In the ever-evolving cryptocurrency world, there seems to be one constant: almost all cryptocurrencies are supported by a blockchain. You may think of the blockchain as a the public ledger whereby all transactions on a given network are stored as public information, and you are not wrong, but blockchains are so much more than that.
In order to function in the way Bitcoin does, blockchains must have what is known as a consensus algorithm. While the term “consensus algorithm” may already be enough to scare you off, it shouldn’t.
Consensus Algorithms
Consensus algorithms serve 2 purposes. For one, they ensure that the next block on the blockchain is the only one of its kind and cannot be replicated or altered. Secondly, it serves as a protection for the network, thwarting any powerful entities from disrupting/derailing the network. Though all consensus algorithms serve the same purpose, they are not all identical. Understanding this, it follows that Bitcoin’s consensus algorithm is a bit different from that of Ethereum.
As it stands, most consensus algorithms are supported by either Proof of Work (PoW) or Proof of Stake (PoS) systems. Just as it is with consensus algorithms, PoW and PoS systems reach the same final destination, but do so by different means of travel. The difference between Proof of Work and Proof of Stake, as well as what these differences mean, will be explained in the following sections.
Proof of Stake Explained
Proof of Stake, as the name implies, requires users to have stake in the network whose blockchains they are helping to build. The “miners” in a PoS are rewarded for the coins they offer up. In other words, the number of coins that are staked in order to help facilitate other transactions helps determine just how much of a reward the miner will get. Proof of Stake is not necessarily a new concept, however it is slowly but surely gaining traction in the cryptocurrency world because of the many inherent benefits.
One of those main benefits has everything to do with the miners and how they receive rewards for helping to process transactions. To understand this, you need to know a bit more about how the alternative, the Proof of Work, concept functions. In this type of system, miners do nothing more than offer up computing power in order to solve complex math problems that ultimately allow transactions to be completed and added to the blockchain.
Problems with Proof of Stake
Inherently, according to some, this system is flawed in that a miner does not necessarily need to be in possession of any of the currency in order to participate. While this, in and of itself, is concerning, what is even more distressing is the fact that, in theory, a single entity could wind up in control of more than 50% of the computing power, thus creating a situation where a single entity was in control of what is supposed to be a decentralized system.
Proof of Stake systems solve the aforementioned problems by mandating that the miners have stake in the system they are supporting. This results in a situation where the best interest of the miners align with the best interest of all users.
The exact rewards earned by a miner in a traditional PoS system work in a simple way. A miner chooses how many of their own coins they would like to stake. Once decided, the coins are designated as staked and a miner gets to sit back.
Interest on the coins that are staked are paid to the miners in specific intervals, whether that be weekly, monthly, or annually. As such, it makes sense that miners will want to stake more coins in order to reap more rewards. It also ensures that the miners who are making the most money also have a large stake in the cryptocurrency system they are supporting. You can think of that as a company offering its employees stake in the company as part of their employment. It incentivizes them in more than just one way.
Proof of Work Explained
Proof of Work is the system that is most famously associated with Bitcoin. As was touched upon before, the miners; those who process transactions, thus adding blocks to the blockchain, process transactions by performing complex math problems that verify the legitimacy of the transaction itself. The larger a transaction is, the more computing power must be offered up in order to solve it and add it to the blockchain. In the PoW system, miners are rewarded proportionally to the size of transactions they process.
People like the PoW system because, rather than one central authority controlling the processing of all transactions, the network of miners help things go. The PoW system would not work without the miners, and the miners would have no work were it not for the people making transactions. It is a symbiotic relationship, of sorts, and is perfect because it eliminates the need for a central authority.
With that being said, we have mentioned the possibility of one single entity controlling more than 50% of all computing power in a PoW system. In this unlikely scenario, there would be, in theory, a central authority that can control and manipulate the network in any number of different ways.
Which System is Better?
Now that you know more about the Proof of Stake and Proof of Work systems, you might be wondering which is the best. As is the case with many things, that all depends on your personal wants and needs. On one hand, the Proof of Work system is not environmentally friendly because it consumes a lot of power in the form of electricity.
In the same breath, the Proof of Work system is more proven and reliable, in the eyes of many, than the Proof of Stake system. As you could have probably guessed, this is true because Bitcoin is run by a PoW system, and Bitcoin is arguably the most popular and trusted cryptocurrency that exists.
Proof of Stake is by no means an inferior system, but rather one that has not exactly been proven. There are a number of cryptocurrencies that run on a PoS system, however their combined popularity does not even come close to that of Bitcoin. Over time, there is a strong feeling that this will change as the unsustainability of PoW systems is more readily publicized and acknowledged.