What you Need to Know About Proof of Stake vs Proof of Work

Today, the issue of moving Ethereum from Proof of Work to Proof of Stake is being actively discussed. This change can significantly affect the cryptocurrency market, which is closely related to mining...

Today, the issue of moving Ethereum from Proof of Work to Proof of Stake is being actively discussed. This change can significantly affect the cryptocurrency market, which is closely related to mining. Every investor should understand what positive and negative sides this change carries.

It would not be an exaggeration to say that Proof-of-Work is the main idea behind Bitcoin: it is the one that serves as the basis for a distributed registry.

First you need to understand what mining is. Mining is complex computer calculations that must be carried out to create a new block and add it to the blockchain.

The importance of blockchain consensus

Proof of Stake vs Proof of Work

The most important advantage of the blockchain is decentralization. This is a distributed database that jointly supported by the computers involved in it and called “nodes”. All nodes are registers, that is, they store the entire transaction history in a blockchain. The network cannot be destroyed by unloading any central server.

Information records, called “blocks”, are linked via a protocol program, and none of the existing blocks can be deleted or changed. Adding a new block is the only way to update a blockchain, any node can do this without any central command.

If a node ignores predefined standards and creates a block, other nodes ignore it. However, if an incompatible node continues to create blocks without adhering to standards and other nodes begin to create blocks on top of improper blocks, then a conflict will arise in the community. A consensus mechanism is needed to prevent the emergence of incompatible nodes that create so-called forks.

May exist malicious nodes that suppress other network nodes using a “distributed denial of service” (DDoS) attack. Such nodes can trigger false actions. Preventing this also requires a consensus mechanism.

Proof of Work

Proof of Stake vs Proof of Work

Proof-of-Work (PoW) is used when the miner’s technical equipment solves complex math problems. The miner receives a reward in the form of cryptocurrency for adding a verified block to the blockchain. Finding solutions is a complex process that requires significant computational power. As soon as the computer finds a solution, it sends a message to other computers in the community for verification. The solution is easy to verify because other computers are answered.

The key feature of this mathematical problem is asymmetry: it should be moderately difficult for the miner, but rather simple for the network as a whole. This is achieved using cryptography. Every miner in the network tries to find a solution to the problem first; at the same time, it can actually be found only by the direct enumeration method, therefore, a successful solution requires many attempts.

An example, perhaps a little fantastical, but illustrative. Imagine that you were handed a keyboard with several millions of numbered keys. You are looking for exactly the key that you need to perform the task correctly, but you don’t know its number, so you search through everything. A crowd around you is also looking for the right key. Suddenly you found the right key, telling everyone “guys, I found the key, its number is 22 875”. Everyone around is starting to check the key number 22 875, and oh yeah, this is it. The one who first found the key gets a prize. Then each is given another keyboard with a few more millions of keys on it. It all starts again.

Unfortunately, while the mining company finds solutions in the real world, it also uses a large number of real-world resources. Mining requires the constant purchase of equipment and a huge amount of electricity. People concerned about the planet and the environment are beginning to raise the issue of excessive use of electricity for mining. It takes a lot of energy to run computers or clusters that are mining. The constant turnover of equipment, arising from the fact that the process quickly wears out the components of computers, creates a massive warehouse of outdated parts. From an environmental point of view, it hurts the planet.

In addition, the fact that mining requires serious computing equipment, costing more than the average person can afford, means that the mining society consists mainly of rich and powerful people. This conflicts with the idea of decentralization in a big way, it creates the risk of being seized by a person who controls more than 51% of the computing power of the entire mining ecosystem. Considering the enormous costs of the equipment, which will allow you to make money, it is unlikely that the average person will be engaged in this business.

Proof of Stake

Proof of Stake vs Proof of Work

The idea of Proof-of-Stake was proposed for the first time on the bitcointalk forum back in 2011; a year later, the first cryptocurrencies using this method appeared – Peercoin, ShadowCash, Nxt, BlackCoin, NuShares / NuBits, Qora and Nav Coin.

