When it comes to blockchain, you often come across the terms 'proof of work' and 'proof of stake', but what exactly do they mean? For that, we first need an explanation of blockchain, the technology behind bitcoin and other crypto-currencies.In a nutshell, blockchain is a decentralized database. All information is not managed by one party, but by everyone on the network. More information about blockchain technology can be found here.The information added to a blockchain database must be approved by the participants in the network, also called the 'nodes'. They must all agree on the transaction (consensus) before a transaction takes place.There are several methods for this process. The best known is the proof of work method. This is used for one of the best-known applications of blockchain: bitcoin, among others.But how exactly does this 'reaching consensus' work? How is a transaction approved and added to the chain?
With the consensus model behind bitcoin comes the term "mining. Any participant on the blockchain can make his/her computer work for the network. You are then called a "miner”. For approving transactions that person receives a small reward.This approval is done by the miners solving a complex mathematical puzzle. Finding the solution requires a lot of computing power. Compare it to a padlock with a numerical code. The miners try to open the lock by entering different codes each time.After millions of attempts, the correct combination of numbers is finally found and then checked by the rest. The computer that is first to solve the puzzle wins and is rewarded with a small amount of the corresponding crypto currency. The block is then complete and is added to the existing chain. With bitcoin, this process takes place every ten minutes.
One of the biggest criticisms of the proof of work system is the huge, so-called mining farms, are created. These are gigantic rooms with all computers that try to mine as many blocks as possible. After all, more computing power means a greater chance of being the first to find the solution.First, this undermines the decentralized nature of blockchain. The power within the network shifts to the parties with the most computing power. You can forget about getting rich in your attic by mining bitcoins.Also, these computers together consume a lot of power. Even so much so that warnings are issued at popular places to mine bitcoins. For example, Iceland will probably soon use more electricity to mine bitcoin than to power all of its households.Yet the complexity of the puzzle is also why proof of work is so secure. It takes an enormous amount of computing power to find the solution to add a block, let alone change it. Just think how much processing power and time it would take to change all the blocks afterwards.
But proof of work theoretically has a weakness. For example, if the largest mining farms merge, they control more than 51 percent of all miners.What does that mean?Within blockchain, the longest chain of blocks counts as the truth. Once there is a party that owns more than 50 percent of the miners, that party can commit fraud without the system labeling it as untrue. The control mechanism is corrupted. Thus, crypto coins can be issued twice or transactions can be manipulated.
There are other solutions to achieving consensus. What if we could trust nodes not by how powerful their computer is, but by how many coins they have in the blockchain network. Then you end up with "proof of stake.The more crypto coins you have, the greater the chance of verifying transactions. A lot more energy friendly, in other words.With proof of stake, there are no miners. Here they are called 'validators'. They do not mince blocks, but do forging or minting.Suppose you somehow own 3 percent of the crypto currency in a blockchain network, then you have a 3 percent chance of forging the next block. The more coins you have, the more chance you have of winning.In terms of reward, the system also differs from proof of work, where the winner is paid in, for example, bitcoin. With proof of stake, the winner receives the transaction costs of the transactions in a block.The more coins you have, the greater the loss if a false transaction is approved. The potential loss of economic value is what makes the network secure.
This system also has its drawbacks. One of the biggest drawbacks is a "nothing at stake" attack. This is a fairly technical concept, but we try to approach it simply.It can happen that in a proof of stake network, there will be a 'fork'. This is a split of the existing blockchain and can occur due to a bug or a malicious attempt to manipulate the history of the blockchain.In proof of work, miners get their biggest return by staying on the right chain. Miners compete to crack the code and mine a block as quickly as possible. If they were to bet on multiple chains they would have to divide their computing power. That is not profitable.With proof of stake this is not the case. The validators do not use any computer power and therefore do not lose anything if they place their stake on both chains. This is the most profitable; after all, they are only concerned with the transaction revenue.A malicious user can therefore make the same transaction twice, which is profitable for him. By the way, this chance is very small and not likely, since you have a stake in the network.
With proof of stake, there is also the possibility for a 51 percent attack. A party or individual must own 51 percent of relevant crypto currency in that network in order to carry out malicious actions.The catch here is that if someone wants to own 51 percent of all coins in the network, that person (depending on the value and size of the crypto currency) has to throw tens if not hundreds of millions of euros at it.
An important difference between the two consensus models is that it is easier to participate in the verification of blocks in proof of stake than in proof of work.This is because in proof of work you need expensive equipment to have any chance at all in the mining process. As a result, proof of stake is more accessible, so more validators participate. This makes the network a lot more decentralized than proof of work.Another big difference is energy consumption. Proof of work turns out to have a big impact on our environment. Proof of stake, on the other hand, not.Yet proof of stake also has its flaws. A rogue "nothing at stake" attack is possible, even though the consensus models are often updated to nip such practices in the bud.The final difference is security. In proof of work, the complexity and computational power is actually a built-in security. Proof of stake has to rely more on the potential loss of economic value, so the system provides security in a different way.If you came across terms in this article you’re not familiar with no worries. Check here our article about the 51 crypto terms you most know.