There continues to be a push from crypto developers toward the Proof-of-Stake consensus mechanism over the Proof-of-Work. There are a lot of factors driving this change including concerns over power consumption, costs, and scalability. Here is everything you need to know about PoS vs PoW networks.
How PoW Works
Bitcoin introduced the PoW consensus algorithm to the world. It was the first digital currency validation system to include a timestamp which enabled Satoshi Nakamoto to finally solve the double-spend issue that had plagued all previous attempts at making a successful digital currency.
Proof-of-Work networks are decentralized protocols that rely on network nodes called miners. In Bitcoin’s PoW system, all network nodes validate the state of the blockchain while adding new transactions to the network. These transactions come in the form of blocks every ten minutes.
Miners complete the validation process and then compete to answer a mathematical equation. The first node to answer the equation correctly receives the rewards. This equation is called the SHA-256 equation. Interestingly, the SHA 1 (secure hashing algorithm) system has been in use by the military in the past. However, the SHA-256 algorithm is unrelated.
Mining Rewards
Currently, the Bitcoin mining reward is 6.25 BTC. Notably, this reward was designed to decrease over time. Nakamoto realized that as the network difficulty rose, the value of the token would increase. As such, the first Bitcoin miners received 50 BTC as a reward, which has halved roughly every four years.
In a Proof-of-Work system mining rewards is the only time new currency enters the market. This approach provides these networks with a predictive monetary supply. Roughly every ten minutes new Bitcoin enters the market. In comparison, fiat currency can be printed on a whim to meet the needs of politicians. Bitcoins predictive issuance, coupled with its limited supply of 21 million tokens, continues to help drive the token’s value up which makes it an excellent store of value.
How Does PoS Work?
Proof-of-Stake systems work differently than PoW networks. For one, they do away with miners altogether. Instead, anyone in the community can help to validate transactions and the state of the blockchain via staking protocols. Staking is a term used to describe providing liquidity to a network smart contract.
Staking is much easier to do than mining. Users simply need to meet the staking requirements in terms of token amount and agree to lock up their coins for the time requested. Once staked, these tokens are out of general circulation which helps to drive the overall token value up. Additionally, stakers receive rewards for their efforts.
Unlike trading, where your rewards are based on your performance, staking protocols provide you with your reward payout levels when you set up the stake. As such, they are more convenient, less labor intensive, and easier to achieve consistent results. All of these factors have driven more protocols to choose PoS over Pow as a way to keep their networks secure.
Advantages of PoS
There are some clear advantages that PoS networks bring to the market. For one, they are a greener alternative. Because PoS networks don’t need miners, there is no need for users to conduct power-hungry computations. As such, PoS networks have smaller carbon footprints. In some cases, these networks seek to become net zero.
Bitcoin’s power consumption continues to raise eyebrows amongst environmentalists. Reports have put Bitcoin’s power consumption on par with top GDP countries. Even with the fact that a large majority of the network relies on renewable energy, the protocol still requires a lot of resources to keep up.
Scalability
PoS blockchains provide more scalability to the market for a couple of reasons. These networks are set up to enable anyone to take part in the approval process. As such, blocks are approved faster. Faster blocks mean faster finality which improves the tps rate of the network. There are PoS networks capable of thousands of transactions per second. In comparison, Bitcoin handles around 7 tps.
Part of the reason that PoS networks can operate so much faster is that they eliminate the complex mathematical equations associated with PoW networks. They also have a larger capacity as many leverage off-chain solutions to scale vertically to meet the needs of the community. When compared to a PoW network, most PoS networks are more decentralized due to their higher level of community participation.
Inclusivity
Another major reason why people are leaning towards PoS networks is inclusivity. PoS networks lower the entry bar for the market. There is no need to purchase expensive mining rigs to validate these networks and secure passive rewards. The current price for a high-end ASIC mining rig is +$3000. This is far more than a first-time crypto enthusiast is ready to fork out to get involved in the network.
These financial and technical barriers are counterproductive to the growth of the entire market. PoS protocols recognize these barriers and replace them with a more open and easier-to-navigate alternative. As such, more people can do their part and earn when using a PoS network.
Notably, even networks with high staking requirements like Ethereum (which requires you to stake 32 ETH) allow regular token holders to earn via staking pools. Staking pools combine users funding together and split the rewards with the group based on their contribution levels.
Gas Prices
The rise of gas prices on the world’s largest DeFi network, Ethereum, has shed light on scalability concerns. The Ethereum network has the highest gas prices it has seen due to record congestion. When the network was created, the developers included a difficult adjustment and fee hike as a way to help fight congestion issues.
These systems work by increasing the gas fee based on network congestion. The original goal of the protocol was to reduce spam posts through the price hike. However, since most of Ethereum’s current congestion is due to DeFi’s popularity, the mechanism has had a negative effect.
Ethereum’s team recognized these issues and has put forth a plan to convert the network over to a PoS system this year. The network already began the upgrade last year with staking services going live. The upgrade will provide Ethereum with lower gas fees and high transaction throughput. Additionally, it will cost users and developers less to utilize the network’s smart contracts or send transactions.
