Proof of work is all about trust, or absence of trust, because of blockchain technology, you don’t have to trust anyone.
Your Visa, Mastercard, bank transactions are centralized systems, meaning you must trust one company or entity because they have all of the history of your transactions. Your centralized ledger.
When a transaction goes through a centralized ledger, it is verified by the central server, because of double entry systems, if you have $100 in your bank account, you can’t send $200.
This is because a central server has your transaction history and knows exactly how much you have.
With the blockchain, everything is decentralized, meaning you don’t have to trust anyone, and everyone has a copy of all transactions, the decentralized ledger.
When a transaction goes through a decentralized ledger, it must be verified by the network, also called, distributed consensus. However, your transaction lives with all of the other transactions in real-time in something called a block, but all transactions on the block must be verified through something called mining.
Now, we’re getting into proof of work, but pay attention because we’re headed into tricky territory.
The transaction could not be verified right away, it needs to be solved, what does that mean?
Imagine each transaction as a cryptographic puzzle piece, and thousands upon thousands of transactional puzzle pieces come together to form a block. This entire block needs to be solved, the process of solving that puzzle, or solving the block is called mining.
If you Google Bitcoin mining, you’ll see people with hundreds upon hundreds of computer mining for Bitcoin. They’re all trying to solve these blocks using vast computing power.
Why do some miners have a ton of computers solving the blocks? Well, because the more computers you have, the faster you can solve the blocks and it results in the monetary equivalent.
However, there’s a downside.
In the process of mining, miners are using tons of resources. First, they’re buying expensive hardware called A.S.I.C.S or application-specific integrated-circuits and then they use electricity that burns off as heat.
They can’t let the computers overheat, so in some cases, fans are installed to cool down the hardware, so you end up using even more electricity. It’s a vicious cycle. But all of that energy is used to solve the block, and after that block is solved, that block gets added to the public blockchain. But that’s not even the craziest part.
Some miners even located their mining operations in Ice Land, to take advantage of the cheap geothermal energy. So, it’s a vicious cycle of resources, but what take all these resources just to solve a block?
Well first, it’s to validate each transaction. What’s the point of having a cryptocurrency, if you can’t use it as a currency?
Second, you get rewarded.
When a miner solves a resource-intensive task of solving a block, they’re handsomely rewarded with coinage. For Bitcoin, as of today, it’s 6.25 BTC and for Ethereum, it’s 5 ETH. This is also the process in which new Bitcoins and Ether is created.
In today’s US dollars, the miners are making $100,000 – $150,000 per block. But why even mine it all? Why solve these block puzzles. It’s all about security, just think, more miners equals more security.
So that’s proof of work. It involves the process of mining so that we can validate transactions, the miners get their reward and another block gets added to the public blockchain.
What is proof of stake?
One word: wealth. In proof of stake, miners are instead called validators, there is a block that needs to be generated and there are 4 validators. Each validator deposits their money into the blockchain to get the opportunity to validate or sign a block. Validator 1, has the most money. He takes up 38% of the block, Validator 2 has a 25% stake, Validator 3 has 21% and Validator 4 has 16%.
With mining, the chances you had of solving the block was dependent on the hardware that you have, the bigger your stake, the bigger the chance you have of solving the block. So, if you’re Validator 1, you have a 38% chance of solving the block, after some random calculations, Validator 1 wins with the largest stake wins and gets to sign to the block.
Your stake percentage to win signing a block is dependent on how much you own in a stake pool, so you would be competing against many other stakeholders, not just four.
Validator 1 is rewarded not with new coinage, but with transaction fees. So the rich get richer, and why is that? We’ll get into that later.
Now is proof of stake better? Well, let’s take a look at these 4 facts.
- Environmentally friendly – Proof of stake is actually a lot more environmentally friendly than mining. With proof of work, all of the hardware that you’re using to compute and mine actually burns up a lot of energy. In order to secure a blockchain, it’s estimated both Bitcoin and Blockchain burn over $1,000,000 worth of electricity in hardware costs as part of their consensus mechanism.
While proof of work requires miners to effectively burn computational power on useless calculations to secure the network, proof of stake effectively stimulates the burning, so no real-world energy or resources are ever actually wasted.
- Deflationary fee burning – With proof of work, new coins can only be generated by solving blocks, and for Bitcoin the coin supply maxes out at 21,000,000,000 which is supposed to happen 100 years from now.While Ethereum doesn’t have a supply cap right now, they’re planning to partially burn transaction fees to make Ether deflationary so that it becomes more valuable over time. Because with proof of stake, no new coins can be generated or mined.
- Fewer cartels – Proof of stake discourages centralized cartels, right now Bitcoin has a lot of mining cartel problems which is causing the hard fork, soft fork crisis.If you go to blockchain.info/pools, as of today, you’ll see that the top 10 mining pools control 83.1% of the Bitcoin mining power, and out of the 10 mining pools, 8 of them are located in China.But there are way too many mining cartels that have too much power. Proof of stake would prevent that.
- Impossible 51% attacks – Proof of stake makes a 51% attack virtually impossible. What is a 51% attack? Here’s a rundown:
Let’s say that there are 100 nodes in a network. In a 51% attack, a bad actor must control a 51% of the network to implement an attack or hard fork the blockchain so that it benefits him. However, with proof of work mining, this is done by having more raw computing power than 51% of the entire network. That’s a very large energy expense.
With proof of stake, a validator would have to control at least 51% all-digital currency in existence, which would make it very expensive.
Ethereum is also planning to implement steep penalties for people who are trying to duplicate blocks, they’ll actually destroy your Ether and your stake.
“The intention is to make 51% attacks extremely expensive so that even a majority of validators working together cannot roll back finalized blocks without undertaking an extremely large economic loss. A loss so large, that a successful attack would no net increase the price of the underlying cryptocurrency.” – Founder of Ethereum, Vitalik Buterin
Going back to how the wealthy get wealthier. The idea is that the validator with a large stake, can contribute to the security of the cryptocurrency, and B will not endanger his large stake by manipulating the blockchain.
By doing so, he will devalue his stake or even lose it all together, and this all leads back to proof of stake being more secure and much more stable. Now, it’s not all rainbows, sunshine, and butterflies.
Here are just a few problems and possible attacks on the proof of stake system:
- Nothing at stake problem
- Initial distribution problems
- Long-range attack
- Bribe attack
- Coinage accumulation attack
- Pre-computing attack
So the proof of stake by no means perfect, but the geniuses over at the Ethereum foundation are developing a distinct POS system called Casper. That’s a whole other beast because it’s a combination of proof of work and proof of stake.