Reportedly proposed here first, proof of stake is a consensus algorithm that aims to replace proof of work and improve on some of its downsides. Just as proof of work, which we explained in a previous guide, proof of stake aims to secure a blockchain without the need for a central governing body.
And while proof of work achieves this by making miners guess the answer to a mathematical puzzle, a very electrically and monetarily expensive endeavor, a proof-of-stake algorithm validates (forges) new blocks based on predefined rules that work on autopilot, eliminating the need for expensive mining hardware and obnoxious electric bills.
In its simplest form, proof of stake allows people to stake a digital asset in order to have the chance to be chosen as a validator of a new block, collecting the transaction fees from the block as a reward.
Take Ethereum for example. The project has been eyeing, for a while now, replacing its current proof-of-work algorithm with one based on proof of stake. If that happens, smart contracts will be made available that will automatically govern the proof-of-stake algorithm, allowing anyone to join the pool of validators by staking their ETH.
The more ETH one stakes, the higher the chance they will be picked to validate a new block. For instance, if someone owns 1% of the entire stake pool of validators, they will, on average, validate 1 out of 100 blocks.
While this might seem like it is unfair as it promotes the richest to get even richer, it is still more mathematically viable than current proof of work algorithms, which are somewhat of a closed network since the entry fees for miners nowadays are obscene.
Nevertheless, different modifications to the basic proof of stake algorithm have been created, tackling this exact problem of stake-to-validations ratio.
One good example is selection of validators not only based on stake, but also based on stage age. The idea is that every time a validator is chosen, they enter into a cooldown period and cannot be selected to validate another block until that cooldown ends, giving a chance to other validators with a smaller stake to be selected by the algorithm.
Some of the advantages of proof of stake over proof of work are quite obvious – others not so much. Let’s start with the former.
With proof of stake, there is no more need for expensive hardware that has the sole purpose of guessing hash values to win a mathematical puzzle. Once the mining hardware goes, the big electric bills will also be on their way.
Another thing that goes out the door with proof of stake is block rewards. Currently, miners on the Bitcoin network are rewarded 12.5 BTC for finding a valid block. At the time of writing, this 12.5 BTC is around $107,000. That is $107,000 rewarded to a bitcoin miner every 10 minutes.
This constant pump of the circulating supply of BTC makes for a volatile environment as miners are forced to liquidate assets in order to cover the extensive costs of mining. Moreover, specifically in the case of BTC, block reward halving events have usually caused extremely volatile situations, albeit usually uptrends.
With proof of stake, there is no need for block rewards as transaction fees from transactions included in each block will be rewarded to validators. This should, in theory, create a more stable digital asset environment. However, the best “side effect” of the lack of block rewards is the expected lowering of transaction fees, making cryptocurrencies more competitive with regards to traditional financial institutions.
What’s even better is how proof of stake naturally handles 51% attacks, which are one of the most common weaknesses of proof-of-work algorithms.
To do a 51% attack on a blockchain secured by a proof-of-stake algorithm, a malicious actor would have to obtain the majority of the crypto asset, which will be much more expensive compared to purchasing mining hardware, though the latter is also not realistically plausible.
However, even if they do manage to purchase 51% of a crypto asset and stake all of it to dominate the blockchain, they don’t really have any incentive to act malevolently since they now have the largest financial stake of anyone in the success of the blockchain in question. Thus a 51% attack is not really a concern with proof-of-stake consensus algorithms.
Since there is essentially no entry fee, aside from purchasing the crypto asset itself, proof of stake allows for a much more decentralized consensus protocol, whereas proof-of-work algorithms have culminated in large mining pools that band together to keep the peace, effectively eliminating the chance for small-scale operations to enter the game.
As more and more projects opt to either use a proof-of-stake algorithm right off the bat or migrate to one later on, this “challenger” to proof of work is steadily gaining speed in the crypto sphere, though the biggest proof-of-work implementation, namely Bitcoin, has yet to show any concrete signs of wanting to switch.
Projects are still heavily experimenting with the best combination of rules and methods that define a good proof-of-stake algorithm, hoping to prematurely mitigate potential unforeseen exploits of the system. As such, there is already a number of unique proof-of-stake-based algorithms that govern different cryptocurrencies, each exploring a different variation of the much-hyped consensus algorithm.