Proof-of-Work and Proof-of-Stake
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At the heart of every cryptocurrency is a network of computers that helps to protect the software from malicious actors and regulates the issuance of new blocks in the blockchain.
This system is called the consensus mechanism.
The two most widely used consensus mechanisms are Proof-of-Work and Proof-of-Stake; they offer differently structured proof-of-work mechanisms.
The consensus mechanism
The consensus mechanism is an algorithm by which the blockchain verifies the authenticity and fairness of transactions. Its main task is to remove the third party from the transaction, which takes on the role of guarantor of the transaction. For example, in real estate transactions, the notary and government agencies ensure the fairness of the transaction, while in money transfers, it is the bank or another payment system. Notaries, governments, and banks charge a certain fee for their services, which increases the cost of the transaction.
When Satoshi Nakamoto came up with the concept of the Bitcoin cryptocurrency, he decided to remove the guarantor from transactions and instead transferred that function to the system itself. Since neither banks, notaries, nor governments could provide 100% guarantees while increasing the cost and duration of transactions.
To implement his idea, Satoshi Nakamoto used a concept invented by Cynthia Dwork and Moni Naor, which they presented in their 1993 research paper "On Memory-Bound Functions For Fighting Spam." It described an elegant mechanism for combating email spam, in which the sender of an email had to pay for its transmission with the processing time of their device's CPU.
The payment had to be small enough for regular users not to feel it, but significant enough to cause problems for spammers. For example, if the payment was 10 seconds of CPU processing time, a spammer would have to spend around 28 hours on 10,000 emails.
At the time, Cynthia Dwork and Moni Naor's concept did not catch on, but the idea was picked up by Adam Back, who launched the Hashcash system in 1997, which used the described concept to protect against spam and DoS attacks. Hashcash popularized the concept, and after two years, it received its current name - Proof of Work.
Proof-Of-Work
Proof-of-Work (PoW) is a cryptocurrency operating algorithm based on proof of completed work - miners solve a task to form a block and confirm transactions between all network participants. The main criterion is the computing power of the device used.
At the same time, the network difficulty (hash rate) depends on the total amount of computational power, users, and load on it. Security is ensured by the fact that the hash of each block contains the hash of the previous one, making it impossible to violate the order of creation.
To perform this work, a huge amount of computational power is required, which is provided by a large number of participants. However, this also leads to certain problems, such as high electricity costs.
But there are other difficulties associated with Proof-of-Work. As the network develops, the requirements for computational power also increase, driven by the algorithms of cryptocurrencies. This is why mining Bitcoin on weaker equipment has become completely unprofitable.
The main goal of Proof-of-Work is to protect the distributed system from various attacks such as DDoS, spam, double-spending, and so on. The essence of the algorithm comes down to complete transparency of the network with the ability to easily and quickly verify the result.
To put it simply, the Proof-of-Work algorithm ensures the network's ability to verify that the miner who is adding a new block to the blockchain has correctly performed the calculations.
Proof-Of-Stake
Proof-of-Stake (PoS) does not require a massive amount of computing power, unlike Proof-of-Work. In PoS, the blockchain is formed based on the miner's share of the cryptocurrency. That is, the probability of solving a problem is directly proportional to the user's number of tokens. Therefore, the more cryptocurrency in the account, the higher the chances of receiving a reward.
In some cryptocurrencies based on Proof-Of-Stake, there is no reward for solving a task, and the miner receives a reward for transaction fees instead.
Proof-of-Work concept originated back in 1999 as a defense against email spam, whereas PoS has a more recent history. The Proof-of-Stake idea emerged in 2011 specifically for cryptocurrencies as a solution to the main problem of Proof-of-Work - massive energy consumption.
The main difference between PoW and PoS is the energy consumption. For PoW mining, hardware is required, which also includes maintenance costs and electricity consumption. For PoS, it is enough to buy the cryptocurrency and hold it in a wallet.
In Proof-Of-Work mining, the probability of generating a block depends on the power of your equipment or the combined power of the pool you join. In PoS, the income depends on the amount of cryptocurrency you hold. The longer you hold it without withdrawing, the higher the probability of generating a block becomes.
In Proof-Of-Work, increasing earnings requires increasing the power of the equipment, which will also increase the costs.
But it's not all that simple with PoS either. If the amount of coins sent for staking remains the same, the profit may decrease.
Let's say that 1% of the total number of coins are frozen for mining, which means that the reward will also be 1%. But as soon as a large holder ("whale") enters the game, the percentage of your coins from the total number will decrease, and consequently, your earnings will also decrease.
