The recent news surrounding the SEC's action to shutter Kraken's staking services got me thinking about how little I know about staking. (Kraken is a US-based cryptocurrency exchange. You can read more about what happened in this Reuters article). This led me to take a deep dive to explore the topic. My efforts were fruitful, but before we can jump into the world of staking, we need to take a step back to understand the difference between Proof of Work (PoW) and Proof of Stake (PoS).
PoW and PoS are consensus mechanisms for blockchains, which we first discussed briefly in our Basics of Blockchain Technology article. In that article, we learned each "new block [of a blockchain] is validated by a node using complicated computer algorithms (usually via Proof of Work or Proof of Stake)." In other words, a blockchain's consensus mechanism allows it to be regulated and grow without a centralized party overseeing it. But what's the difference between PoW and PoS, and why does it matter? It turns out there are significant distinctions ranging from speed and efficiency to impacts on the environment. Let's get into it!
Proof of Work
Satoshi Nakamoto first adopted the Proof of Work (PoW) consensus model for the OG cryptocurrency, Bitcoin. In PoW, blockchain transaction verification is done through a process called mining, and those who participate in this process are called miners. Essentially, miners compete to solve cryptographic puzzles in order to propose valid blocks that meet the rules of the network. Whoever solves the puzzle first broadcasts their result/proposed new block out to the nodes on the network for validation. Once consensus is reached that the block is valid, the block is added, and the miner who submitted it earns rewards for their work in the form of that chain's cryptocurrency (aka native token).
Although miners complete the process, there isn't a person sitting at their desk solving math puzzles all day. Miners have complex, high-powered computers that do the work automatically. PoW is a first-come-first-served system, incentivizing only the fastest miner. In turn, people create mega computer setups requiring tons of energy to "out mine" others.
Some concerns that come along with the use of this model include the following:
- Environmental impact: As Bitcoin, and other chains that adopt the PoW model, grow, the environmental impacts also rise due to the increased energy consumption by the miners.
- De facto centralization: If only the most powerful miners are participating in creating new blocks, it is centralizing the "management" of the blockchain to a few mega powers, the very thing that blockchain technology is trying to eliminate. While there are mechanisms in place to prevent a powerful miner or group of miners from overtaking the blockchain, the question of equity in mining and promoting the "rich getting richer" ethos are present.
- Scalability: Blockchains with many applications running on them have high activity, which can overload the system during busy times, creating a bottleneck for transactions. When this occurs, transaction speeds are slow, and gas fees get quite expensive. Ethereum 1.0 used the PoW, and such issues were widespread.
There are well over 300 blockchains that used the Proof of Work consensus model at the time this article was written. A few noteworthy chains include:
- Bitcoin (BTC)
- Ethereum 1.0 (the new version uses Proof of Stake)
- Dogecoin (DOGE)
- Litecoin (LTC)
- Monero (XMR)
Proof of Stake
Due to the above concerns, different consensus models began to emerge. In 2012, Proof of Stake (PoS) was created with the goal of increasing speed and efficiency while reducing gas fees. PoS creates a more equitable verification system where validators are chosen randomly instead of computers working to solve puzzles quickly. To participate, you must stake a specified amount of native tokens from that blockchain (more on this in our next article). Participation in the validation process in PoS is rewarded with the chain's native token. This system also vastly decreases the environmental impact seen in PoW.
Sounds like a win-win, right? Well, kind of. The bar of entry to be a validator is very high and dependent on the size of the network, so as the networks grow, it continues to become more expensive. Due to the significant investment needed, again, this promotes the participation of only wealthy people. With that said, there are other ways to participate and some additional drawbacks, but we will discuss that more in our next article.
There are well over 200 blockchains that use the Proof of Stake consensus model at the time this article was written. A few noteworthy chains include:
- Ethereum (ETH)(Ethereum successfully merged to PoS from PoW in September 2022)
- Binance Coin (BNB)
- Cardano (ADA)
- Solana (SOL)
- Tezos (XTZ)
With this basic understanding, we are ready to jump into the world of staking head first. Be on the lookout for that article next week!
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The content is for informational purposes only. Nothing contained in this article constitutes a solicitation, recommendation, endorsement, or offer of a security, token, or application. This is not investment or legal advice. Please do your own research.