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Unlike fiat currency such as the US Dollar or British Pound which is printed, cryptocurrencies follow one of two models when it comes to the creation and validation of cryptocurrency onto the blockchain. These two models are called Proof of Stake (PoS) and Proof of Work (PoW). Proof of Work was and is still used for the first cryptocurrency, Bitcoin, but over the last few years, we have seen a rise in popularity for the Proof of Stake method due to several differences and has been adopted by some of the largest cryptocurrency projects, such as Solana and Cardano.
PoW and PoS are the backbone ‘consensus mechanisms’ of any blockchain, used to verify transactions allowing cryptocurrency networks to be decentralized without a governing authority. Consensus mechanisms allow each computer attached to the network to agree on legitimate transactions to avoid middlemen such as PayPal.
The Two Consensus Mechanisms
Proof of Work (PoW)
The first consensus mechanism used to power Bitcoin harnesses miners all around the world to acquire the large amount of processing power required to keep the network running and stable.
The miners are all competing in a competitive process to be the first to solve a math problem, the winner receiving a pre-determined amount of cryptocurrency as their reward (often referred to as a block). The mining process is used to verify and add all new transactions to the PoW blockchain.
During the early days of Bitcoin mining, individual miners utilizing a singular GPU could make it worthwhile. However, as the network grows and more miners pile in, the mining difficulty only increases, requiring a higher and higher hash rate or computing power. This is why large-scale mining operations are now the norm if miners want to be successful.
The image below demonstrates the exponential growth in mining difficulty for Bitcoin miners.
Is Mining Still Profitable?
The simple formula that miners use when seeing if mining bitcoin, for example, is still profitable is:
- Price of X bitcoin > Cost to Mine X bitcoin
The price of bitcoin is constantly fluctuating, but the cost to mine may increase and decrease depending on many factors
- Cost of electricity
- Cost of mining machines
- Current ‘ Hash Rate ’
Hash Rate
As mentioned before, the higher the mining difficulty the higher the hash rate, which will increase the number of miners there are, in order to maintain the same amount of bitcoins being produced every ten minutes.
Now that we see professional mining centres, individual miners which could have used their own setup way back in 2009 are outmatched by superior processing power, especially since the release of ASICs.
Proof of Stake (PoS)
The second consensus mechanism is Proof of Stake which has gained massive popularity over the last few years and is the reason why Ethereum 2.0 is being built, to switch over to a PoS mechanism. The main aim for PoS was to switch from being reliant on computer power to currency power which will increase the scalability and efficiency of the network.
Currency power means the more coins a validator is holding the more chance they will be allowed to validate transactions.
PoS drastically reduces the amount of work needed to validate transactions and keep a blockchain secure by utilizing ‘validators’. These validators don’t receive rewards for validating blocks, but
Validators
Unlike PoW, PoS validators are randomly selected to validate each block instead of having all validators compete with each other, which is how PoW miners operate. Each validator on a network must stake a certain amount of the network’s coins to ensure they have skin in the game, which can be used to punish them for bad behaviour, a process called slashing.
For example, Ethereum 2.0 validators require a minimum stake of 32 ETH to ‘activate’ their validator software, currently costing around $90,000.
PoS allows Participating
PoS mechanisms require many validators to validate even a single block, but not everyone can afford the minimum requirements of most ‘validator’ statuses, which is why PoS mechanisms allow individual users to contribute their cryptocurrency to a pool via a delegation system.
Delegation systems allow any token holder to delegate their cryptocurrency to the validator’s stake, which will grant them a percentage of the validator’s rewards. This system allows anyone to contribute to the PoS mechanism and gain rewards from doing so. When offering your capital to a validator you incur the same rewards and risks that they do which incentivises validators, to be honest, and reputable, working towards a common goal of the network which will increase security and decentralization as many more holders are able to get involved.
Slashing
Slashing is a mechanism used in many PoS systems to punish bad behaviour which negatively impacts the network. Validators who ‘misbehave’ will have a percentage or predefined amount of their stake slashed or removed as punishment.
Bad behaviour usually consists of excessive downtime or ‘double signalling’. The slashing event is not just limited to the validator’s tokens but will also slash the delegator’s tokens which are staked. This means those delegating tokens to a validator should choose only the most consistent and safest validators which promotes a supportive system with the validator and delegator both wanting the best for the network to avoid slashing events.
Proof of Stake Mechanisms, Where Do The Initial Coins Come From?
As no mining for coins is occurring, cryptocurrencies utilizing Proof of Stake mechanisms essentially print their tokens before an ICO, initial coin offering, to be distributed based on their tokenomics, described in the project’s whitepaper.
Before and during an ICO the project’s coins or tokens are in theory worthless as they have zero market data making them an extremely risky investment. A certain percentage of the total supply is saved for pre-sale, locked or distributed to the founders and team.
What are the Main Differences?
*Proof of Work creates coins, like bitcoin, whilst Proof of Stake does not, with the coins having been created at the start of the project.
