Cryptocurrencies like Bitcoin use vast amounts of electricity to secure their networks and encourage practices making the certain blockchain more centralized thus causing additional risks. Follow the article if you want to learn more about the flaws and possibilities behind proof-of-stake and proof-of-work algorithms.
Mining new coins using a proof-of-work algorithm takes a lot of computing power. The idea was first introduced in 1993 to fight spam emails and was formally called ‘proof-of-work’ in 1997. Until Satoshi Nakamoto created Bitcoin in 2009, the proposed solution was mostly unused. Satoshi used the algorithm to reach a consensus between multiple nodes on the network and to use it as a way to secure the bitcoin blockchain. The algorithm works by having all nodes solve a cryptographic task. The first miner to complete the task gets a reward. This causes a situation where people are building increasingly larger mining farms to get bigger rewards. Bitcoin miners alone, use close to 120 TWh of electricity, which is enough to power over 10 million households in the US.
“Hashrate” refers to the total combined computational power that is being used to mine and process transactions on a proof-of-work blockchain, which also gives more rewards to people with faster equipment. The higher your hashrate is, the higher the chance you will have to create the next block, thus recieve the mining award more frequently.
To increase the chances, even more, miners can come together to create so-called ‘mining pools’, combining their hashing power and distributing the awards equally across every miner in the pool. That creates risk and again makes the blockchain less decentralized. Let’s say the three biggest mining pools merge together- they would control a large portion of the network and could start approving fraudulent transactions.
To sum it up: Proof-of-work uses mass amounts of electricity and it encourages the use of mining pools which make the blockchain more centralized than decentralized. What is the solution? Is there an algorithm equally effective or better than proof-of-work?
In 2011, ‘QuantumMechanic’ a user of a Bitcoin Talk forum proposed a new technique called proof-of-stake. Instead of mining, it allows people to ‘mint‘ or forge blocks. The new protocol also causes a slight change in terminology as it it has no miners but validators. Proof-of-work uses an election process in which one node is to validate the next block. To become a validator, a node has to deposit a certain amount of coins into the network as a stake. You can think of it as a security deposit in a regular bank. The size of the stake naturally determines the chance of a validator being chosen to forge the next block.
If/when a node is chosen to validate the next block, he will then check if all the transactions within it are valid. If so, the node signs off the block and adds it to the blockchain. As a reward, the node receives the fees associated with the transactions within the particular block. Validators might also lose a part of their stake if they approve fake transactions. As long as their stake is higher than what the validator receives as the transaction fee, we can trust them to correctly do their job. Because of not, they can lose more than they gain. When a node stops being a validator, his stake and all the transaction fees earned will be released after a given period of time.
Proof-of-stake doesn’t allow everyone to validate transactions and to mine for gains so it uses less energy. It is more decentralized as creating a staking pool is less expensive as it doesn’t require mining equipment, allowing more people to set up a node making the network more secure.
Risks and summary:
Although proof-of-stake is not perfect it’s a major upgrade from proof-of-work. If a user is wealthy enough to buy a majority of the in the network, he can approve fake transactions. The procedure is called ‘51% attack‘ and has first discussed as the weak point of the proof-of-work algorithm. If a certain miner can obtain a majority of the hashing power, he can effectively affect the blockchain. Proof-of-stake makes this attack very impractical depending on the value of a certain cryptocurrency (if we convert Bitcoin to proof-of-stake, acquiring 51% would be a big expense- less likely to happen yet still possible).
Another risk that proof-of-stake algorithms have to be careful how they selected the next validator- it cannot be completely random as the size of the stake has to be factored in and at the same time, it is not enough to provide security. The staked amount as the only factor would favor the more wealthy as they would be selected more frequently thus receive more fees enlarging the gap even more. There are numbers of possible solutions to fix this- coin age-based selection for instance. As you might see already, proof-of-work brings additional risks in comparison to proof-of-work and a lot of researches work on minimizing them to furtherly improvee it as a possible future of blockchain and crypto market.