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Proof of Work vs. Proof of Stake

Securing bitcoin’s shared ledger is the work of miners, and relies on an energy-intensive activity called proof of work (PoW). But there are other approaches to maintaining the blockchain, the most popular of which is proof of stake (PoS). How are they different, and why is it important?

With the launch of the Bitcoin protocol, Satoshi Nakamoto – the cryptocurrency’s anonymous creator – achieved the seemingly impossible. When anyone and everyone has control of the database, how do you keep everyone honest? How do you prevent someone from spending the same funds twice when there are no trusted third party keeping accounts?

Mining #101
The simplified version is that you make it very easy to check whether a transaction is legitimate, but very hard (though not impossible) to add new transactions to the ledger. Miners, the computers tasked with enforcing the honesty of everyone who uses the network, have to expend resources to compete for the prize of adding a new block of transactions to the blockchain and get paid with newly-created bitcoins as a result. Those resources – in Bitcoin’s case, electricity and specialist hardware – are expensive.

A miner that tries to add a fraudulent transaction to the blockchain will quickly be noticed since every miner in the network has a copy of the ledger. The rest of the network will discard the block added by the dishonest miner, and they will forfeit the prize of new bitcoins. Worse, they will have wasted resources (electricity) in the process of trying to cheat the system.

The upshot is that it is far more profitable for miners to act honestly. The only possible way they could get away with a fraudulent transaction is to have more power and influence than the rest of the network put together – and given that there are thousands of miners in total, that’s no small ask. It’s not impossible, but the financial costs of doing so would vastly outweigh the benefits.

Proof of Work
Drilling down a little deeper, Bitcoin miners have to prove they have expended resources in order to add a new block of transactions to the ledger. That is achieved through a game of digital ‘hunt the needle in a haystack’.

To win the prize, Bitcoin miners have to produce a number with special properties through a process called hashing. Hashing is ‘computationally expensive’ process – it is time-consuming and difficult to calculate a number that meets the required criteria, even for a computer. In fact, it is so difficult that the entire Bitcoin network manages to find one of them every ten minutes on average. The difficulty of this process constantly updates, so that bitcoins are created at a steady rate: the more computers join the network and the more mining power is dedicated to finding a suitable number, the harder it becomes. Every time a block is added to the blockchain, the competition restarts with updated criteria, so no one can get a head start.

It is hard to comprehend the amount of computational power that underpins Bitcoin. At the time of writing, the total ‘hashrate’ of the Bitcoin network is over 43 Exahash per second. That is, every second, more than 43 million million million (43,000,000,000,000,000,000) hashes are generated. That burns a lot of electricity – by some estimates, as much as Ireland and rising fast.

Proof of Stake
Bitcoin has received plenty of criticism for its inefficiency (Agustin Carstens, the head of the Bank of International Settlements – the central bankers’ central bank – famously called it ‘a bubble, a Ponzi scheme and an environmental disaster’). Some critics have posed apocalyptic scenarios for what will happen to the world’s energy consumption as bitcoin grows in popularity.

An alternative to proof of work emerged in 2013 and has become increasingly popular for new blockchain projects, for a variety of reasons. Proof of Stake (PoS) takes a different approach to maintain the network and processing transactions.

While in a proof of work system, miners expend a scarce resource in the form of electricity, in PoS the scarce resource is coins themselves. Each coin acts like a lottery ticket, and the odds of a given miner (or ‘staker’) being approved to add the next block of transactions to the blockchain are proportional to their coin stake. An address containing 100,000 coins has a tenfold greater chance of mining a block than one with 10,000 coins.

In a PoW system, anyone who attacks the network needs to have more hashrate than everyone else put together. They would need to invest heavily in specialized mining computers and pay steep electricity bills. In a PoS system, the attacker would need more coins than everyone else together. They would have to buy them on exchanges, driving up the price exponentially – only to find the attack on the protocol would dramatically devalue their own holdings. Like PoW, it’s far more beneficial to stay honest.

Proof of stake has some critical differences and arguably advantages over proof of work:
Low power use – no specialist and energy-intensive hardware is needed.
Low costs entailed, as a result, meaning that miners do not need to be rewarded with new coins, and coin supply can be non-inflationary.
Closer alignment of financial interests between those who hold the currency and the miners who maintain the network (PoW miners often need to sell the coins they receive to pay their overheads, pushing down prices for investors).

Nevertheless, the world’s largest and most valuable cryptocurrency network is Bitcoin, a proof of work currency. That’s because bitcoin is the first and best-established crypto, with huge network effect and the largest user base. Its technology has been battle-tested for almost ten years and never found wanting, while PoS is a relative newcomer. Whatever the drawbacks of bitcoin’s PoW, it certainly works – and that’s worth a lot when you’re dealing with the security of a $100+ billion network.