- Security
PoW is often seen as the more secure mechanism due to a multitude of factors, such as PoW’s full replication ability whereas PoS uses sharding to increase scalability. Replication of a blockchain allows several nodes to fail without losing the integrity of the information stored whereas fragmentation can fail rapidly if only a few nodes start to get lost.
Etherplan created a diagram perfectly showing the differences:
It seems relevant to mention an often talked about 51% attack on a PoS cryptocurrency where a singular entity owns or stakes 51% of the cryptocurrency. Although such attacks are possible in theory, the hacker would be left with a massive amount of worthless cryptocurrency.
2.Rewards
As mentioned before, PoW miners are rewarded in new ‘minted’ cryptocurrency from the block, such as bitcoin for their validation efforts whereas PoS validators and their subsequent delegators are rewarded with collected fees from the network.
Also, the validators are rewarded very differently. Miners are constantly competing against each other to be the first one to solve the block to receive the reward, whereas validators on PoS mechanisms are chosen at random depending on the amount of coins held by the validator. Also, PoS allows all token holders to be rewarded whereas PoW mechanisms are reduced to a select few with enough computing power.
3.Energy Usage
PoW with its physical miners has been berated for using too much electricity and power as a consensus mechanism, having the same output as some countries, last year using more total power than Pakistan. There is constant debate around how damaging PoW mechanisms actually are, however, the most important difference is how does it compare to PoS?
Well, as PoS uses no physical miners its energy usage can often be seen as negligible when compared to PoW. When Ethereum 2.0 begins to use the PoS mechanism, they expect a reduction of energy usage by 99.95%, a reduction of 2000%. Ethereum posted a great representation of just how massive this change will be.
4.Funding
Many cryptocurrency purists point out that for Bitcoin to maintain running, a large amount of physical assets are needed, in the form of mining equipment, which is often bought with fiat instead of cryptocurrency. On the flipside, validators for PoS mechanisms simply stake the required amount of cryptocurrency, not fiat to start validating.
Moving Forward
With the second-biggest cryptocurrency, Ethereum, moving over to a PoS mechanism, it can be hard to think about any new cryptocurrencies utilizing Proof of Work. Not only is PoS much more energy-efficient, it allows all token holders to participate in the validation and security of the network, a much more scalable and efficient network at that.
If most large cryptocurrency projects utilize PoS, the ‘green’ mechanism, it will only break down another barrier or argument that non-believers are using to try and prevent mainstream cryptocurrency adoption. We still have a long way to go before PoS takes over all large projects and may only happen if mass adoption occurs as networks will require a greater amount of transactions per second to cope, something Ethereum 2.0 has already anticipated.
Unlike fiat currency such as the US Dollar or British Pound which is printed, cryptocurrencies follow one of two models when it comes to the creation and validation of cryptocurrency onto the blockchain. These two models are called Proof of Stake (PoS) and Proof of Work (PoW). Proof of Work was and is still used for the first cryptocurrency, Bitcoin, but over the last few years, we have seen a rise in popularity for the Proof of Stake method due to several differences and has been adopted by some of the largest cryptocurrency projects, such as Solana and Cardano.
PoW and PoS are the backbone ‘consensus mechanisms’ of any blockchain, used to verify transactions allowing cryptocurrency networks to be decentralized without a governing authority. Consensus mechanisms allow each computer attached to the network to agree on legitimate transactions to avoid middlemen such as PayPal.
The Two Consensus Mechanisms
Proof of Work (PoW)
The first consensus mechanism used to power Bitcoin harnesses miners all around the world to acquire the large amount of processing power required to keep the network running and stable.
The miners are all competing in a competitive process to be the first to solve a math problem, the winner receiving a pre-determined amount of cryptocurrency as their reward (often referred to as a block). The mining process is used to verify and add all new transactions to the PoW blockchain.
During the early days of Bitcoin mining, individual miners utilizing a singular GPU could make it worthwhile. However, as the network grows and more miners pile in, the mining difficulty only increases, requiring a higher and higher hash rate or computing power. This is why large-scale mining operations are now the norm if miners want to be successful.
The image below demonstrates the exponential growth in mining difficulty for Bitcoin miners.
Is Mining Still Profitable?
The simple formula that miners use when seeing if mining bitcoin, for example, is still profitable is:
- Price of X bitcoin > Cost to Mine X bitcoin
The price of bitcoin is constantly fluctuating, but the cost to mine may increase and decrease depending on many factors
- Cost of electricity
- Cost of mining machines
- Current ‘ Hash Rate ’
Hash Rate
As mentioned before, the higher the mining difficulty the higher the hash rate, which will increase the number of miners there are, in order to maintain the same amount of bitcoins being produced every ten minutes.
Now that we see professional mining centres, individual miners which could have used their own setup way back in 2009 are outmatched by superior processing power, especially since the release of ASICs.
Proof of Stake (PoS)
The second consensus mechanism is Proof of Stake which has gained massive popularity over the last few years and is the reason why Ethereum 2.0 is being built, to switch over to a PoS mechanism. The main aim for PoS was to switch from being reliant on computer power to currency power which will increase the scalability and efficiency of the network.
Currency power means the more coins a validator is holding the more chance they will be allowed to validate transactions.
