Proof of Work vs Proof of Stake Explained
In the rapidly evolving world of cryptocurrencies and blockchain technology, understanding the underlying mechanisms that govern these digital assets is crucial. Two of the most prominent consensus algorithms used to validate transactions and maintain network security are Proof of Work (PoW) and Proof of Stake (PoS).
While both serve the same fundamental purpose, they operate based on distinct principles, each with its advantages and drawbacks. In this blog post, we will delve into the intricacies of PoW and PoS, demystifying their differences and exploring their implications for the future of cryptocurrencies and blockchain networks.
Hashcash and Proof of Work
Proof of work (PoW) is the process of producing a cryptographic hash that, when an input of any given length is run through a cryptographic hash function, an output of a fixed length is formed. Proof of work in current blockchain systems historically originate from its use in Hashcash. Hashcash was conceived by Adam Back, and is a proof of work system that was designed to limit email spam and denial-of-service attacks. Hashcash came in the form of a software plugin that inserted a ‘X-Hashcash:’ into the email header section of an email layout:
From: Someone <[email protected]>
To: Adam Back <[email protected]>
Subject: test hashcash
Date: Thu, 26 Jun 2003 11:59:59 +0000
In order to send the email, Hashcash requires the sender to compute proof of work calculations on what is effectively the recipient’s email address, which in this case is: ‘[email protected]’. The email address, along with some accompanying data, forms the below input:
This string of data is then used as an input for a cryptographic hash function, which at this point was Secure Hash Algorithm 1 (SHA-1). Running this input produces an output of:
The process of finding the correct hash in Hashcash involves the presence of a specified number of leading zero bits, as demonstrated above. However, reaching this correct cryptographic hash typically entails repeated hashing of the input data, with slight modifications made to the data during each iteration. For legitimate email senders, the computational power needed to generate a valid hash using Hashcash is relatively minimal since they do not send a significant volume of emails. On the other hand, spam emailers face greater difficulty in generating the required proof for mass email distribution due to the substantially higher computational resources required. This proof of work mechanism employed by Hashcash closely resembles the proof of work system utilized in cryptocurrencies like Bitcoin.
Proof of Work in Cryptocurrency Systems
Proof of work in Bitcoin (and other proof of work cryptocurrencies) functions as a tool that is used to process blocks of transactions and add them to the blockchain. In other words, proof of work is utilized for block generation. The process of generating correct proofs in order to add a block to the blockchain is known as ‘mining’ and the individuals that participate in the mining process are known as ‘miners’. Just like Hashcash, miners must take data from a block header as an input, and repeatedly run it through a cryptographic hash function, which in this case for Bitcoin, is Secure Hash Algorithm 256 (SHA-256). Miners hash slight variations of the input data by including an arbitrary number (a nonce) each time the input data is ran through the cryptographic hash function. Similarly to Hashcash, the correct hash is found when a defined number of leading zero bits is found. Producing a correct hash value in cryptocurrency proof of work systems is a probabilistically low activity that requires the generation of a considerable number of hashes before a valid hash is arrived at. However, possessing higher computing power will translate to an increased likelihood of generating a valid hash, due to the individual being able to simply generate more hashes.
Proof of work cryptocurrency systems also incorporate a network difficulty feature, which measures the level of difficulty in finding a hash that falls below a specific target hash. The target hash refers to the maximum value that the hashed block header should be equal to or lower than. In the case of Bitcoin, the network difficulty is recalibrated every 2016 blocks, based on the time it took to mine the previous 2016 blocks. The mining of 2016 blocks is estimated to take around two weeks. If the previous set of blocks is mined in less than two weeks, the network difficulty increases. Conversely, if it takes more than two weeks, the network difficulty decreases. This dynamic adjustment ensures a consistent rate of block generation, with Bitcoin aiming for one block every ten minutes.