PoS in DeFi
PoS networks are becoming the new norm in the DeFi market and for good reasons. These systems provide more earning opportunities and are more open to the public. All of these factors make them ideal for the DeFi movement which centers on providing more earning opportunities to the average user.
ETH 2.0
There are many popular PoS DeFi networks in operation today. The largest and most popular is ETH 2.0. EHT 2.0 is the updated Ethereum network, The system has completed its upgrade from a PoW protocol and is now fully operational Users can stake 32 ETH to become network validators and secure passive returns.
The Ethereum upgrade was seen by many as a major milestone for the network and the PoS community. Ethereum is by far the largest Dapp and DeFi network in the world. The ecosystem encompasses hundreds of thousands of tokens and Dapps of every type and use case scenario.
Cardano (ADA)
Cardano is another PoS network that has made waves in the market since its launch. Cardano was founded by two previous Ethereum developers to expand the network’s shortcomings and provide a more scientific approach to blockchain development. Notably, Cardano is often referred to as the “smart blockchain” due to its close ties to the academic sector.
The main draw to Cardano is that it was created using proven scientific methods and peer review. This approach has helped the network to find a home in the educational sector. There are already a host of research projects that leverage the blockchain’s massive computing power to accomplish complex tasks.
Solana
Solana is another PoS network worth mentioning. This highly programable blockchain offers lightning-fast service to users and low fees. The blockchain continues to see growing developer usage due to its capabilities and efficiency. Users can stake their SOL tokens and secure passive returns. Notably, the staking requirements for SOL are far less than ETH making it more open to the average user.
PoS Variants
The PoS concept has been expanded upon by multiple platforms in the market. Today, there are a wide variety of PoS networks that help drive innovation and adoption. One of the most common styles of PoS variant is DPoS (delegated-proof-of-stake) systems. These networks operate by reducing the number of validating nodes down to a specific amount.
These nodes are either voted in, randomly chosen, or elected by developers at the launch to handle validation processes. The other network participants stake their tokens to the validator nodes and receive a percentage of their returns based on their stake. The main advantage of this strategy is that it improves scalability even further.
Since the network only has to get validation from the elected nodes, it can reduce transaction times significantly. DPoS networks are among the fastest in the market. Additionally, they provide the open nature of PoS with other advantages like subsecond finality.
DPoS Safehaven Assets
The introduction of DPoS systems and DeFi upgrades has led to some interesting developments in the market including safehaven tokens. These assets leverage the stability of stablecoins and introduce additional protections in the form of smart contracts to provide even more stability.
The most popular safehaven asset in the market today is the META 1 Coin. This project raised eyebrows when it entered service for multiple reasons. For one, the token gets its stability from a reserve of gold-related assets. The decision to diversify the gold-related reserves provides the token with more stability and protects it from any losses brought on by the discovery of large gold deposits.
Protect the Stability at all Costs
The META 1 Coin is the first project to introduce an asset protection measure. This system continually scans the market for META 1 Coin trades. These trades must meet the minimum asset value to execute. This approach prevents whale traders from dumping their bags and causing the token to lose its pegged value despite having sufficient reserves on hand.
Anti Whale Systems in Place
The META 1 Coin is also the first DeFi network to ban all non-human participants. Corporations, trading firms, and governments cant trade META 1 Coins. The project was built from day one to support the community and this restriction falls in line with the founder, Robert P Dunlap’s, goal to achieve a more transparent and fair economic system.
Token Limit
Another unique feature that META 1 Coin pioneered is token limits on individual traders. The developers realized that whales come in all forms. They instituted a $5M token limit to prevent a single trader from influencing the price of the token and causing others to lose their savings. Additionally, it prevents corporations from sneaking in disguised as individual traders in an attempt to gain control over the community and project.
Downsides of PoS Networks
Like all systems, there are some downsides to PoS networks that traders should consider when they join a network. For one, PoS networks are newer than PoW networks. Additionally, they commonly have staking limits. Staking requirements vary from network to network but most have a minimal amount and connectivity requirements.
Centralization Concerns
Another concern that PoS networks have shed light on is centralization. Many PoS networks base their validation process on who has the most tokens staked. This approach creates more centralization and can leave new users out of the loop. The same goes for community governance systems as in many instances, the largest token holder has the most say.
One way in which developers have sought to combat these concerns is through the introduction of random validation systems. These protocols chose a validator based on random criteria like time held or other participation. Some are completely random, although, they will require a solid internet connection.
Lock Up Concerns
The last concern that you need to be made aware of with PoS networks is the loss of liquidity. When you stake your tokens, they are out of circulation. You can’t access them. As such, you may miss trading opportunities. However, it’s important to recognize that staking also helps to drive up the value of the tokens as it reduces circulating supply.
PoS vs PoW – Is There Room For Both Types?
There may be enough room in the market for both types of consensus to co-exist. There are even a variety of hybrid projects that leverage the PoW consensus mechanism for validation and PoS for scalability and smart contract programmability. There is no one-size-fits-all when it comes to consensus mechanisms and understanding what type of consensus a blockchain uses can help you to be a more informed investor. For now, you can expect to see more people push for more PoS networks in the coming weeks