Understanding Cryptocurrency Consensus Mechanisms: Proof of Work and Proof of Stake

Cryptocurrencies operate on a blockchain, a decentralised, distributed ledger. This is just like an open Excel Spreadsheet. Every participant (node) on a certain blockchain network has a valid copy of that spreadsheet at every point in time.

But how does each participant or node verify that everyone else on the network is adhering to the rules?

How does every participant on the network come to agree on an outcome without the need for a central authority?

This is achieved by what is known as Consensus Mechanism.

A consensus mechanism is a fault-tolerant mechanism that is used in computer and blockchain systems to achieve the necessary agreement on a single data value among distributed processes or multi-agent systems such as cryptocurrencies.

Simply, this helps the cryptocurrency network to achieve an outcome that all participants are okay and can live with, it allows the participants to be able to trust each other.

This mechanism or protocol differentiates the blockchain from every normal database, it is useful for record keeping. 

In a normal database, the book-keeper or the person in charge of the database has control of the records or data and can decide to alter the data. Participants of that network can not verify if the book-keeper is following the rules. This is what the consensus mechanism tries to prevent.

In the crypto space, the two most prevalent consensus mechanisms are the Proof of Work (PoW) and Proof of Stake (PoS).

Proof of Work (PoW)

Initially created to solve the problem of spam emails, PoW was invented in 1993 by Cynthia Dwork and Mani Naor. 

It would later be adopted in 2004 by the late American Developer, Hal Finney to secure digital money. In 2009, Bitcoin became the first application of Hal Finney's idea as Finney was the recipient of the first bitcoin transaction.

Proof of Work is used as a consensus mechanism algorithm for validating transactions and cryptocurrency mining.

Some notable cryptocurrencies that use Proof-of-Work as a consensus mechanism include Bitcoin, Litecoin, Dogecoin, Ethereum, Ravencoin etc.

How Proof of Work works and how it solves the problem of double spending

In order for there to be an agreement among equal nodes in a peer-to-peer network about who should be able to add to the distributed ledger or open spreadsheet, proof of work is employed.

It works by requiring some nodes in the network to compete with each other in solving arbitrary comolex mathematical puzzles to prevent anybody from rigging the system.

These nodes that carry out this job are known as miners and the process is known as mining.

The miner that wins the competition gets to be able to add the newest block of data to the previous chain after each node on the network has validated that all transactions are valid.

The miner is then rewarded with some coins, by incentivizing miners to verify the newest transactions in a blockchain, proof of work solves the problem of double spending.

Advantages of Proof of Work

• •Security: Proof of work makes a cryptocurrency more secure, there are less chances of a person or group taking control of more than half of the network in what is known as a "51% attack".

• •Rewards for Miners: By rewarding them with coins and tokens, PoW incentivizes miners to verify new transactions on a cryptocurrency network.

Disadvantages of Proof of Work

• •Energy Consumption: There are concerns about the energy consumption of Proof of Work as mining coins takes a lot of energy, sometimes even greater than that used by some countries.

• •Validation time: Verifying the integrity of new blocks of data and validating new transactions on the blockchain by proof of work takes time. For example bitcoin uses PoW and takes around ten minutes to validate transactions. This process is therefore not suitable for multiple fast transactions.

Proof of Stake (PoS)

To solve the problem of high energy consumption by coins that employed the use of proof of work, Scott Nadal and Sunny King invented the Proof of Stake mechanism in 2012. 

It was introduced to be the consensus mechanism for Peercoin. It cost a large sum of $150,000 per day to maintain the bitcoin network as at then.

The Proof of Stake mechanism looks to achieve the same outcome as the Proof of Work, of course they are both consensus mechanisms, but in a different way.

Some other cryptocurrencies that use the PoS mechanism include Peercoin, Cardano, Solana, Polkadot etc.

How PoS works 

In this system, certain nodes known as stakers lock up the cryptocurrency they own. When they do this, they are known as validator nodes. 

The tendency of a node being the one to verify new transactions and add the newest block to the chain, and earn rewards depend on how much cryptocurrency they stake.

The more cryptocurrency you stake, the higher your chance of being the node that is selected to validate the new block.

Advantages of Proof of Stake

• Security: Only stakeholders in that network can participate in staking, this creates room for greater security. There is a lesser chance of a "51% attack" in this mechanism.

• Energy efficient: Validators in PoS systems do not need to solve complex mathematical puzzles involving high power consumption like in the PoW system. It is energy efficient, better for the environment.

• Scalability: Cryptocurrencies that employ the use of a PoS mechanism are able to validate transactions faster, as a result they are able to handle multiple transactions at a time. This indicates a higher "throughput rate" and therefore makes room for scalability.

Disadvantages of Proof of Stake

• Wealth concentration: Only stakeholders with high staking power get the chance to earn rewards. In other words, this mechanism enables the "rich get richer" scenario.

It is important that you as a participant in the crypto space understand some of the mechanism and technology behind some cryptocurrency projects. It's all part of the "DYOR" process.

Ethereum's founder has stated that ETH 2.0 will be able to handle up to 100,000 transactions per second as Ethereum hopes to switch from PoW to PoS.

The future of PoW mechanism is uncertain as PoS proves to be a fairer and efficient mechanism in most ramifications. Of course, I feel that the PoS mechanism will thrive than the PoS which might see the death of cryptocurrency mining.

I am in favour of the PoS but I can not recommend a particular coin that utilizes a particular mechanism to you because as always… you have to "DYOR".

Which is your favourite among both mechanisms, PoS or PoW?

Let me hear your answer in the comments.

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