What is ‘proof-of-stake’ (PoS)?

Every blockchain uses what we call a consensus mechanism to validate transactions before they are added to the distributed database. The most popular mechanisms in use today are proof-of-work (PoW) and proof-of-stake (PoS). While PoW requires miners to solve complex cryptographic puzzles, PoS uses cryptocurrency tokens contributed by validators instead.

PoS is considered to be a faster and more efficient consensus mechanism that is better suited to scalability. These are just some of the reasons it will soon be adopted by Ethereum, one of the biggest blockchains in the world. In this AAG Academy guide, we’ll explain how the proof-of-stake mechanism works and how it differs from proof-of-work.

How does proof-of-stake (PoS) work?

In the early days of cryptocurrency, proof-of-work (PoW) — a concept brought to life by Bitcoin in 2009 — was the go-to consensus method for all blockchains. We won’t go into PoW in too much detail here because we have another AAG Academy guide on that, but in a nutshell, PoW relies on miners to solve complex cryptography puzzles to validate cryptocurrency transactions. It’s time-consuming and requires powerful hardware.

In 2012, three years after Bitcoin made its official debut, Sunny King and Scott Nadal published a paper describing a new consensus method designed to fix some of the problems faced with PoW. The new consensus method, which King and Nadal called proof-of-stake (PoS), was intended to be faster, more energy efficient, more scalable, and just as secure.

Instead of relying on miners to solve complex problems, PoS simply requires validators to stake their cryptocurrency tokens by “locking” them in. The stake acts as collateral, which can be destroyed if the validator behaves dishonestly — or does not perform their tasks in a timely manner. Validators are responsible for checking that new blocks are valid.

Anyone who has invested into a cryptocurrency project that uses PoS can stake or invest the tokens they have acquired and become a validator if they choose to. And like in the PoW mechanism, stakers and investors are rewarded for their efforts with additional tokens, depending on how many tokens they invested into the PoS system.

Staking your tokens also gives you a say in how a project is managed, and the more you stake, the more of a say you have. However, to ensure PoS projects don’t become too centralized and cannot be compromised, there is usually a limit on how many tokens can be staked. Most projects won’t allow users to invest more than 5% of the total token supply.

Examples of proof-of-stake

As this is an AAG Academy guide, let’s use AAG’s staking systems as an example of the PoS mechanism. AAG uses a single-sided staking pool, which means that all you have to do is stake your $1AAG tokens to be used in the PoS system for validating transactions. You will then earn additional $1AAG tokens as a reward for allowing your tokens to be put to work.

This particular pool receives 1.5% of the total supply of $1AAG tokens, and rewards are determined by how many tokens you stake, how long you leave them in the pool for, and whether you hold any AAG NFTs, like Genesis NFTs, which boost your reward percentage.

In the coming weeks, Ethereum, which has used the PoW mechanism since it launched in 2012, will switch to its own PoS system exclusively “because it is more secure, less energy-intensive, and better for implementing new scaling solutions,” it says on its website. This will give Ether holders the opportunity to stake tokens and become validators for Ethereum transactions.

Advantages and disadvantages of proof-of-stake

So, we know Ethereum considers PoS to be a superior alternative to PoW, and that’s certainly the case in a number of key ways. But like most things, it’s not completely perfect. It has its advantages as well as its disadvantages. Let’s take a look at those to get a better understanding of PoS, and how it differs from PoW.

Advantages of proof-of-stake (PoS)

One of the biggest advantages of PoS is that it is significantly faster than PoW because of how cryptocurrency transactions are verified. PoW requires substantial processing resources (powerful computers) to solve cryptographic puzzles, while PoS simply assigns randomly chosen validators to the task. This also makes PoS far more efficient.

A big complaint many have with PoW, particularly those who are concerned about the environment, is that it consumes far too much power. The time it takes to process transactions, coupled with the computational power that’s required, is not environmentally friendly. PoS consumes a lot less energy to achieve essentially the same result.

Furthermore, PoS is more scalable since it doesn’t require the same kind of resources and, in some ways, it’s more reliable. With PoW, miners are free to pull their resources from the chain any time they want, so if they don’t agree with the direction of a certain project, or they feel they aren’t receiving a satisfactory reward, they can walk away. If enough miners or mining pools disappear at the same time, this could negatively impact the entire blockchain.

With PoS, however, that’s less of a concern since user tokens are “locked” into the system for a certain period of time. What’s more, it’s possible to contribute tokens to help the PoS system and earn rewards without actually getting involved in the mining process, so it’s a more attractive prospect for those who cannot afford pricey mining rigs.

Disadvantages of proof-of-stake

One of the biggest downsides to a PoS mechanism is governance. Because those who invest their tokens get a say in the project, it is theoretically possible for someone with enough money to acquire a large amount of tokens and have a great influence on the project. However, many projects combat this by limiting how many tokens users can stake.

Another downside is the set-up cost for validators, who must acquire a certain amount of the project’s native cryptocurrency to get started. PoW isn’t exactly cheap, either, since it requires a powerful computer, but many of us already own one of those.

Finally, there are security concerns we must take into account. While Ethereum claims that PoS is more secure, that’s not necessarily true. The threat of attacks is just as high as it is on PoW, though it is considered to be more expensive to attack a PoS system — simply because of the amount of tokens that would need to be acquired to compromise the network.

Why do cryptocurrencies need proof-of-stake?

Now that we’ve looked at the advantages and disadvantages of PoS, you can probably see why the cryptocurrency industry needed an alternative to PoW that’s faster and more efficient in terms of its energy consumption. PoS was also designed to make things fairer — to give everyone who joins a network an equal opportunity to be rewarded for their efforts.

PoW also allows anyone to join a network in theory, but it is incredibly competitive, and the computer resources you contribute usually determine how much you can earn. That means if you have plenty to spend on the best hardware available, or you can afford to set up a dedicated mining rig, you have a better chance of earning than many others.

PoS levels the playing field. You will still need some capital to get started — or a certain amount of cryptocurrency, to be more specific — but the barrier to entry isn’t as high.

References

• What is Proof-of-stake (PoS)
• Proof of Work VS Proof of Stake: Which One Is Better?
• Proof of Work (PoW) vs. Proof of Stake (PoS)