What is Proof-of-Stake (PoS)? Advantages, Staking, and Blockchain Impact

Main

• Proof-of-Stake (PoS) is the most popular consensus algorithm on the blockchain, and many cryptocurrencies and blockchain platforms such as Ethereum, Cardano, Solana, Tezos, and Algorand are based on it.
• The popularity of PoS is due to the lack of need to buy expensive mining equipment and the possibility of easy passive income through staking cryptocurrencies.
• The advantage of Proof-of-Stake over the other popular Proof-of-Work (PoW) algorithm is the low energy consumption for generating blocks and securing the blockchain;

Why and how did Proof-of-Stake come about?

When designing a blockchain architecture, which is a decentralized protocol for transfers with a continuously updated database, two key questions arise:

• To whom and on what principle to grant the right to generate new blocks;
• how transactions will be approved to protect against double-spending and other abuses.

Addressing these issues has led to the emergence of several consensus mechanisms, that is, sets of rules by which participants in a decentralized network agree on exactly how transactions can be approved and included in new blocks.

Bitcoin creator Satoshi Nakamoto proposed the Proof-of-Work mechanism in October 2008 in white paper of the first cryptocurrency.

According to PoW, operators of node decentralized network (miners) in the mode of free competition solve resource-intensive mathematical problems - search for the hash of a block using the matching method. In case of success, the winning miner or pool gets the opportunity to add the found block, and in return receives a reward - new bitcoins.

A couple of years after the launch of Bitcoin, it became clear that the Proof-of-Work principle leads to a constant increase in mining power, and therefore in energy costs. In addition, due to the need to use powerful equipment, the availability of mining was decreasing.

On July 11, 2011, on the then popular cryptocurrency forum Bitcointalk the idea of an alternative consensus mechanism for bitcoin was proposed, which was called Proof-of-Stake, or ”proof-of-ownership”;

It was proposed that all participants in a decentralized network should receive voting rights according to what share of the total number of coins they own.

Already in August 2012, this new consensus mechanism received its first practical realization in the PPCoin cryptocurrency. New coins were distributed through mining, and transactions could be processed by any node that stored PPC cryptocurrency. The same hybrid consensus scheme was used in other early PoS projects, such as Gridcoin and Blackcoin. The first ”pure” PoS cryptocurrency without mining was the Nxt blockchain, launched on November 24, 2013.

The Proof-of-Stake consensus mechanism turned out to be so successful and flexible that in the following years it was implemented in hundreds of cryptocurrencies in different variants and modifications.

How Proof-of-Stake works

According to the original concept of Proof-of-Stake, the right to manage the blockchain is granted to all its participants according to the share of coins they own.

For example, in the Nxt cryptocurrency with its ”canonical” PoS mechanism, all users who have at least 1002 NXT in their official NXT Client wallet during the last 1440 blocks have a chance to form another block. In this case, each wallet is actually a complete node (node) and stores its own copy of the blockchain. Such a wallet can be run on a high-performance server, a laptop, a Raspberry Pi microcomputer, or even a cloud service.

The more coins an NXT wallet has, the more likely it is that it will be allowed to form a new block, and then the user will get all the transaction fees for the transactions in that block. Ideally, a wallet that owns 1% of the coins will form 1% of all new blocks.

The process of creating blocks in Nxt and other early PoS cryptocurrencies was called ”forking”, but the term has rarely been used to date.

The process of holding a cryptocurrency in a wallet to be rewarded for participating in the security of the network is called ”steaking”. Today, in many PoS cryptocurrencies, sending coins to staking involves locking them into a special smart contract with the inability to move them for a certain amount of time, from a few hours to a few weeks.

How coin delegation has affected PoS performance

Using a Proof-of-Stake mechanism, where virtually any cryptocurrency holder can be a block producer, allows for a high level of decentralization and blockchain security. However, according to the blockchain trillemma, performance has to be sacrificed in doing so. In the aforementioned Nxt cryptocurrency network, throughput is only 4 transactions per second, which is noticeably lower than many cryptocurrencies that use the PoW consensus. Dogecoin, for example, processes 33 transactions per second.

To find a compromise between decentralization and performance, they proposed the concept of delegation, where coins from multiple wallets, along with voting rights, can be delegated to a few computational nodes.

In 2013, Daniel Larimer, an American programmer and crypto entrepreneur, used this concept to create the Delegated Proof-of-Stake (DPoS) mechanism. It was first implemented in the BitShares blockchain platform, and then in different variants was embodied in the most famous crypto projects EOS, Cardano, Tezos, etc. Today, the delegation function has become an industry standard and is used in almost all PoS implementations.

In DPoS, cryptocurrency owners can choose not to participate in the network themselves, but to give their coins to validators - professional participants who manage the blockchain's nodes. In return, the validators are obliged to give the coin owners rewards, often minus a small commission.

