What Is Proof of Stake (PoS)?

What Is Proof of Stake (PoS)?

A man looks at his cryptocurrency wallet
•••

staticnak1983 / Getty Images

Proof of stake is a consensus mechanism that gives those who own a certain amount of a cryptocurrency the power to validate transactions and create new blocks for that cryptocurrency network. Compared to other consensus protocols, proof of stake is faster, offers lower transaction costs, and requires less computational power.

Keep reading to learn how proof of stake works so you can better understand the inner workings of your cryptocurrency portfolio.

Definition and Examples of Proof of Stake

Proof of stake is a cryptocurrency consensus mechanism where the mining and security of the network are determined by the accounts with the biggest stakes in the network. The concept was introduced by Sunny King and Scott Nadal in a 2012 whitepaper for PPCoin.

Consensus mechanism is the method the computers running a cryptocurrency’s ledgers use to track transactions, communicate with one another, and maintain network security.

Under proof of stake, network members with a certain stake in the cryptocurrency are randomly chosen to create new blocks and validate new transactions. These members are then rewarded for their work.

This is different from proof of work, the consensus mechanism used by Bitcoin. With proof of work, computers known as miners compete to create new blocks and earn mining fees. With proof of stake, there is no competition.

Ethereum began as a proof of work platform but began its move toward a proof of stake platform with the launch of its Beacon Chain in December 2020. In Ethereum’s proof of stake protocol, a network user would need to stake a minimum of 32 ETH to be eligible as a validator.

How Proof of Stake Works

With proof of work, power-hungry computers worldwide compete to validate the next group of transactions, known as a block. With proof of stake, computers work together to decide which node (computer) validates the next block.

Under proof of stake, those with a larger stake—a larger amount of the currency held in a wallet—have higher chances of being selected to validate a block and earn the transaction fee.

Proof of stake has further evolved into models where those with small amounts of cryptocurrencies can pool them through a stake pool to earn rewards, or where transaction fees may be split among validators using a different methodology.

While proof of stake offers several major benefits over the more popular proof of work method, the three most noteworthy benefits are faster transactions, lower costs, and lower energy use.

The biggest downside of proof of stake happens if someone or a group accumulates more than 50% of a currency. Nodes and validators are picked by votes, and those with larger stakes get more votes. If someone accumulates 51% or more, they effectively have 100% control of the blockchain and can act in their own best interests to the detriment of others on the network in what is known as a 51% attack.

This is very unlikely with large currencies such as Ethereum, where it would require a lot of money to pull off, and is a bigger risk with smaller, more concentrated currencies.

While mining cryptocurrency tokens is rewarded and incentivized, the proof of stake system also disincentivizes bad behavior by way of slashing stake, ejection from the network, and other penalties.

Cryptocurrencies Using Proof of Stake

Networks using proof of stake are easy to find among the cryptocurrency landscape. Here’s a list of several popular platforms using a proof of stake validation method:

  • Ethereum 2.0
  • Cardano
  • Polkadot
  • Algorand
  • Nxt
  • Cosmos
  • ThorChain

Pros and Cons of Proof of Stake

Pros
  • Fast transaction times

  • Low network fees

  • Energy efficient

Cons
  • 51% security risk

Pros Explained

  • Fast transaction times: Compared to competitive proof of work currencies, proof of stake offers fast transaction times and supports higher transaction volumes.
  • Low network fees: Proof of stake currencies typically charge very low fees due to the efficient network validation method.
  • Energy efficient: Fewer computers and less competition mean proof of stake coins require relatively little energy to maintain.

Cons Explained

  • Security risk: With fewer computers in control of the network, there are added security risks. Notably, if someone controls 51% or more of a cryptocurrency, they get effective control over the entire network.

Alternatives to Proof of Stake

Proof of stake looks to be a popular consensus and validation method going forward, but it isn’t the only choice. Here are other types of blockchain validation to know about, and some of them have evolved from proof of stake:

  • Proof of work: The method behind Bitcoin, proof of work relies on miners competing to create the next block and earn a reward.
  • Delegated proof of stake: With this variation of proof of stake, users who stake their coins can vote on the number of delegates to create a new block. EOS and Cardano are examples of delegated proof of stake currencies.
  • 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.

What It Means for Individual Investors

For individual investors, proof of stake cryptocurrencies offer a lower cost and more efficient method to buy, sell, and trade currencies. That makes them more useful for everyday transactions than currencies that rely on proof of work.

Given that proof of stake requires less computational power compared to proof of work, it reduces the environmental impact of transactions on that network. That can be a factor impacting investors, especially since there have been questions about Bitcoin’s energy consumption and environmental impact.

Users on certain delegated proof of stake chains can stake small amounts of the cryptocurrency in their wallets to earn rewards for creation of new blocks or transaction validations.

For those who plan to acquire cryptocurrency through mining, proof of stake protocol offers a reprieve from expensive mining-only computer equipment.

Key Takeaways

  • Proof of stake is a method used by cryptocurrency networks to validate and confirm new transactions.
  • Proof of stake is faster, lower cost, and more energy-efficient than the more popular proof of work method.
  • Proof of stake has a security risk when a small number of owners control a large portion of the network’s currency value, but this is unlikely to occur with large, widely held currencies.