The Proof of Stake Mechanism in Cryptocurrency

In the previous article, we learned about the proof of work mechanism. We also learned about how the popularity of Bitcoin means that the proof of work mechanism remains the most powerful and widely used consensus mechanism in the cryptocurrency market. We also learned that one of the biggest shortcomings of the proof of work mechanism was that it was very resource-intensive. Hence, a lot of productive computing power and electricity were being utilized for seemingly arbitrary tasks. This was taking these resources away from more productive endeavors in the economy.

Many experts in the cryptocurrency community agree with this criticism. This is why they have created another mechanism called the proof of stake mechanism. The proof of stake mechanism has been adopted by another popular cryptocurrency called Ethereum. This mechanism is relatively nascent but it is still being considered to be a viable alternative to the proof of work concept.

What is Proof of Stake?

Proof of work is a competition between computers to decide who gets the right to enter the next block of data in the blockchain. This competition is won based on computing ability. However, proof of stake is different. This is because instead of using computing power, participants can use actual coins in order to obtain the right to update the blockchain and earn more coins.

This stake is used as a security deposit which ensures that the validators do not forge incorrect data into the blockchain. This is because if they do forge incorrect data, they lose a part of their stake in the process. It is for this reason that the transactions routed to a particular node generally have lower transaction amounts as compared to the value of the security deposit which they will have to forfeit if they make an error.

How Does Proof of Stake Work?

  1. In the first step of the proof of stake mechanism, willing participants are supposed to deposit coins (money) in their node (computing device). Once this is done, the network considers the computing device to be ready for the competition

  2. In the next step, all eligible nodes compete with each other in order to update the next block of data in the distributed ledger. It needs to be understood that the terminology used here is different. When proof of work mechanism is used, coins are mined. However, in this case, the block is said to be “forged” (not mined). Also, the people who forge new blocks of data are called validators (not miners).

  3. In the third step, the network chooses a random computing device to actually forge the record. The developers of cryptocurrency have ensured that the computing device is chosen at random based on several factors. For instance, nodes that have been competing for a long time but did not get a chance are also given an opportunity to forge the next block. This is done to ensure that no group of people are able to gain complete control over the forging process.

  4. Finally, after the block has been mined, the node used for forging gets some coins as a reward for their efforts. There are several types of cryptocurrencies that use this mechanism and each has its own way to determine how to calculate and distribute rewards.

  5. In order to provide the network with some time which will allow them to double-check the validity of the transactions, the reward received as well as the stake are locked up for some time. They are only released after the network knows that the transaction isn’t incorrect or fraudulent.

Advantages of Proof of Stake

  1. The proof of stake mechanism is much less wasteful as compared to the proof of work mechanism. It uses an existing coin as collateral in order to ensure the accuracy of the transaction. Also, the validators are chosen in a random fashion which makes the system decentralized.

  2. Proof of stake mechanism can be run on any average computing device. It does not require expensive mining equipment as a prerequisite. This is the reason that proof of stake attracts a large number of validators which ensures that the system grows while also making it more robust.

Issues With Proof of Stake

  1. The algorithms for proof of stake are written in such a manner that the stake plays a very important role in the selection of the validator. This means that if person A has $10 invested as stake and person B has $50 invested as stake, then person B is five times more likely to get an opportunity to validate the transaction. In a way, the proof of stake method favors the rich. However, this was also the case with proof of work wherein the rich had an opportunity to buy more advanced equipment which utilizes higher computing power. The proof of stake system works in such a way that the rich get the opportunity to validate more transactions. As a result, they become richer which further increases their chances of being chosen as the next validator.

  2. In continuation of the above point, it is also true that if an investor or a group of investors were to invest 51% of the stake in the nodes, they could obtain majority control. This would allow them to write and validate fraudulent transactions. However, this is impractical given the fact that most cryptocurrencies today are valued in billions of dollars. Any group of investors who have that kind of money is unlikely to get involved in outright fraud.

From the above points, it is apparent that proof of stake is a more environment-friendly mechanism for validating blockchain transactions. It is also as effective (if not more) than the proof of work concept to ensure that the integrity of the system remains intact.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.