What is Proof-of-Stake, and How Does it Work?

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By Max
Estimated reading: 7mins

What Is Proof-of-Stake in Crypto?

Proof-of-stake consensus mechanisms have become essential in the DeFi space. Investors can now earn from their favorite coins, potentially never having to sell to make great ROI.

Compared to traditional finance, it might sound too good to be true. It might seem unsustainable, centralized, and inflationary. Yet, PoS seem to be the direction that the crypto industry is heading.

How does that work?

What Is a Consensus Mechanism in Blockchain?

Cryptocurrencies use decentralized, distributed blockchains. Thousands of node devices keep copies of this financial database. As people make transactions, these devices create their own blockchains based on the original.

Some blocks might be common (AKA confirmations), others might be unique. Assuming they’re all valid, how do you know which chain to upload to the actual blockchain?

There are no “correct” answers in crypto, only consensus mechanisms. In Bitcoin, whatever validator verifies the transaction first will be the “right” block. In proof-of-stake, the validator with the most coins will have the highest chance of being chosen.

Every time you trade a PoS cryptocurrency, there’s a random algorithm running. Validators can influence their probability by putting more tokens at stake.

What Are the Different Kinds of Consensus Mechanisms?

Consensus mechanisms inspire by factors like processing power, token quantity, holding history length, memory capacity, and activity. There’s no universal agreement as to what criteria are best. The most popular ones are:

  • Proof-of-Work relies on processing power. It’s about solving a math puzzle that gets more complex with every block (only via trial and error).
  • Proof-of-Stake relies on stake amount, stake time, and randomness. A simplified way to understand PoS is to replace “staking” with “lending.”
  • Delegated-Proof-of-Stake. Validators can still lose won blocks if their device isn’t 24h available. DPoS allows them to select delegates to run validator devices for them, improving security. E.g., Cardano, Tron, EOS.

Alternative consensus algorithms include:

  • Proof of history
  • Proof of capacity
  • Proof of elapsed time
  • Proof of activity
  • Byzantine Fault Tolerance
  • Proof of burn
  • Proof of authority

How Does Proof of Stake Work?

For users, staking might be as simple as a “Stake” button on a Defi platform. But how does it work behind the scenes? Suppose you send Ethereum using a PoS blockchain:

  1. The algorithm will randomly choose a validator. The more tokens staked, the better the chance.
  2. If the validator isn’t available, the process repeats. If it is, it verifies the block.
  3. Nodes add your transaction to their blockchain, increasing its “confirmations.”
  4. After enough confirmations, your transaction is complete.

Even though PoS has existed since 2012, it didn’t become mainstream until 2020. To understand what makes it so different, let’s compare it with the first-ever consensus model: Proof of Work.

Proof of Stake vs Proof of Work

Have you noticed? Very few proof-of-work tokens rank in the Top 20 of CoinMarketCap. These are mostly old coins launched before 2014.

Not only PoS is more popular, but some PoW coins like Ethereum have switched to this consensus method. Is it really that big of a difference? Let’s see:

  • Validation Process: PoW validators are “miners” who rely on hardware processing power to validate blocks. PoS validators are contributors who win blocks based on randomness, token amount, and history length. To become a validator, you have to meet the minimum storage space and token amount (e.g., 32ETH on Ethereum 2.0.).
  • Incentives: All PoS validators receive rewards for their stake. In PoW, only the winner earns block rewards, which is typically a “pool” of mining devices. PoW rewards tend to be lower and harder to get. PoS rewards are variable yet somewhat stable, as long as there’s a reliable deflationary system.
  • Security: Both consensus models are vulnerable to 51% attacks. In PoW, you’d need to control 51% of the computing power (very expensive on large networks). In PoS, you’d need to own 51% of the whole network’s cryptocurrency.

Now, it’s not enough to only compare proof-of-stake vs proof-of-work. PoS has as many cons as pros, and every project manages them differently. It doesn’t mean that every PoS cryptocurrency will outperform Bitcoin.