Depending on the blockchain architecture, the number of validators involved in block production varies considerably from blockchain to blockchain:

• Polkadot - up to 16;
• BNB Chain and EOS - 21;
• Near - 100;
• Cardano - about 3,200;
• Avalanche - about 1,200;
• Solana - more than 3400.
• Ethereum - more than 400 thousand.

As a rule, running a validator requires special equipment with constant internet access, as well as a significant amount of native network coins. For example, a validator on the Ethereum network must have at least 32 ETH, and a Tezos validator must have at least 8,000 XTZ.

Proof-of-Stake and Staking

To compensate computational nodes for the cost of verifying transactions and generating new blocks, most PoS blockchains have a reward that is paid in native coins of the network. As a rule, its size for each block is fixed, but can vary depending on the current parameters of the network.

For example, in the blockchain platform Tron the super-representative (as the validator is called in this case) who generated the next block and processed the transactions receives 32 TRX. He shares part of this amount with users who put their TRX into steaking and thus voted for it. 

The profitability of steaking for validators and coin holders is determined by two factors:

• issue rate, which is determined by a fixed value of coins issued for each new block;
• the proportion of coins in circulation that are blocked in staking (Staking Ratio);

For example, if 1 million coins are issued through staking per year with a total supply of 100 million coins, the yield of staking with 50% of coins blocked will be 2% per annum. If 25% of the supply is blocked, the yield doubles to 4% per annum.

What varieties of Proof-of-Stake exist

Many consensus mechanisms have been developed on the principles of PoS and delegation, which differ in a number of nuances, for example, the distribution of roles among the participants of the decentralized network.

To cite a few of them:

• Leased Proof-of-Stake(LPoS,”leased proof-of-stake”) - used in the Waves blockchain, where users rent their coins to a validator for a fee;
• Nominated Proof-of-Stake(NPoS,”nominated proof-of-stake”) -is used in the Polkadot blockchain platform and involves so-called nominators who post pledges for validators and are responsible for their integrity;
• Pure Proof-of-Stake(PPoS, ”pure Proof-of-Stake”) - used in the Algorand network, where validators for the next block are secretly and randomly selected among all wallets with a balance greater than 1 ALGO;
• Effective Proof-of-Stake(EPoS, ”effective proof-of-stake”) used in the Harmony blockchain platform. It has a special reward distribution mechanism that encourages running many small validators instead of a small number of large validators, which encourages decentralization;
• Proof-of-Authority (PoA) a hybrid algorithm that combines proof-of-stake and reputation validators, each of which must be approved by developers. In PoA, the validator must undergo an identity verification process similar to KYC. This algorithm uses BNB Chain.

Is the transition to Proof-of-Stake possible for Bitcoin and other cryptocurrencies?

The high energy cost of mining cryptocurrencies powered by the PoW algorithm has been the subject of criticism for years. According to research by the Cambridge Center for Alternative Finance, bitcoin mining is responsible for emitting 0.1% of all anthropogenic carbon dioxide.

It is this factor that has become one of the main arguments in attempts to ban mining in various countries. Thus, by the end of 2021, cryptocurrency mining banned in China. In March 2022, the European Parliament put a vote on banning cryptocurrencies. Although the bill was not supported, it marked a trend to push PoW out of the legal field.

Since the successful transition of the Ethereum network to Proof-of-Stake consensus September 15, 2022, the network's power consumption has decreased by nearly 2,000 times, or 99.95%. In this regard, the discussion of the transition of popular PoW cryptocurrencies to PoS has unfolded with renewed vigor.

Back in December 2021, the developers of the meme cryptocurrency Dogecoin announced its imminent transition to the Proof-of-Stake algorithm.Vitalik Buterin, co-founder of Ethereum, has decided to help them in this process.

Electric Coin Company, developer of the anonymous cryptocurrency Zcash, is also discussing with the community the prospects of switching to PoS. According to founder Zuko Wilcox, this would not only improve the security and energy efficiency of the blockchain, but also help to involve ZEC owners in the management of the protocol.

The biggest doubt is the possibility of switching to PoS in the case of bitcoin.

First, the first cryptocurrency does not have a single developer. Several independent groups of developers are discussing all the proposed innovations, so even the implementation of even the smallest of them causes fierce debates and takes years;

Secondly, the transition to PoS will not be supported by mining pools, which are threatened by the loss of revenue. It is noteworthy that back in 2020, a group of developers launched a fork of Bitcoin PoS, which the crypto community simply ignored.

In turn, PoW supporters point to the greater level of security of this algorithm: with the current, extremely high level of decentralization of the bitcoin network, it is virtually invulnerable to external attacks.