But in case of a price drop, both PoW and PoS miners will suffer losses, but with some difference. Proof-of-Work miners will continue to receive bills for electricity, while receiving less rewards when converted to fiat currency, while PoS miners will only lose the value of their stake.
Suppose you bought Tezos cryptocurrency for $1 and staked it. But tomorrow, its price drops to $0.50. In this case, the miner will lose 50% of the liquidity of their asset, but will not incur any costs, and the tokens will still remain in the account and generate income.
Of course, one might think that PoS is vastly superior to Proof-of-Work due to its lower costs. However, it also has its drawbacks, mainly related to decentralization.
For example, cryptocurrencies based on this algorithm are protected from a 51% attack, but instead, control over the network can be seized by large coin holders who own 51% of all tokens.
Alternative options
In addition to these most common consensus algorithms, there are other approaches to achieving consensus in cryptocurrencies.
The list of these consensus algorithms can be quite extensive, so let's name a few of the most well-known ones:
- Proof of Activity is a standard hybrid scheme that combines PoW and PoS.
- Delegated Proof of Stake (DPoS) - a general term describing the evolution of basic consensus protocols based on proof of stake. DPoS is used in BitShares, EOS, and Tezos.
- Proof of Burn is a consensus mechanism where coins are "burned" by sending them to an address where they cannot be spent. By getting rid of their coins in this way, the user earns the right to lifetime mining, which is structured as a lottery among all the owners of the burned coins.
- Proof of Capacity is an implementation of the popular "megabytes as resources" idea. It requires a significant amount of disk space to participate in mining.
- Proof of Storage - a concept similar to the previous one, in which the allocated space is used by all participants as a shared cloud storage.
Hashing algorithms working with PoW
The first cryptocurrency to use Proof-of-Work (and the first cryptocurrency in general) was Bitcoin. It uses the SHA-256 hashing algorithm. However, after the first fork and the creation of Litecoin in 2013, a new algorithm called Scrypt was introduced.
At that time, progress did not stand still for a moment, and developers were looking for more efficient solutions for cryptocurrencies, which gave rise to quite a few Proof-of-Work-based solutions.
Six-Hash was an interesting solution, which was a combination of six different block hashing algorithms.
The essence of this algorithm was that a miner needed to have six ASIC chips to start minimal mining. Thus, the number of users decreases, but at the same time, the total computational power does not decrease. Six-Hash was implemented in the cryptocurrency Quark.
Later on, this algorithm spawned such upgrades as X11 (DASH), X13 (Bitcoin Diamond, Stratis, Navcoin), X14 (BERNcash), X15 (Kobocoin), and X17 (Verge). As the name suggests, they combined an even larger number of algorithms. However, initially there was no serious hardware requirement - it was possible to mine even on a CPU. One of the most popular coins on such algorithms is DASH, but to this day there are hundreds of them.
Next are various versions of the Scrypt algorithm - Scrypt-N (Vertcoin), Scrypt-jane, CryptoNote (Monero), and so on. In these, developers have attempted to decrease the probability of a "51% attack," increase GPU performance, as well as add other useful features.
How time-consuming are the calculations?
The complexity of the described operations is actually quite high, and the computational process can involve users. On the other hand, the procedure for verifying results is quite simple and not resource-intensive. Any node can receive proof of a miner generating a new block. However, due to the complexity of the computational processes performed by miners, it is very difficult to determine which one will perform faster than the others.
To verify the validity of a new block, its hash value is compared to the current target. If it is smaller, the block is considered valid. This visually demonstrates that a certain amount of work was done to generate the block.
The structure of the blockchain is such that every created node added to the chain stores information about the previous one. Modifying the "cells" is impossible. Only a new one can be "appended" at the same level, which will store the hash of the previous block. To do this, it will be necessary to perform work to generate all the previous nodes. This task is quite non-trivial and resource-intensive. This ensures reliable protection of the network against third-party interference and double-spending of tokens.
PoW and PoS
The disputes between supporters of PoW and PoS have been going on for a long time, but the nature of these disputes is mostly theoretical. In practice, the role of the developer in ensuring security is still very high.
At the same time, many consider a hybrid PoS-PoW system to be the most secure solution. This approach is already actively practiced - many cryptocurrencies have a PoW stage, during which the currency is issued through classic mining, and a PoS stage, which begins after the end of emission.
However, despite the fact that PoS systems will always be easier to implement and equally secure in terms of security, most major cryptocurrencies are unlikely to abandon PoW.