In the process of proof of work mining, miners engage in competition with each other to discover a valid hash value that grants them the privilege of adding a block to the blockchain. By dedicating substantial computational resources to solving multiple proofs, miners earn a block reward in the form of cryptocurrency, such as bitcoins. Before the block is appended to the chain, other nodes in the network verify that the miner has indeed identified the correct hash. Cryptocurrency proof of work systems are designed to make the discovery of valid hashes challenging, requiring significant time and expense, while ensuring that verification of these hashes remains straightforward.
Proof of Stake
Proof of stake presents itself as taking a novel approach with regard to block generation on a blockchain. With proof of work, as previously mentioned, miners who find the correct hash are allowed to generate new blocks and are rewarded for doing so. However, with proof of stake systems, individuals that are chosen to generate a block, also known as validators, depend on a different set of criteria. This criteria differs depending on the proof of stake system, but largely speaking, a validator is chosen to generate a new block based on their economic stake in the network. A validator’s economic stake can include:
Relative value: The relative value of coins held in the validator’s wallet, which is equal to: the total value of coins in the validator’s wallet divided by the total value of coins on the network. Validators are selected to generate a new block with a probability that is proportional to the amount of coins that the validator possesses. Thus, the more coins a validator houses in his wallet, the increased likelihood of being selected to generate a block.
Coin age: Some proof of stake systems also take into account the length of time that a validator has held coins in their wallet, with this criteria being referred to as ‘coin age’. Coin age is defined as the coin amount multiplied by the number of days that the coins have been held in a wallet. Therefore, a validator possessing a large holding of coins over a lengthy time-period is more likely to be selected to generate a new block.
With proof of stake, a validator generates a new block by sending a special type of transaction that locks up their deposit. This deposit (or stake) serves as collateral for the block generation process. If the validator attempts to cheat the system and validate fraudulent transactions, then their deposit is slashed. Validators that correctly validate blocks of transactions are returned their deposit and also collect the transaction fee for the validation process.
Nothing at Stake Problem
The nothing at stake problem is a unique challenge specific to proof of stake systems. It occurs when two blocks are generated simultaneously, leading to the creation of two competing blockchains.
In this situation, validators have an incentive to contribute blocks to both chains to ensure they support the winning chain in the end. However, if validators act based on economic rationality, the convergence of the two chains may not happen, and neither chain may prevail. This is because staking does not drive the convergence of competing systems since validators can apply the same stake to multiple competing chains, enabling them to increase their rewards without taking any risks.
This differs from proof of work systems where splitting computing power across competing chains would not be profitable. This is due to the energy-intensive nature of computing proofs in proof of work, which requires a finite and financially costly real-world resource.
To address the nothing at stake problem, a solution known as “slashing” can be employed. This strategy involves penalizing validators who contribute blocks to multiple chains simultaneously by slashing a portion of their deposited collateral as a penalty.
Proof of stake is presented as being a superior block generating mechanism to proof of work because of reasons primarily pertaining to energy consumption. Operating proof of work systems such as Bitcoin requires a tremendous amount of energy. It is estimated that over roughly 6.5 million U.S. households could be powered by the energy that is consumed operating Bitcoin.
Instead of consuming electricity to produce countless hashes for the right to generate a block, as is required in proof of work systems, validators in proof of stake systems are selected for block generation based on their economic stake in the network, which is a system that requires considerably less computing resources to operate.
Understanding the differences between proof of work (PoW) and proof of stake (PoS) consensus algorithms is essential in grasping the intricacies of cryptocurrencies and blockchain networks. While PoW relies on computational power and the discovery of correct hashes, PoS operates based on the economic stake and selection of validators.
Both systems have their advantages and drawbacks. PoW requires significant computational resources and energy consumption but offers straightforward verification. PoS reduces energy consumption and allows validators to generate blocks based on their stake but faces challenges like the “nothing at stake” problem. The implementation of slashing penalties can help address this issue.
Ultimately, the choice between PoW and PoS depends on factors such as energy efficiency, network security, and decentralization goals. As the crypto industry continues to evolve, understanding these consensus mechanisms is crucial for the future of cryptocurrencies and blockchain technology.