator’s staked cryptocurrency can be fined or taken away if the validator engages in malicious behavior or performs the validation incorrectly, serving as a deterrent against such conduct. Simply put, when using PoS as a validation mechanism, each validator’s share of the cryptocurrency plus a random selection method creates a robust and efficient system for verifying transactions and adding blocks to the blockchain.

Proof of Stake vs. Proof of Work

The transactions on popular blockchain networks tend to be validated using one of two consensus techniques, Proof of Stake (PoS) and Proof of Work (PoW). Although similar in intent, the two systems take distinct approaches to achieve their goal of a secure, decentralized system. There are benefits and drawbacks to using any given algorithm, and overall, consensus methods for blockchain networks vary according to their use cases and requirements. To help differentiate between the two algorithms, let’s take a look at a quick back-to-back comparison:

Proof of Stake

To validate transactions, users in a PoS-based blockchain are selected depending on the amount of cryptocurrency they “stake,” or put up as security. For this reason, the more cryptocurrency a user has, the more likely they are to be selected to validate a transaction. The user who verifies the transaction receives a financial incentive.

Proof of Work

A user in a blockchain that relies on Proof of Work to validate transactions must first complete a certain amount of computing work. Mining refers to the process of validating transactions and adding them to the blockchain through the resolution of complicated mathematical problems. The user who submits the first correct solution will receive a certain quantity of cryptocurrency as a reward.

Advantages of Proof of Stake

Learn all the advantages of using the Proof of Stake mechanism

1. Energy Efficiency

The energy efficiency of PoS far outweighs that of PoW, which necessitates a lot of processing speed. This makes PoS a greener choice than other blockchain network security methods.

2. Increased Security

Although widely contested, PoS is more secure than PoW because it requires more cryptocurrency to launch an attack on the network, which in turn increases the difficulty of the attack. Consequently, the network becomes more secure and stable since it is more difficult and expensive to breach.

3. Faster Transaction Speeds

When compared to Proof of Work, the time it takes to validate transactions and produce new blocks can be significantly reduced with Proof of Stake because it does not require extensive processing capacity to do so. In addition to speedier transaction times, PoS’s streamlined validation process compared to PoW is another reason for its popularity.

4. Lower Barrier to Entry

Unlike PoW, which requires expensive mining equipment and specialized knowledge to participate in the validation process, PoS has a lower barrier to entry. Because of this, the network can be both more distributed and more welcoming.

Disadvantages of Proof of Stake

Broken chain signifying the disadvantages of using proof of stake

1. Vulnerable to 51% Attacks

If an attacker can get control of 51% of the cryptocurrency staked in a network, they can effectively take over the validation process and undermine the network, raising concerns about the security of PoS. Because of this, the network’s security and stability are compromised, and malicious activity is more likely to occur.

2. Centralization Risk

A network using PoS could lead to centralization since the biggest players in the game would naturally gravitate to the role of validators, which could lead to an unwieldy concentration of power. Although there is always a randomization aspect to validator selection, the chances of a user with a higher stake will always be higher than those with lower stakes.

3. Complex

When compared to Proof of Work, Proof of Stake can be more complicated. Therefore, a more in-depth understanding of the mechanism is necessary before it can be implemented and used. However, reduced network adoption and user participation can result from this.

4. Reduced Incentive

In general, the payout for staking in PoS networks is smaller than the payout for mining in PoW networks. This has the potential to lower network security and stability because fewer users will have the financial motivation to participate in staking and maintaining its integrity.

Coins That Use Proof of Stake

Ethereum is an example of a cryptocurrency that uses Proof of Stake

Despite the technology being approximately five years younger than Proof of Work, there are quite a few cryptocurrencies on the market that have adopted the Proof of Stake consensus mechanism. Here are the top three coins that utilize PoS:

Ethereum (ETH)

Ethereum is possibly the second-most popular cryptocurrency out there to date. Decentralized apps (dApps) and smart contracts can be built on Ethereum’s distributed platform. In September 2022, Ethereum successfully fully migrated from its previous Proof of Work consensus mechanism to a Proof of Stake mechanism — dubbed Ethereum 2.0. This migration was done in an effort to improve performance while decreasing resource usage.

Tezos (XTZ)

Tezos is an open-source blockchain framework for creating dApps and smart contracts. Liquid Proof of Stake (LPoS) is the PoS mechanism used, and it facilitates both speedy and secure transaction validation in addition to extensive decentralization of the underlying network.

Cosmos (ATOM)

To put it simply, Cosmos is a distributed network of parallel blockchains that are independently powered by their own consensus mechanisms. Tendermint, the PoS technology used by Cosmos, facilitates instant, trustworthy exchanges on the network.

The Bottom Line

To ensure the integrity of blockchain networks, transaction validation, and security measures can be implemented using the Proof of Stake (PoS) consensus mechanism. The system functions on the premise that validators must “stake” some quantity of the network’s cryptocurrency in order to take part in the validation process. This collateralized coin is designed to punish bad actors and keep the network safe and reliable. The primary goals for using PoS are the promotion of efficiency, decentralization, and scalability. Much like Proof of Work (PoW), the PoS mechanism has its own advantages and disadvantages, and it’s important to understand every aspect of what makes cryptocurrency work before making any big decisions.