Exploring Crypto: Proof-of-Work vs. Proof-of-Stake

Token Takeaways ✍

✨ Proof-of-Work and Proof-of-Stake are two different types of consensus mechanisms for securing blockchains.

✨ Bitcoin, the world's first blockchain, uses Proof-of-Work, while most newer networks use Proof-of-Stake.

✨ The two mechanisms both have their own advantages and disadvantages.

Blockchains are globally distributed systems. As they are not controlled by any single party, the nodes on each network have to find a way to agree on what the accurate record of data for the blockchain should be. To achieve this, they rely on cryptographic consensus mechanisms. The earliest example of a consensus mechanism for a blockchain was Proof-of-Work, introduced by Satoshi Nakamoto for Bitcoin. Ethereum also launched with a Proof-of-Work consensus mechanism but has since migrated to another type of mechanism called Proof-of-Stake. In this guide, we’ll explain how they both work, as well as the benefits and drawbacks of each.

Proof-of-Work explained ⛏

In the world of cryptocurrency, the Proof-of-Work (PoW) mechanism, first introduced with the Bitcoin blockchain, is a cornerstone for achieving consensus on the network. This method is pivotal in securing the blockchain, ensuring that all nodes reach an agreement on every transaction, which is crucial in a crypto exchange environment.

The importance of PoW extends especially to preventing “double spending,” a significant concern in the best crypto exchanges. In the context of Bitcoin, if users were able to spend their coins more than once, it would inflate the supply beyond the fixed limit of 21 million, leading to a debasement of the asset and a loss of its value.

A blockchain acts as an open ledger, recording the full transaction history of the network. New transactions are added in blocks. In Bitcoin's case, miners, integral to the crypto ecosystem, add new blocks through PoW. The "work" in Proof-of-Work refers to the process of mining, a fundamental operation in crypto exchanges.

During mining, participants in the best crypto exchanges race to solve complex computational problems, earning rewards for their efforts. Specifically, Bitcoin miners compete to find a 64-digit hexadecimal number, known as a “hash,” which must be equal to or lower than a designated “target hash.” The complexity of these problems is immense, with each block having a specific difficulty level. For instance, at the time of publication, the difficulty level stands at 14 trillion, meaning the likelihood of generating a suitable hash on the first try is 1 in 14 trillion.

The mining process, essential in the crypto exchange world, requires substantial energy and advanced hardware, with miners generating new hash possibilities at an incredible speed. It typically takes around 10 minutes for a miner to find the target hash.

Through mining on the best crypto exchanges, Bitcoin miners earn a block reward and transaction fees, incentivizing them to add new blocks to the main chain. PoW not only facilitates chain extension but also significantly challenges potential attacks on the blockchain.

For a malicious attack to succeed on the Bitcoin blockchain, it would necessitate control over 51% of the network's hashrate. However, achieving this is increasingly challenging due to the extensive network of miners contributing to the system, a critical aspect of maintaining security in crypto exchanges.

It's noteworthy that blocks can sometimes be mined simultaneously, resulting in a temporary fork in the chain. The main chain is then solidified when a new block is mined, marking the point of "finality" for a transaction, after which it becomes irreversible. This finality is a key feature in ensuring the integrity of transactions on the best crypto exchanges.

Advantages and disadvantages of Proof-of-Work 👍👎

Proof-of-Work has many advantages in the best crypto to invest in. Unlike with Proof-of-Stake, anyone can add new blocks to the chain without holding the underlying asset. For this reason, some Bitcoiners argue that it is a better system of coin distribution than Proof-of-Stake in the best crypto coin exchange context. The mechanism also has something of a Lindy effect — it’s successfully secured Bitcoin, a leading crypto, since 2009.

However, it’s hard to overlook Proof-of-Work’s flaws in the crypto space. The most common criticism of Proof-of-Work is its staggering energy usage. Vast amounts of power are required to run the mining rigs completing the complex computational problems. According to data from Cambridge University, Bitcoin currently uses about as much energy as Chile.

In 2021, Elon Musk spoke out against Bitcoin’s energy usage when he confirmed that Tesla would stop accepting Bitcoin payments until mining became more sustainable. The move sparked debates surrounding Bitcoin’s environmental impact and arguably helped the asset, considered one of the best cryptos to invest in, tumble in value. Although many Bitcoin miners are turning to renewable energy sources, the network is a long way off achieving carbon neutrality.

Moreover, as mining requires sophisticated equipment, it can potentially lead to centralization due to large mining pools controlling significant amounts of the hashrate. Mining equipment also has a high start-up cost, which excludes many people from getting started in the crypto investment journey.

