Proof of Work (PoW) and Proof of Stake (PoS) are two of the most popular consensus algorithms used in blockchain networks. It is therefore important to understand how they work as well as what their benefits and drawbacks are.
Let’s start with defining what a consensus model is and why it is important:
What is a consensus model?
A consensus model refers to the mechanism by which multiple parties on a network agree on the state of the ledger. In simpler terms, it’s the way in which everyone on the network can agree on what transactions are valid and which ones are not.
Why is having a consensus model important?
A consensus model is a critical component of blockchain technology because it ensures that all nodes on the network are on the same page and that there is no ambiguity or inconsistency in the ledger. Without a consensus model, it would be possible for malicious actors to manipulate the blockchain by creating invalid transactions or tampering with existing ones. In blockchain there are two main consensus models which are used, proof of work and proof of stake.
How does Proof of Work and Proof of Stake work?
Proof of Work (PoW) is a consensus algorithm that requires users to solve complex computational puzzles in order to validate transactions and add them to the blockchain. A blockchain network that uses PoW requires users to expend computing power and energy to solve complex mathematical puzzles in order to add a new block to the chain.
Proof of Stake (PoS) is a consensus mechanism that requires users to stake their own cryptocurrency in order to validate transactions and add them to the blockchain. A blockchain network that uses PoS requires users to lock up a certain amount of their own cryptocurrency in order to be eligible to validate transactions and add new blocks to the chain. The amount of cryptocurrency staked will determine the user’s influence in the network.
Therefore, difference between Proof of work and proof of stake can be broken down into a single concept: Allocation of scarce resources.
Each consensus mechanism requires a different allocation of resources. With this comes a host of benefits and drawbacks for each model. We have broken them down into differences in: Security, Sustainability and Scalability.
Comparing Proof of Work vs. Proof of Stake
Economies of Scale
In PoW, as a result of economies of scale, larger players can take capital more efficiently and turn it into a profit. This means having access to better technology and cheaper electricity than the average miner who is buying second-hand validators and sourcing electricity from a home power outlet. Due to this, profitable bitcoin mining is conducted at a large scale, creating an oligopoly of a few big companies.
In PoS, on the other hand, the economic asset which must be dedicated to the network is the token itself; this creates a much more distributed level of power. Also, since anyone on centralized or decentralized exchanges can usually trade the network token, there is also a high degree of liquidity. Therefore, converting tokens into staking rewards is a much purer function of return on capital.
As shown on the diagram above, in PoW the security margin is only equivalent to the return. This is because the crypto economic capital is external to the protocol itself (physical miners). However, in PoS the assets are within the protocol, therefore the security margin is the sum of the return and the crypto economic capital. This means that for the same amount of crypto economic capital PoS offer a substantially higher security margin.
In PoW, when a malicious actor manages to control more than 51% of the network, he is in God mode. This means he is in full control and can validate any transaction he wishes, for example, he can double-spend tokens. Since in PoW the attacking assets are outside of the network there is nothing which can be done do to stop the attack. In PoS on the other hand the capital is within the network and can be slashed (burned) or can be socially intervened. This process can be atomized, and the protocol can automatically detect malicious actors and slash their assets. Furthermore, other types of attacks, such as censoring transactions, can be socially coordinated around.
In POW the amount of mining power needed to secure a protocol scales with the value of the protocol. This results in energy consumption becoming too high and the network is unsustainable. Due to this Bitcoin has experienced increasing scrutiny, consuming around 110 Terawatt Hours per year.
Comparing this to countries’ electricity consumption, Bitcoin would be in the top 30 energy users worldwide.
In the case of PoS, the only electricity needed is the power which it takes to keep a computer running. To get a better understanding of the scale of power consumption between PoW and PoS we can take a look at Ethereum. With the “Merge” Ethereum switched its consensus mechanism from PoW to PoS. In doing so, it reduced its power consumption from 77 Terawatt Hours per Year to 0.0026 Terawatt Hours per year, a reduction of 99.995%. This is because the dedication of scarce resources is not energy. It is ETH itself.
PoS is also a lot more scalable than PoW. One benefit is that the block time is 10% faster, and there is less variance in timing. The main benefit, however, is that it opens up the door to more sophisticated consensus mechanisms. With PoW, the consensus mechanisms are external to the protocol we cannot sophistically coordinate them to do more complex tasks. In PoS, it allows us to utilize sharding, which refers to randomly choosing different consensus participants to do distributed work across multiple subsets of the protocol
In conclusion, PoS is a substantially more effective consensus mechanism. When addressing security, PoS has a more decentralized power structure and higher security margins. It also allows for much higher scalability and coordination between validators all while using 99.995% less power consumption.