Unlike Proof-of-Work, where the algorithm rewards miners who perform calculations to validate transactions and create new blocks, in Proof-of-Stake, the creator of a new block is selected by the system in advance based on its state, that is, its share in the total cryptocurrency.

The idea of a proof-of-stake is to solve the problem of proof-of-work associated with large amounts of electricity. Instead of the computational power of the participants, counts the number of cryptocurrencies in their account. Thus, instead of using a large amount of electricity to solve the PoW problem, the PoS participant has a limited percentage of possible transaction checks. The limit matches to the amount of cryptocurrency held by the participant.

Proof of Stake (PoS) is used when the miner blocks a predetermined number of coins to check a block of transactions. Cryptographic computing in PoS is much easier for computers. You only need to prove that you own a certain percentage of all coins available in a given currency. For example, if someone owns 2% of the total Ethereum (ETH), he can get 2% of all transactions through Ethereum. Some people think that PoS will be a fairer system than PoW, since technically anyone can become a miner. PoS offers a linear scale relative to the percentage of blocks that the miner can confirm based on the share of that person in the cryptocurrency exchange. This means that a person who has ten times more coins (for example, one has $10,000, and another has $1000), can create only 10 times more blocks than another.

Some believe that switching to PoS could contribute to a wider participation of the world community, as well as more complete decentralization of capacities. By snatching mining from the hands of multi-GPU farms, mining work will be evenly distributed throughout the network, which will lead to a more democratized system.

Other consensus models

Other consensus algorithms appear on the market. For example, the proportionality factor “Proof of Space”, based on how much storage space a node has. There is also PoET (proof of elapsed time) and a number of other algorithms, most of which have not yet been confirmed. In fairness, it should be said that technology continues to evolve exponentially, and it is impossible to predict what may happen or disrupt the balance in the mining world. Nevertheless, the Hydrominer is structured in such a way that we can innovate when new ideas and technologies emerge. Having several lines of business and services, you can quickly move between departments as needed to increase revenue.

Why does the Proof of Work continue to evolve and exist?

Proof of Stake vs Proof of Work

Source of the image cointelegraph.com

While PoS is definitely better than its rival, we believe that PoW will not disappear in the next ten years, its need during mining will increase.

PoW provides many benefits for participants and industry that are not in PoS.

Offer distribution. Proof of Work is much better than its opponent for distributing currency sales. Although miners are paid for their work, the costs associated with checking the found solutions require them to sell their stock of coins rather than keep them. This creates a more even distribution and liquidity in the market. The accumulation of assets is not profitable for the miner, as in the Proof of Stake algorithm, so the miner will receive a large profit for buying and selling, and not for holding.

SPV consensus and clients. In Proof of Work, when a blockchain is divided into two chains due to social or technical problems, it is much easier to determine which one has the best mining support. Miners, as a rule, follow the chain that has the largest number of completed works. This creates a more robust blockchain with less likelihood of double payment or verification.

Inflation management. The Proof of Work algorithm is excellent for the development of inflated currencies, it can at any time change the complexity of the equation to correct the creation of new coins. In the Proof of Stake algorithm, there is no cooperation between technologies and markets to regulate and maintain deflationary offer. Mining is determined by balances in the wallets of coin owners. The blocks are produced according to the established schedule, the distribution of new coins is determined proportionally, based on how many cryptoactive owners have unspent coins. In essence, the “Proof of Stake” does not leave the market mechanism able to regulate inflation. Theoretically, the development of coins through the PoS algorithm occurs stably, regardless of their value and profitability, but this completely destroys any market rules that control the development. As a result, even with a general shortage of supply, supply errors will damage the PoS-based monetary system, leaving no room for stability and hampering robust economic growth.

Quality of equipment. While working with the PoW protocol, the mining community is constantly improving the equipment used and is looking for less energy-intensive solutions. Using the best equipment is often exponentially better than less expensive counterparts when working through the PoS algorithm.