Proof-of-Stake explained 🥩

Proof-of-Stake is a consensus mechanism that has gained popularity in recent years. Many newer cryptocurrency networks use it for security.

Ethereum completed “The Merge” from Proof-of-Work to Proof-of-Stake in September 2022. The update is called The Merge as the new Beacon Chain (otherwise known as the consensus layer) “merged” with the original Ethereum chain (otherwise known as the execution layer).

Like Proof-of-Work, Proof-of-Stake aims to achieve consensus on the network. However, it has some major differences.

After Ethereum’s move to Proof-of-Stake, it began to rely on validators staking ETH on the network rather than miners contributing computational power.

Becoming a validator on Ethereum requires depositing 32 ETH to a staking contract on the Ethereum Beacon Chain, though there are staking pools that allow users to secure the network by depositing a smaller amount of ETH.

Staking incentivises users to be reliable validators. If a validator goes offline when they should be adding a block to the chain, a small amount of their stake will be slashed. If they maliciously collude against the network, meanwhile, they face losing their entire stake.

With Proof-of-Stake, instead of competing to commit new blocks to the chain, validators are randomly selected by an algorithm. This also means that they don’t require huge amounts of computational power.

Ethereum slashed its energy consumption by 99.95% when it completed “The Merge” to Proof-of-Stake (Source: Ethereum)

Ethereum 2.0 will see the network add 64 shard chains to the Beacon chain. Validators will have a duty to add transactions to shard blocks. 128 other validators will also have to attest each shard block as part of a “committee.”

The committee will have a time “slot” to validate shard blocks, which each feature one block. There’ll be 32 slots created per “epoch”, after which a new group of validators will form a new committee.

When a new shard block has a sufficient number of attestations, a “crosslink” will confirm the block and the transaction in the Beacon chain. At this point, the validator will receive the block reward. Ethereum’s current block reward is around 2 ETH.

Finality is achieved when ⅔ of validators agree on a block’s state at a given checkpoint via the Casper finality protocol.

While a 51% attack is possible with Proof-of-Stake, it requires 51% of the staked ETH rather than the mining hashrate required in Proof-of-Work. This means that Ethereum becomes more secure as more ETH is staked. The network contains over 26.5 million ETH worth around $53 billion at the time of writing, so there would be a huge expense to attacking the network. It’s likely that the value would drop in the event of a 51% attack, meaning there is little incentive for an attacker holding a significant amount of the staked asset.

Advantages and disadvantages of Proof-of-Stake 👍👎

Proof-of-Stake in Crypto has many advantages over Proof-of-Work. It has a lower startup cost to secure the network, as it’s easy to run a node with relatively affordable hardware. For this reason, it allows for participation from a broader user base than mining, improving decentralisation. In Ethereum’s case, staking also creates a way to have secure sharding, which makes the network more scalable. Another major advantage of Proof-of-Stake is the energy efficiency it offers over Proof-of-Work. According to data from the Ethereum Foundation, Ethereum became 99.95% more efficient when it switched to Proof-of-Stake in the cryptocurrency space.

However, there are some disadvantages to Proof-of-Stake in Crypto. Some blockchains require large amounts of the network’s reserve asset to become a validator. Critics have pointed out that Ethereum requires 32 ETH, which is a $64,000 outlay at today’s prices, and therefore excludes many participants. However, staking pools make it possible to help secure the network with a much smaller investment in the crypto ecosystem.

Proof-of-Stake is also less battle tested than Proof-of-Work in the realm of cryptocurrencies. Bitcoin’s consensus mechanism has secured the network since 2009, whereas Proof-of-Stake is a much more recent innovation in cryptocurrencies.

Final thoughts 🧠

In conclusion, Proof-of-Work and Proof-of-Stake are useful mechanisms for helping blockchains achieve consensus. While there are clear benefits and drawbacks to both mechanisms, the industry has started to embrace Proof-of-Stake in recent years. A big factor behind this move is the energy efficiency Proof-of-Stake offers over Proof-of-Work. It remains to be seen whether Bitcoin will achieve sustainable mining. Now that you’ve learned about both consensus mechanisms, what do you think about Ethereum’s move to Proof-of-Stake?

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Please note: Investing in cryptoassets is risky. Due to the volatile nature of the cryptocurrency market, investors run the risk of losing their funds when they make an investment. Returns from cryptoasset investing are not guaranteed, therefore users should always be aware of the risks.