Proof of Stake: Advantages and Disadvantages

It seems proof-of-stake has become the standard for modern blockchains. Most major coins use some variation of PoS. Polkadot, Tezos, Cardano, Tron, Cosmos, EOS, Avalanche.

That doesn’t mean it’s the perfect consensus mechanism. For non-PoS, it might seem like the only viable option. But its features don’t come without trade-offs.

The Proof of Stake advantages are:

  • Efficiency. It saves 99% of the energy consumption of PoW.
  • Accessibility. You don’t need special hardware or tech knowledge to stake.
  • Speed. When comparing proof of stake vs proof of work, you’re comparing seconds to minutes.

The Proof of Stake disadvantages are:

  • Centralization risk. Despite randomness, the largest holders control the network most of the time. This can become a problem depending on the network size. ETH has ~300,000 validators while BSC has 21.
  • Volatility. If a PoS token relies too much on the staking amount, it might behave like a liquidity pool. Lower market caps correlate with higher APYs and price volatility. Which is risky considering lock periods.
  • Variable APYs. If you lock a token for 90 days at 15% APY, that rate will change every day. Even though you can’t “lose” staking, you might if the token price falls. Staking APY tends to decrease long term.

Despite limitations, it seems proof-of-stake is the best solution so far. Not only it outperforms PoW but also encourages community building. Besides staking, users are more likely to contribute with their ideas to improve the blockchain.

PoW is about competition, PoS is about teamwork. The question is, what proof-of-stake blockchain is the best?

If you believe Pulsechain could be “the one,” stake PLS, PLSX, and LOAN tokens with our Liquid Loans validator.

FAQ

Here are more specific Q&As about proof-of-stake and consensus methods.

Is Bitcoin Proof of Stake or Proof of Work?

Not only is Bitcoin proof of work, but it’s the largest PoW blockchain today. Which also makes it the most expensive for crypto mining and network attacks. Bitcoin’s algorithm makes PoW more intensive as validators mine more blocks.

Bitcoin has over 15,000 nodes and consumes ~0.55% of the global electricity production. While Bitcoin could become proof-of-stake, it’s unlikely. Validators won’t give up their mining profits, which come from a handful of pools controlling most of the block rewards.

Is Ethereum Proof of Stake or Proof of Work?

The current ETH blockchain (Ethereum 2.0.) has been proof-of-stake since late 2020. The network has become more scalable, cheaper, and faster. So have all other apps backed by ERC-20 tokens, which now allow staking.

ETH supported both PoW and PoS until merging into a single PoS chain in 2021. Note that proof-of-work still exists on earlier Ethereum forks such as Ethereum Classic and Expanse.

Will Proof-of Stake on ETH2.0 Reduce Gas Fees?

Before 2.0., Ethereum gas fees were increasing, averaging $100 to $200 last year. So far, fees have been below $60 for at least six months (besides occasional spikes). So while ETH 2.0. has reduced fees, they’re nowhere near as competitive as <1$ on Binance, Solana, or Avalanche.

Is Pulsechain Proof of Stake or Proof of Work?

Pulsechain is the proof-of-stake Ethereum fork that will hopefully close the performance gap. Ethereum has more dApps than all other networks combined, and it’s because of this market size that many developers stay in it.

Now, Pulsechain allows them to copy all ERC-20 tokens to a faster and cheaper network. This benefits smaller traders, developers, and even Ethereum (because of load sharing).

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Max

Max is a European based crypto specialist, marketer, and all-around writer. He brings an original and practical approach for timeless blockchain knowledge such as: in-depth guides on crypto 101, blockchain analysis, dApp reviews, and DeFi risk management. Max also wrote for news outlets, saas entrepreneurs, crypto exchanges, fintech B2B agencies, Metaverse game studios, trading coaches, and Web3 leaders like Enjin.

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