Because we’re on the verge of Ethereum 2.0, an update that will bring game-changing revisions to what’s already a unique and innovative crypto, there seems to be a lot of hype surrounding the Proof-of-Stake (PoS) consensus mechanism. The move to a PoS system from a Proof-of-Work (PoW) mechanism is one of the most anticipated changes in this update, but we understand that all of this can seem a little intimidating to the casual trader. So what is Proof-of-Stake and what does that entail for Ethereum?
First, let’s talk about what a consensus mechanism is. In its simplest form, consensus mechanisms are what make blockchains safe. Because most cryptocurrencies are decentralized, they need a system to keep the network secure. Distributed systems and their networks use them to agree on a single source of truth.
In centralized systems, for example, the truth is decided by a single entity like the financial authorities in charge. However, in decentralized systems, many autonomous entities are needed to maintain a single network. To secure the network and validate transactions, they have to adopt an identical cryptographic mechanism to arrive at a consensus.
What it is and how it works
To give you a better idea of how Proof-of-Stake works, let’s first talk about how PoW works. Right now, the Proof-of-Work system is the more prominent system, being used in popular cryptocurrencies like Bitcoin (BTC) and the current version of Ethereum (ETH). Satoshi Nakamoto pioneered it with the release of BTC in 2009.
For an emerging technology like the blockchain, the Proof-of-Work system was incredibly secure and trustworthy. It has two main components: miners and energy. Miners, the individuals that maintain the network by running and managing nodes (or computers), use computational power in the form of electricity to solve complex mathematical puzzles. The first miner to solve the problem earns the right to add a block of transactions to the blockchain, creating a single and verifiable history of data on a PoW blockchain. That miner would then get rewarded with a newly-minted coin. This basically meant that the person with the highest mining power would have the best chance of getting paid.
Now, let’s move on to PoW’s alternative: what is Proof-of-Stake? Since the aspect of mining is completely eliminated, there’s a completely different way to validate blocks. If PoW miners use energy (or electricity) to mine blocks into existence, Proof-of-Stake validators commit stake (money) to attest blocks into existence. They do this by staking cryptocurrency on the network and making themselves readily available to be randomly selected to propose a block. Other validators on the network will then attest that they’ve seen the block and once enough attestations have been collected, it’s then added to the blockchain. All the validators who participated (those who proposed the block and those who attested it) will receive rewards.
Because of the way it’s designed, the Proof-of-Stake system creates compelling incentives for proper behavior as well as severe penalties for bad behavior. Remember that validators stake their own money in the network, so instead of paying for power costs and mining rigs, PoS validators put their money on the line through the network.
By staking your money on the chain and fulfilling your duties as a validator, you can earn rewards by proposing blocks and attestations when it’s your turn. However, if you don’t fulfill these duties, you are penalized. For example, it’s your turn to propose or attest a block. However, you weren’t online to do so and therefore missed your turn. Because you couldn’t do your job as a validator, a small amount will be deducted from your staked money.
The monetary value of the penalties will vary depending on the severity of your offense. Being offline will get you a relatively mild fee. However, more serious offenses like deliberately attacking or compromising the network could result in a more substantial deduction of your stake—possibly the whole amount. On top of that, you’ll get kicked off the network, barring you from participating as a validator ever again. Think of it this way: your entire stake being deducted is the equivalent of asking a PoW miner to burn down their full rig instead of having them pay the cost of electricity they spent on a failed attack.
Proof-of-Stake’s improved system
As secure as the Proof-of-Work system is, it has faced three main challenges in its lifetime:
Between the fancy rigs and the power bills, the barriers to entry to becoming a PoW miner can get a little high. The maintenance and verification of blocks is a highly energy-intensive process and to earn significant block rewards, miners will usually move to countries with lower energy costs. Additionally, jurisdictions will often offer lower electricity rates to corporations, meaning that you’d have to start a company and buy enough hardware to offset the efforts and costs.
On top of that, rigs aren’t exactly cheap. Remember that to get the reward, you need to beat out big companies using top-of-the-line hardware. Together, these two points significantly increase the barrier to entry for those looking to make money from cryptocurrency mining.
With the Proof-of-Stake mechanism, the energy-intensive mining rigs are entirely eliminated from the equation, meaning that the barriers to entry are much lower. However, just because it’s much lower doesn’t mean it doesn’t have a barrier to entry. It’s worth noting that to become a validator, you’ll need to put your money in. If you’re looking to become a validator for Ethereum’s Proof-of-Stake update for ETH 2.0, you’ll need to stake 32 ETH (at the time of writing, this amounts to around 89,000 USD). But just like PoW chains, there are pools you can join to help alleviate that burden.
In PoW, you can lend your processing power to a mining pool and split the rewards with others in a group. In PoS, there are staking pools you can join that will aggregate funds from participants unable or unwilling to put that much money in.
Because PoW chains have high barriers to entry, it brings a second problem: miners become more centralized. The less profitable mining becomes, the fewer people are inclined to try it out. This centralizes it into two major groups: larger conglomerates that operate in areas with low energy costs and mining pools that split rewards among all the people in the group.
Since PoS chains get rid of the expensive power costs and hardware rigs, people have more opportunities to become a validator. To become one, all you need to do is give a non-zero amount of crypto, have a stable internet connection, and a computer (or smartphone/tablet). Because you don’t need a lot to start, the doors are wide open to participate.
With the PoW system, blocks are mined consecutively. Each block can hold a certain amount of data (block size). This means that if there are pending transactions that won’t fit on the current block, they’ll have to wait for the following block to be added to the chain.
Proof-of-Stake networks, per se, do not improve scalability. However, they do provide the architectures that allow the implementation of scalability solutions like sharding. Sharding is a scaling mechanism that partitions the blockchain into multiple shard chains, each having the capability to process blocks. Because of this, blocks won’t have to be processed one at a time, meaning that transactions won’t have to wait for the next block. Instead, more blocks can be processed all at once, all without the risk of reducing security. Ethereum 2.0, for example, will partition the ETH blockchain into 64 separate shard chains. This means that the network, theoretically, will be able to process transactions at least 64 times faster.
A system of the future?
The PoW consensus mechanism is being used for some of the biggest cryptocurrencies, such as Bitcoin and Ethereum. As many problems as it has, we can’t deny how revolutionary it is in terms of security.
Although there’s a lot of promise in the PoS system, there’s no way of telling what will happen when Ethereum 2.0 finally rolls out. We have to remember that Proof-of-Stake is a new technology and remains the novel alternative to Proof-of-Work. The future developments will depend on how it proves itself in real applications, so for now, we’ll just have to wait and see how this thing goes.