Key Takeaways
The Ethereum network is switching to a proof of stake validation method in 2022.
Proof of stake promises less energy use and faster block verification.
Centralization of earning power to early adopters is a main concern for proof of stake.
Ethereum, the second largest cryptocurrency with a current market cap of $380B+, is officially switching from proof of work to proof of stake in 2022. This blog covers what exactly that means.
A defining characteristic of most of the largest cryptocurrencies is that they are decentralized. Proponents point to this as one of their main benefits. But the lack of a central authority responsible for verifying transactions also presents a challenge. This creates the need for a consensus and validation method.
Proof of work and proof of stake are the two main ways cryptocurrency transactions are verified. Where proof of stake involves a competition to see which new block has the most crypto staked in its favor, proof of work involves a competition to see which new block has the most computational work performed in its favor.
A review of proof of work
Proof of work is what Bitcoin miners do and is likely what you have heard of. In a proof-of-work network such as Bitcoin all the computers (nodes) on the network are competing to be the first to solve a computational problem and 'prove their work,' and they get to add the latest batch of transactions to the blockchain and earn some bitcoin in exchange. This is called mining.
Pros of proof of work
Secure. Proof of work is very secure because of the operating costs of a 51% attack
Decentralized. The network is more decentralized because miners without coins can start earning.
Proven. It has been proven to be secure at a large scale (Bitcoin network as had a market cap of over a trillion dollars)
Cons of proof of work
Energy and e-waste. Miners need to invest increasing sums of money in ever-more powerful computing equipment that consume growing amounts of electricity.
Slow. Due to the lengthy process involved in solving the mathematical puzzles.
What is proof of stake?
Proof of stake requires participants to put cryptocurrency as collateral for the opportunity to successfully approve transactions. Proof of stake revolves around a process known as staking. This is a bit like voting, although with most proof-of-stake cryptocurrencies the process doesn't involve "one person one vote." Instead, participants — known as validators — stake a certain amount of crypto behind the block they want added to the chain, with different blockchains setting different limits for this amount (For Ethereum, users will need to stake 32 ETH to become a validator).
A key distinction between the two consensus mechanisms is the fact that there is an economic incentive for nodes to participate well in proof of stake. If they 'validate' bad transactions or blocks, they will face something called 'slashing' — which means they are penalized. For example, a user can lose a portion of their stake for things like going offline (failing to validate) or their entire stake for deliberate collusion.
Pros of proof of stake
Fast and scalable. Proof of stake promises greater scalability and throughput than proof of work, since transactions and blocks can be approved more quickly, without the need for complex equations to be solved.
Environmentally friendly. Proof of stake is less energy intensive and doesn’t require all the computing hardware of proof of work.
Secure. A 51% attack is also unlikely on a proof of stake network because even if a bad actor manages to purchase 51% of a crypto asset and stake all of it to dominate the blockchain, they don’t really have any incentive to act malevolently since they now have the largest financial stake of anyone in the success of the blockchain in question. Thus a 51% attack is not really a concern with proof-of-stake consensus algorithms.
Cons of proof of stake
Centralization. Proof of stake can tend toward centralization because a few early adopters could hold a majority of the coins. In certain proof-of-stake cryptocurrencies, there isn't really any limit on how much crypto a single validator could stake.
Unproven. Proof of stake hasn't really been proven on the scale that proof-of-work platforms have
Which has a lower barrier to entry?
This is debatable. The argument for proof of stake is that reduced hardware requirements means you don’t need huge upfront capital investments to stand a chance of creating new blocks. The argument for proof of work says that anyone can mine without owning a large sum of the coin already. The truth is that neither are as democratized as crypto enthusiasts wish they were.
Alternative methods of consensus
There are a number of alternatives to proof of work and stake. They are less mainstream but are interesting to consider:
Proof of authority: Blockchains using proof of authority rely on specific nodes, known as authorities, with specific permission to validate and create new blocks.
Proof of burn: To participate in mining in a proof of burn network, new participants must “burn” (a term for sending to a wallet where the coins are not retrievable, effectively destroying them). The more currency an account burns, the higher the likelihood of being selected to validate the next block and earn a reward. Slimcoin uses the proof of burn method.
Proof of capacity: With proof of capacity, nodes with the most available hard drive space dedicated to the project are in the best position to validate the next block and earn rewards. The Signum currency uses this validation method.
Proof of elapsed time: Proof of elapsed time relies on miners similar to proof of work, but uses a trusted system to reduce competition and energy use. Intel developed this method. The Sawtooth Hyperledger coin relies on proof of elapsed time.
For now, proof of work and proof of stake are the leading ways of verifying transactions without using a central authority. Proof of stake has many benefits when it comes to energy use and speed. If the Ethereum network’s transition to proof of stake is successful in 2022, we can expect more coins to follow suit.
Note: This post is not an endorsement for any cryptocurrency. It is always recommended that investors carry out thorough research and perform due diligence before pumping hard-earned money into any of these crypto investments.