While cryptocurrency struggles for mainstream acceptance, a different struggle has been brewing under the surface pitting digital currency developers against each other. Cryptocurrencies require a system of trust to work, but not all coins operate on the same system. Proof of work (PoW) was the original system, where colossal computing power was required to solve complex equations. This is what Bitcoin and Ethereum operate on today.
But proof of stake (PoS) seeks to improve upon that system by reducing the computing power needed to create an authentic block in the digital currency chain. By reducing the electricity needed to mine cryptocurrency, proof of stake proponents claim that the mining process is more environmentally friendly and less reliant on computers that only the richest miners can afford. However, no system has universal acceptance and proof of stake has its own issues that require addressing.
Main Takeaways: PoS vs. PoW
- Proof of stake and proof of work act as security systems to verify the uniqueness and validity of cryptocurrency transactions.
- Proof of work was the original system, which required unique equations to be solved to earn rewards.
- Proof of stake doesn’t require equations to be solved but instead randomly rewards miners based on how much capital they put up, or stake.
- Proof of work requires serious computer power and energy to solve equations, which winds up rewarding the miners with the best equipment. Proof of stake also tends to reward the wealthiest miners, but requires far less energy and greatly speeds up the transaction process.
What is Proof of Work?
Proof of work is the original security system of cryptocurrency, which was first popularized by Bitcoin creator Satoshi Nakamoto. Digital currencies have certain security risks that physical assets like cash, gold or even stocks don’t have. When you buy a stock, you own a share of a publicly-traded company that has been recorded and cataloged. Before digital brokerages, brokers would send investors actual certificates verifying their claim of ownership of the stock. You can’t buy the same shares twice, just like you can’t spend a $10 bill twice. But with a decentralized digital currency, “double-spending” poses a significant problem.
Satoshi’s solution was the proof of work system which gives Bitcoin its legitimacy. To prevent fraud and double-spending, blockchain transactions are secured by digital cryptography. Bitcoin miners solve complex mathematical equations with sophisticated computer technology in order to be rewarded with new coins. Since mining new blocks requires high-tech computers and specific expertise, attacking the blockchain with nefarious intent is exceedingly difficult.
The equations solved by miners have no real deeper purpose other than creating a unique signature on each block in the chain. Many of the criticisms of proof of work revolve around this rather pointless expenditure of computing power.
Mining Bitcoin requires more and more power as the cryptocurrency nears its maximum limit and rewards for mining decrease. More work for less pay is not a great recipe for future growth, but Bitcoin doesn’t have the high aspirations of other digital currencies like Ethereum. Ethereum currently runs on a proof of work system, but the long-term goal of its developers is to evolve into a proof of stake system, which in theory would increase access to the mining process by decreasing the computational power required to mine.
What is Proof of Stake?
Most digital currencies use the proof of work system to secure transactions, but proof of stake coins are out there, too. The first was Peercoin, which didn’t reward miners based on their ability to solve unique and sophisticated mathematical equations. Instead, Peercoin uses the proof of stake system, which rewards miners based on how many coins they already possess in their portfolio.
By using a miner’s own capital almost as a form of collateral, proof of stake solves 2 different problems. First, since the computing power needed to mine is reduced, transaction speed is greatly accelerated. Proof of stake coins can process far more transactions per second than coins using the proof of work system. And second, since possession of coins is required to mine, hackers and fraudsters would need to acquire a tremendous amount of capital to launch an attack. Buying a ton of Peercoin just to attack the blockchain would be akin to lighting money on fire thanks to the proof of stake system.
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Similarities Between PoS and PoW
Proof of stake and proof of work are both security systems used to reach what’s called “consensus mechanisms.” Since cryptocurrencies aren’t issued by a central authority, protecting digital assets from fraud has always been at the forefront of development. The consensus mechanism informs all users of the blockchain that a specific transaction is legitimate, which allows new blocks to be created.
Both proof of work and proof of stake solve the issue of double-spending and prevent cryptocurrencies from being reused. Both systems also provide an incentive to miners by rewarding them financially through either new coins or fee collections.
Differences Between PoS and PoW
Proof of stake and proof of work secure digital assets through cryptography, but the similarities pretty much end there. Not all cryptocurrency developers have the same goals and ideals and this is represented in the difference of the systems.
Proof of work is all about computational power. New blocks are created by solving one-time equations that only powerful computers can handle. These equations are unique and act as a time stamp on each transaction to verify legitimacy. Miners are rewarded with new coins for their trouble.
Proof of stake puts the power in the hands of the currency holders. To mine new blocks — or forge new blocks as PoS proponents call it — you’ll need to already be holding some of the digital currency in a wallet or trading platform. The more coins you already possess, the greater your chance of forging new blocks and collecting the reward, which in this case is a transaction fee instead of new coins. Proof of stake systems enable much faster transaction speeds but have been criticized for sending most of the rewards to the richest miners.
Securing the Blockchain Isn’t One-Size-Fits-All
Both proof of work and proof of stake have similar goals, but they take different avenues to get there. Securing digital transactions on a decentralized network has always been the biggest issue with crypto adoption and there’s yet to be a consensus viewpoint on the best way to provide this security.
Proof of work provides the more egalitarian method of rewarding its miners, but transaction speeds are slow and the process is energy inefficient. Proof of stake is faster and requires a fraction of the energy, but older miners who own the most coins reap most of the rewards and it's hard for new miners to build capital. Neither system is without its flaws, but digital currency developers have created impressive methods of providing security without a central authority.
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About Dan Schmidt
Dan has written about a wide range of topics including stocks and investing, cryptocurrencies, banking, student loans, and credit cards.