Reducing the possibility of a global attack. PoW encourages ecosystem forces working to improve the community by encouraging investment in the system — miners who use more computing hardware for the blockchain and earn more cryptocurrency. First of all, it promotes honesty, because ensuring the integrity of transactions also guarantees the miner remuneration. In addition, as more facilities are commissioned and better technological equipment is introduced, it is in the interests of the miner to invest more funds in this industry in order to compete in the market. Although miners still receive a commission for each transaction they process, they still need to compete for part of the network to get a higher chance of mining, for example, Bitcoins cryptocurrency. It is much more difficult to obtain a sufficient hash rate (51%) to launch an attack on the system – this action becomes too expensive for a hacker, gives precious little reward, especially compared to mining. Today, according to experts, such an attack will cost more than a billion dollars.

Safety. The PoS algorithm creates higher security threats to the system that are not inherent in the PoW system. PoS consensus is not fixed in the physical world (with hashing equipment in PoW). Most currencies that rely on PoS also use additional mechanisms to solve security problems, often a combination of both PoS and PoW.

Forking and double payment. Proof of Stake has a serious problem: if there is a plugin the blockchain (random or deliberate), the rational behavior of users of this network is to separate the blocks on both branches. With the help of the PoW algorithm, this behavior is irrational. By splitting resources into several branches, the miner reduces the probability of finding a block. The optimal strategy in the PoW system should always be executed on one branch, since rational behavior in the PoS system is to select blocks on top of all branches that the user knows about. This problem makes it easy to make double payments or other types of attacks that come with a branching blockchain.

The rich are getting more. Unlike PoW, where the miner receives money for doing work, in the world of PoS, the more assets you own, the more you earn. In addition, in accordance with this algorithm, changes in the code of the protocol are not determined by the miner agreement, they are determined by voting wallets. The protocol weighs votes based on the stock of wallets. Therefore, the one who has the most money has the most influence on the vote. This means that a small group of wealthy miners can control the entire mining network, voting for the changes that benefit them. Within such a system, a large organization or a rich group of people, such as the central bank, can use the money to buy huge amounts of coins in the PoS algorithm, holding them until their wallets are eligible to vote.

Having seized power in the system, the control of interests in the PoS network could vote for the removal of restrictions on supply. And since they have the highest stocks of coins, they get the highest return in the whole system – they have control over the entire money supply. Such a vote would, in effect, create a central bank allowing controllers to use and distribute newly issued coins at their discretion. In other words, they can pursue a central bank monetary policy. Consequently, economic cycles, politics and corruption will enter the system, turning the PoS-based economy into total chaos.

Apathy of participants. In delegated PoS, one of the main problems is the apathy of voters. Many people vote once, forget to change their vote or vote for a proxy, forget to follow the results. Voter apathy is a sign that incentives are not properly established in the system. When power is in the hands of users who have a long-term commitment of capital to the project, they have more incentives to vote because they cannot sell for months or years. According to the existing system of delegated evidence, most users prefer to passively make decisions made by others, and then vote to sell the token. When users have the ability to “vote without commitment”, the balance of power changes completely.

Accumulation of assets. POS encourages the accumulation of assets, which is great for speculation, but not for the development of cryptocurrencies or ex liquidity. Since PoS rewards people for the number of coins they have, it would be natural to keep the coins, not to distribute them. This means that liquidity will decrease, and miners with most tokens will control the validation process. This contradicts the whole basis of the decentralized applications and removes the most important part of the blockchain – the trust factor.

Conclusion

Proof of Stake vs Proof of Work

Source of the image holytransaction.com

The reality is that, although the Proof of Stake algorithm copes with some of the problems that exist when the Proof of Work mechanism works, it creates several completely new and different problems. In the cryptocurrency world, the Proof of Work algorithm is the most common protocol. In the Bitcoin world, Proof of Work is the only protocol. In the PoS world, most cryptoactives use a combination of two algorithms. Understanding the reasons behind this all explains why PoW still remains the driving force behind the blockchain community.

In the end, some of the most actively mined currencies (for example, Bitcoin) will reach their limit of tokens. At this point, they will have to switch to Proof-of-Stake. Since it significantly reduces power consumption and does not require such high computing power, gradually all cryptocurrencies will switch to the non-extractive model.

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