Proof of Work (PoW) vs. Proof of Stake (PoS)

04 Mar 2019

Blockchain-based cryptocurrency platforms are still in their early stages of development. Beginning with the blockchain-enabled Bitcoin (BTC) network, which is intended to function as a peer-to-peer (P2P) “electronic cash system”, there are now thousands of digital assets that have been introduced. Many of these second and third-generation cryptocurrencies have been developed on blockchains or some other type of distributed ledger technology (DLT).

Dr. Stuart Haber is credited with inventing the blockchain data structure in the early 1990s, however it wasn’t until late 2008 that the first major application of blockchain technology was proposed in the Bitcoin whitepaper. Satoshi Nakamoto, the pseudonymous author of the Bitcoin whitepaper and protocol, specified for the first time how the proof-of-work (PoW)-based consensus algorithm could be used to solve the double spending problem.  

What Is Proof-of-Work (PoW)?

Achieving distributed consensus through PoW and validating blocks of transactions is carried out by miners. A miner on the Bitcoin network, or any other blockchain-based platform that uses PoW as its consensus protocol, has to solve complex math problems - in order to have a chance (or become eligible) for processing the next block (or batch) of transactions.  

These computationally difficult math puzzles are solved by full-node operators or other miners on PoW-based crypto networks such as Bitcoin and Litecoin. Miners use their computing power to generate (or hash) lengthy strings consisting of numeric characters. This CPU-intensive process is part of the protocol we refer to as PoW and it works by inputting a particular data set into a hash function (SHA-256 for Bitcoin), which then always generates a provably unique hash value.

The first miner to find a unique hash value and validate a block of transactions on a PoW-based network is compensated with newly minted cryptocurrency and transaction fees. Because PoW networks consume large amounts of electricity and have issues with maintaining network security (according to many blockchain developers), an increasing number of cryptocurrency platforms have started exploring other ways to achieve consensus and process transactions.

2013: Crypto Networks Begin Using Proof-of-Stake (PoS)

Beginning with the Nxt platform (in 2013) and a few other second-generation crypto networks such as Peercoin, distributed systems developers began experimenting with proof-of-stake (PoS)-based consensus as a way to secure and verify transactions on blockchains. As its name implies, network participants looking to validate and generate blocks on PoS networks must first stake a certain amount of their funds.

For instance, VeChain (VET), a semi-decentralized supply chain management solution, requires that block validators (referred to as Masternodes) hold a stake in the VeChain platform.

The minimum stake amount is 25 million VET (appr. $116,000) - in order to be eligible for becoming a Masternode candidate on VeChain. Users can also stake lower amounts such as 15 million VET and still be able to perform certain network management duties. Nodes that stake at least 15 million VET can expect to earn a fixed 5.81% in VET tokens as a return on investment (ROI).

On most PoS networks, a transaction validator’s stake must be locked up, so that network managers are discouraged from engaging in dishonest behavior. Should a validator try to introduce fraudulent transactions on a PoS network, then they risk losing their staked amount - in addition to other privileges. Proponents of PoS-based consensus argue that this is a more effective way of managing decentralized cryptocurrency platforms.

Most Frequently Reported Problems With Proof-of-Work (PoW)

One of the main arguments against PoW is that it requires excessive amounts of electricity to maintain crypto networks that use the energy intensive consensus mechanism. The amount of electricity required to run the the Bitcoin network is comparable to the total energy required by entire countries such as Ireland. While PoW advocates have argued that Bitcoin and other PoW-based blockchain platforms such as Ethereum (for now) may be using renewable energy, there have been many security-related issues that have adversely affected PoW-based cryptocurrency networks. 

51% attacks, during which a bad actor(s) gains control of the majority of a crypto network’s hash power, have been on the rise. During 2018, relatively smaller PoW-based cryptocurrencies such as Bitcoin Gold (BTG) were hit with multiple 51% attacks. The hacker(s) that managed to attack these networks were able to do so because these platforms are comparatively easy to target than much larger networks such as Bitcoin or Litecoin.

Since Bitcoin Gold is not secured by as many miners as much larger cryptocurrencies, it’s easier for malicious entities to launch 51% attacks on these networks. While an attacker that is able to gain majority (51% or more) control over a cryptocurrency’s hashing power is only potentially able to double spend his own coins, or funds, it still poses significant security threats and may discourage users from using a crypto platform.

Losing Trust And Bad For Reputation

For instance, the Verge (XVG) platform, a leading privacy-oriented cryptocurrency, was hit with at least three different 51% attacks during 2018. Because of this and other network security-related issues, Verge’s management lost valuable clients it had managed to sign on - including MindGeek, one of the world’s largest providers of adult entertainment.

More recently, even relatively larger PoW-based cryptocurrencies such as Ethereum Classic (ETC) were targeted with 51% attacks. Ranked consistently in the top 20 cryptos by market capitalization, Ethereum Classic may still be vulnerable to more attacks according to researchers at Parallel Industries. The crypto research firm published a report last year in which it noted “there’s declining economic incentive incentive for miners to secure … minority networks”, or those with less users helping to secure the network.

While the report by Parallel Industries specifically compared the security of the Bitcoin network to that of Bitcoin Cash (BCH), it can be argued that smaller PoW-based chains are at significantly greater risk of being compromised due to greater incentive for miners to secure the large crypto platform - provided that both networks are using the same mining algorithm..

Compared to PoW networks, the proponents of PoS chains such as the developers of the Lisk (LSK) platform believe that blockchain networks that require staking funds are more secure. When a transaction validator’s money is locked up, they will be incentivized to act honestly and work productively. This is the main argument in support of using PoS-based consensus, in addition to it being a more environmentally friendly method of managing a blockchain-based crypto platform.

Current Proof-of-Stake (PoS)-Based Consensus Protocols Have Their Own Problems

Although the introduction of large-scale PoS networks is still in its early stages, there have already been several security-related issues that have occurred recently due to improper management of these newer platforms. In September 2018, a leaked document from Maple Leaf Capital, an EOS investor, appeared to show that crypto exchange operator, Huobi may have been engaging in mutual voting as one of the 21 EOS block producers.

The leaked information also seemed to suggest that Huobi had been tipping other BPs who voted for it to continue as a BP, or transaction validator on EOS. Block.one, the Cayman Islands-registered software development company that initially developed EOS, acknowledged that the allegedly dishonest behavior on part of EOS’ BPs “did call into question the transaction reliability of the EOS blockchain.”

Blockchain Consensus Protocols Still In Preliminary Development Stages

As explained, PoW and PoS-based networks and their more advanced versions - such as delayed proof-of-work (or DPoW used by Komodo) and delegated proof-of-stake (DPoS) used by EOS and Tron - are still in their preliminary stages of development. Despite the current issues related with blockchain consensus protocols, developers in the crypto industry appear to be working on seemingly innovative and improved versions of crypto network consensus algorithms.

For instance, NEO’s developers recently told CryptoCompare that they are developing what they believe to be the best blockchain consensus algorithm, called the delegated Byzantine Fault Tolerant (dBFT) consensus protocol. As noted by NEO’s development team, this protocol is similar to the basic proof-of-stake (PoS) consensus mechanism. However, dBFT’s creators have made several changes to early versions of PoS in an effort improve it. At some point during 2020, NEO will be launching NEO 3.0, which will use the newly developed dBFT protocol and introduce other codebase modifications to its network.

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