Proof of stake is a consensus mechanism used to verify new cryptocurrency transactions. Since blockchains lack centralized governing authorities, proof-of-stake is a method of ensuring that data stored on the network is valid.
What is proof of stake?
Decentralization is the core of block chain technology and cryptocurrency. There is no central gatekeeper to manage the transaction and data record of a blockchain. Instead, the network relies on an army of participants to validate incoming transactions and add them as new blocks on the chain.
Proof of stake is the consensus mechanism that helps choose which participants are tasked with this lucrative task, lucrative because those chosen are rewarded with new cryptocurrencies if they accurately validate the new data and do not game the system.
โWhen blockchain participants verify that a transaction is legitimate and add it to the blockchain, we say that the participants have reached a consensus,โ says Marius Smith, head of business development at digital asset custodian Finoa.
With proof of stake, participants called โvalidatorsโ lock set amounts of cryptocurrency or crypto tokens (their stake, so to speak) into a smart contract on the blockchain. In exchange, they have the opportunity to validate new transactions and earn a reward. But if they incorrectly validate incorrect or fraudulent data, they may lose part or all of their bet as a penalty.
Solana, Terra and Cardano are among the largest cryptocurrencies using proof of stake. Ethereumthe second largest cryptocurrency by market capitalization after bitcoinis in the midst of a transition from proof-of-work to proof-of-stake.
What is betting?
Staking is when people agree to lock up an amount of cryptocurrency in exchange for the opportunity to validate new blocks of data that will be added to a blockchain. These validators, or โstakeholders,โ put their cryptocurrencies into a smart contract that is maintained on the blockchain.
The blockchain algorithm selects validators to verify each new block of data based on the amount of cryptocurrency they have staked. The more you bet, the better your chances of being chosen to do the job. When the data that has been deleted by the validator is added to the blockchain, they get newly minted cryptocurrencies as a reward.
โThe simplest way to think of staking is as interest income that requires you to complete a task to earn the interest: verifying blockchain transactions,โ says Doug Schwenk, CEO of Digital Asset Research. โIf I validate only good transactions, I earn interest on my assets. If I include bad transactions, I will be penalized and lose some of my assets.โ
If a validator submits incorrect data or fraudulent transactions, they could be punished with a โcut.โ Your stake is โburned,โ meaning it is sent to an unusable wallet address that no one has access to, rendering them useless forever.
According to Smith, proof-of-stake works because validators say, "Hey, I have so much faith in the legitimacy of this transaction that I'm willing to back it with my own money." And verified transactions earn a cryptocurrency reward in proportion to the size of the bet.
Proof of Stake Benefits
Proof of work has earned a bad reputation for the enormous amounts of computing power (and electricity) it consumes. Given growing concerns about the environmental impacts of blockchains that use proof-of-work, such as Bitcoin, proof-of-stake offers potentially better outcomes for the environment.
"On a global scale, proof of work is most cost-effective when you can get power at the lowest cost," Smith says.
This concentrates crypto mining in a few regions where electricity costs are lower. According to Smith, proof-of-stake's modest energy consumption solves this problem and widely distributed infrastructure, potentially making a blockchain system more robust.
Proof of stake opens the door for more people to participate in blockchain systems as validators. There is no need to purchase expensive computer systems or consume huge amounts of electricity to stake cryptocurrencies. All you need are coins.
Cryptocurrency exchanges such as Coinbase, Binance and Kraken offer betting as a feature on their platforms. There are even dedicated betting platforms, such as Everstake. Depending on the blockchain, cryptocurrency owners can earn returns of 5% to 14% on their holdings by staking.
An additional benefit of proof-of-stake blockchains offers potential for the future: they can be more scalable than their proof-of-work counterparts. Smith says proof-of-stake blockchains can, in theory, support more simultaneous transactions without compromising security or decentralization.
โThis is where a lot of innovation is happening today, and indeed it is a challenge that blockchains will have to overcome if they ever want to become widely used on a global scale,โ he says.
Disadvantages of proof of stake
According to Amaury Sechet, founder of eCash, proof of stake is not without its drawbacks.
โProof-of-stake is not as thoroughly vetted as proof-of-work, which has secured billion-dollar blockchains for over a decade,โ Sechet said.
Certain proof-of-stake implementations could make blockchains more vulnerable to different types of attacks than proof-of-work, such as low-cost bribery attacks. Susceptibility to attacks decreases the overall security of the blockchain.
Validators who hold large amounts of a blockchain's tokens or cryptocurrencies can have great influence in a proof-of-stake system.
Migrating a cryptocurrency from proof of work to proof of stake is a complicated and very deliberate process. Any cryptocurrency that wants to change consensus mechanisms will have to go through an arduous planning process to ensure the integrity of the blockchain from start to finish and beyond.
Proof of Stake vs. Work test
There are two consensus mechanisms that are generally used in cryptocurrencies and DeFi Applications: proof of stake and proof of work. While the former employs staking, proof-of-work requires miners to solve complicated mathematical puzzles to decide which network participants can validate transactions and expand the blockchain.
Proof of stake
- It requires validators to hold part of the blockchain token or cryptocurrency.
- Does not require significant computing power for transaction validation.
- It is a newer approach than proof of work, with less adoption as a consensus mechanism.
- Cryptocurrencies that use proof of stake could be more attractive for an ESG portfolio due to the lower environmental impact.
Work test
- Proof of work has a longer proven history of use as a blockchain consensus mechanism.
- Miners do not need to own any of the blockchain assets and only need computing power to validate a transaction.
- It can use a very significant amount of electricity. Cryptocurrencies that use proof of work are often excluded from ESG portfolios due to power demands.
What cryptocurrencies use proof of stake?
Proof of stake is becoming increasingly prevalent as a consensus mechanism in the world of cryptocurrencies. There are currently around 80 different cryptocurrencies that use PoS as a consensus mechanism. Some of the most popular coins that use proof of stake include:
- Cardano (ADA)
- Tron (TRX)
- EOS (EOS)
- Cosmos (ATOM)
- Tezos (XTC)
The bottom line
While proof-of-stake is still emerging as a consensus mechanism for blockchain, it has significant potential. With lower power demands and a higher level of accessibility for everyday people to participate as validators, proof-of-stake has many attractive features that could bring it into the mainstream of blockchain security.