PoS drastically reduces the amount of work needed to validate transactions and keep a blockchain secure by utilizing ‘validators’. These validators don’t receive rewards for validating blocks, but
Validators
Unlike PoW, PoS validators are randomly selected to validate each block instead of having all validators compete with each other, which is how PoW miners operate. Each validator on a network must stake a certain amount of the network’s coins to ensure they have skin in the game, which can be used to punish them for bad behaviour, a process called slashing.
For example, Ethereum 2.0 validators require a minimum stake of 32 ETH to ‘activate’ their validator software, currently costing around $90,000.
PoS allows Participating
PoS mechanisms require many validators to validate even a single block, but not everyone can afford the minimum requirements of most ‘validator’ statuses, which is why PoS mechanisms allow individual users to contribute their cryptocurrency to a pool via a delegation system.
Delegation systems allow any token holder to delegate their cryptocurrency to the validator’s stake, which will grant them a percentage of the validator’s rewards. This system allows anyone to contribute to the PoS mechanism and gain rewards from doing so. When offering your capital to a validator you incur the same rewards and risks that they do which incentivises validators, to be honest, and reputable, working towards a common goal of the network which will increase security and decentralization as many more holders are able to get involved.
Slashing
Slashing is a mechanism used in many PoS systems to punish bad behaviour which negatively impacts the network. Validators who ‘misbehave’ will have a percentage or predefined amount of their stake slashed or removed as punishment.
Bad behaviour usually consists of excessive downtime or ‘double signalling’. The slashing event is not just limited to the validator’s tokens but will also slash the delegator’s tokens which are staked. This means those delegating tokens to a validator should choose only the most consistent and safest validators which promotes a supportive system with the validator and delegator both wanting the best for the network to avoid slashing events.
Proof of Stake Mechanisms, Where Do The Initial Coins Come From?
As no mining for coins is occurring, cryptocurrencies utilizing Proof of Stake mechanisms essentially print their tokens before an ICO, initial coin offering, to be distributed based on their tokenomics, described in the project’s whitepaper.
Before and during an ICO the project’s coins or tokens are in theory worthless as they have zero market data making them an extremely risky investment. A certain percentage of the total supply is saved for pre-sale, locked or distributed to the founders and team.
What are the Main Differences?
*Proof of Work creates coins, like bitcoin, whilst Proof of Stake does not, with the coins having been created at the start of the project.
- Security
PoW is often seen as the more secure mechanism due to a multitude of factors, such as PoW’s full replication ability whereas PoS uses sharding to increase scalability. Replication of a blockchain allows several nodes to fail without losing the integrity of the information stored whereas fragmentation can fail rapidly if only a few nodes start to get lost.
Etherplan created a diagram perfectly showing the differences:
It seems relevant to mention an often talked about 51% attack on a PoS cryptocurrency where a singular entity owns or stakes 51% of the cryptocurrency. Although such attacks are possible in theory, the hacker would be left with a massive amount of worthless cryptocurrency.
2.Rewards
As mentioned before, PoW miners are rewarded in new ‘minted’ cryptocurrency from the block, such as bitcoin for their validation efforts whereas PoS validators and their subsequent delegators are rewarded with collected fees from the network.
Also, the validators are rewarded very differently. Miners are constantly competing against each other to be the first one to solve the block to receive the reward, whereas validators on PoS mechanisms are chosen at random depending on the amount of coins held by the validator. Also, PoS allows all token holders to be rewarded whereas PoW mechanisms are reduced to a select few with enough computing power.
3.Energy Usage
PoW with its physical miners has been berated for using too much electricity and power as a consensus mechanism, having the same output as some countries, last year using more total power than Pakistan. There is constant debate around how damaging PoW mechanisms actually are, however, the most important difference is how does it compare to PoS?
Well, as PoS uses no physical miners its energy usage can often be seen as negligible when compared to PoW. When Ethereum 2.0 begins to use the PoS mechanism, they expect a reduction of energy usage by 99.95%, a reduction of 2000%. Ethereum posted a great representation of just how massive this change will be.
4.Funding
Many cryptocurrency purists point out that for Bitcoin to maintain running, a large amount of physical assets are needed, in the form of mining equipment, which is often bought with fiat instead of cryptocurrency. On the flipside, validators for PoS mechanisms simply stake the required amount of cryptocurrency, not fiat to start validating.
Moving Forward
With the second-biggest cryptocurrency, Ethereum, moving over to a PoS mechanism, it can be hard to think about any new cryptocurrencies utilizing Proof of Work. Not only is PoS much more energy-efficient, it allows all token holders to participate in the validation and security of the network, a much more scalable and efficient network at that.
If most large cryptocurrency projects utilize PoS, the ‘green’ mechanism, it will only break down another barrier or argument that non-believers are using to try and prevent mainstream cryptocurrency adoption. We still have a long way to go before PoS takes over all large projects and may only happen if mass adoption occurs as networks will require a greater amount of transactions per second to cope, something Ethereum 2.0 has already anticipated.
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By: Finance Magnates Staff
www.financemagnates.com
