Proof of Work vs Proof of Stake

How does a blockchain decide?

The central appeal of blockchain technology is its decentralized architecture. Instead of having a central authority decide on a given state of a shared ledger, participating nodes must agree on a single state of the world. Does Alice still own 5 Bitcoin or has she spent a few on her shiny new car? In a centralized ledger, a bank has this information tied to its servers und updates the ledger in a centrally controlled manner.

In blockchain the mechanism by which a ledger gets updated is a so-called consensus algorithm. The consensus algorithm of a blockchain network determines a given state of the world in a decentralized way. It mediates between all participating nodes and thus finds a shared state of the world on which all can agree.

The Proof of Work consensus algorithm

There are a number of ways to reach consensus in decentralized systems. Most prominently, in their current implementation Bitcoin and Ethereum use the Proof of Work (POW) algorithm to reach consensus. Participating nodes must provide computing power to solve a mathematical problem, which signals to the rest of the network their validation of incoming transactions. Solving the problem and broadcasting it to the network is required to add valid transactions on the blockchain protocol. Once all participating nodes have agreed on the legitimacy of a data set or so-called block, it gets added to the chain. Nodes which participate in this validation process are called miners. Besides having a common mechanism to update a shared ledger, POW helps to secure the network from attacks.

This is because in order to carry out a successful attack on the network, one needs to expend an amount of energy bigger than the potential gains expected from the attack.

The protocol in other words provides no incentive to attack the network. Manipulation of the ledger comes at the economic loss of the attacker.

In total, POW provides the network with a way to reach consensus while at the same time securing the network from attacks.

What are the costs?

Even though POW delegates control over the network across all participating nodes and secures the network from attacks, there are a number of problems associated with the current implementation of POW. These problems only intensify as the networks intend to scale in adoption and number of transactions.

Most obviously, the POW protocol is heavily energy intensive. Energy needs to be expended by the miners to validate a block. As the network scales and more miners enter the mining process to meet demand for verifying transactions, mining becomes harder and thus the energy expended to secure the protocol rises.

It can be argued that Bitcoin was constructed in such a way that it attracts the highest possible number of electricity to further secure the network. Ignoring the goal of energy efficiency, Bitcoin was coded with the primary ambition to have a decentralized and secure ledger of transactions. This observation has led many prominent theorists in the blockchain space to regard Bitcoin as a form of life which independently sets incentives to extract energy from its users. This aspect of the POW algorithm is mirrored in the relentless consumption of energy by the Bitcoin protocol. Only recently did the Bitcoin POW energy expenditure surpass the energy consumption of developed countries such as Denmark and Iceland.

If Bitcoin ever were to become a major currency in use and the use of protocol were not to change at all, one can only imagine the immense magnitude of energy waste this would entail.

Another major downside of the POW consensus algorithm is that over time principles of decentralization have been neglected. In fact, as the Bitcoin network currently stands, POW is executed by an increasingly centralized system of miners. Current implementation of POW distinguish between a user of the network and the provider of the network. Even though miners on a POW algorithm can also be users of the network, in practice most users do not have the means to participate in block mining. The probability of a miner to mine the next block in the chain depends on their relative hashing power. To guarantee steady rewards for participation in the network most miners organize in a so-called mining pool, thus handing over control of the mining equipment to a pool manager. For example, in Bitcoin the five biggest mining pools control 75% of the hashing power.

Proof of Stake as an alternative to Proof of Work

Due to the enormous costs of running a POW consensus algorithm as evidenced in the Bitcoin protocol, developers have worked on many promising alternatives. So far, the most radical solution to proof of work as the blatantly inefficient consensus algorithm has been the proposal of a new consensus algorithm called Proof of Stake (POS).

In POS so-called forgers need to lock up stakes in the form of native tokens so they can legitimately participate in the validation of transactions. In case the forgers try to manipulate the shared ledger to their benefit, the locked-up stakes get slashed. This way forgers are incentivized to validate transactions correctly.

Depending on the relative amount of tokens a forger stakes, the probability they will be chosen as the next forger rises.

Because the staking mechanism requires no waste of energy to secure the network, it can be regarded as a more energy efficient system.

Additionally, all token holders can participate in the forging of new blocks through locking up stakes. This way the network retains its decentralized character.

Potential obstacles to Proof of Stake

Despite the apparent advantages of a proof of stake consensus algorithm over proof of work, there still remain a couple of roadblocks which stand in the way of long term adoption by the community.

First, experts in the community are skeptical of the security provided by Proof of Stake protocols. Even though POS allows for more flexibility when it comes to setting up rules for the network to protect itself against attackers, some experts doubt that it can provide the same amount of security known of a POW algorithm.

Second, the adoption of Proof of Stake blockchains depends crucially on user experience and how users can benefit fully from the various characteristics of a POS blockchain. To offer users maximum convenience we need to build an efficient ecosystem around POS protocols. Pool of Stake wants to offer users a place to stake their different tokens without the need to give up control over their assets. Users who stake their tokens through pool of stake remain in control of their assets, but do not have to conform to all the different requirements necessary to staking such as constant network uptime.

Outlook for Proof of Stake

Given the obvious limitations of POW inefficiency and the contrasting dynamic design of Proof of Stake protocols, the outlook for POS protocols appears promising.

The belief in the Proof of Stake protocol design has been reflected in the recent emergence of POS protocols such as Cardano and EOS to public attention. Notably, Ethereum plans to implement its Ethereum Proof of Stake protocol Casper in 2018/19.

Over the following weeks we will try to address roadblocks in a number of block posts and suggest potential solutions to support an enthusiastic and sustainable Proof of Stake community.