Proof of work vs. proof of stake: Comparing two blockchain verification types

Perhaps you’re looking to invest in blockchain technology to broaden your portfolio diversification strategy. You could invest in cryptocurrency directly, or you might take the less direct route and purchase a stock or fund invested in blockchain development. Either way, you’re going to come across two critical mechanisms designed to ensure the honesty and safety of each blockchain transaction: proof of work and proof of stake.

These terms represent different methods for validating blockchain transactions—an operation that’s critical to a blockchain network’s success. The aim is to ensure all transactions are valid, secure, and tamper proof. Without a robust validation procedure, the blockchain network would have little to no purpose.

Although blockchain technology is still in its early stages, it’s seen by many as the future of digital tech, a disruption that could change the world much as the Internet has done. If you plan to invest in crypto or blockchain tech, it’s critical to understand the two distinct validation procedures, as each could take the development of blockchain technology in different directions.

Will one win out over time, or is there room for both?

Validating blockchain transactions

A blockchain is like a digital public ledger. Think of it as a huge and immutable database that records all digital transactions—from cryptocurrency to any form of information or digital asset—on a peer-to-peer network. All computers (aka nodes) participating in a given blockchain network have a copy of the same blockchain. All copies must always be in agreement.

When blockchains are decentralized, meaning no entity governs or monitors transactions, there has to be a reliable way to verify each transaction. And that’s where proof of work and proof of stake come in.

Proof of work and proof of stake are two algorithmic methods that blockchain networks use to validate transactions.

Both validate transactions by way of agreement or “consensus.” But consensus among what? (There’s no “who” involved.) Various participating computers (nodes) on the network must be in agreement that a transaction is legitimate before it’s recorded.

That’s why proof of work and proof of stake are called consensus mechanisms. Each has its own way of validating transactions by employing various nodes to do the work.

Proof of work: High energy consumption and a big carbon footprint

With the world’s first cryptocurrency, Bitcoin, came the world’s first blockchain validation mechanism, proof of work (PoW).

In a PoW environment, miners (basically, computers across the globe participating in the network) compete to “mine” new blocks. New blocks are needed to add new transactions to the blockchain.

To create a new block, miners have to solve a complex mathematical problem (essentially making guesses), which becomes more difficult after every subsequent block. This is the “work” part. The work is in the calculations to solve the problem, but it also consumes an exorbitant amount of real energy on a global scale.

Bitcoin is often criticized for its environmental impact—its proof-of-work mining consumes around 120 terawatt-hours per year, similar to Argentina’s total electricity use, according to the Cambridge Bitcoin Electricity Consumption Index. While estimates suggest those energy demands may generate tens of millions of metric tons of carbon dioxide annually, figures vary depending on energy source assumptions.

And remember that Bitcoin mining is a global operation, one whose collective power is estimated to be equivalent to 3.7 million supercomputers working simultaneously around the clock. What might happen if other blockchain networks using proof-of-work validation mechanisms become widely adopted and expand?

As an investor who may be interested in gaining blockchain exposure, you’d have to ask yourself whether such an operation is commercially, financially, and environmentally sustainable. The crypto world found it to be highly problematic, so developers introduced a more environmentally friendly alternative: of stake.

Proof of stake: A cleaner and more efficient solution

In a proof of stake (PoS) scenario, there are no miners competing to win the privilege of adding a new block to the chain. Instead, anyone participating in the network can be included in the process of adding blocks by “staking” (versus mining) some amount of coins.

To become a “staker,” a user has to lock up, or stake, an amount of the network’s coins for a period of time in accordance with a network-specified procedure. This usually involves software or a process offered by a crypto exchange. This locking-up process is the “proof” of your personal stake.

The staker who gets to produce the new block—a process called minting or forging, as opposed to mining—is chosen at random. But the larger your stake, the better your odds of being the chosen staker.

The selected staker earns rewards—fees, essentially—that are usually paid in the form of more crypto coins. But if stakers attempt to do anything malicious to cheat the network or interfere with the production of a new block, they may lose a portion of their staked coins (or even get kicked off the network).

If you’re an investor who considers environmental impact to be a make-or-break factor, then investing in a crypto or a blockchain company that uses PoS may be something to consider. The staking process involves significantly less energy consumption than the mining process. Plus, staking allows far more nodes to participate in the creation of new blocks, strengthening its consensus governance in a more decentralized manner.

The most widely adopted crypto using PoS is Ethereum 2.0. Unlike Bitcoin, which was designed to be a monetary asset, the Ethereum blockchain network is designed for additional purposes besides cryptocurrency, such as smart contracts, non-fungible tokens (NFTs), and other digital goods.

Other drawbacks of PoW and PoS

There are additional drawbacks to both PoW and PoS that developers are working to resolve.

In addition to its high energy consumption, PoW mechanisms are slow. Plus, the benefits of decentralization can be diminished if a small number of “mining farms” dominate the mining process.

As for PoS, staking is something of a rich person’s game. The larger your stake, the better your odds of validating the next block, making the notion of a decentralized network a bit questionable—the wealthiest coin holders will likely be the most dominant validators.

The bottom line

You’re probably wondering which proof mechanism might be more adoptable, reliable, sustainable, and thus investable for the long term. The fog of potential innovation in both mechanisms can make such a decision difficult, and the pros and cons of either will likely be transformed as developers actively seek ways to enhance their capabilities and mitigate their risks.

If you’re a crypto investor, you might consider a diversified approach and invest in a bit of each validation type. And remember: blockchain is a rapidly developing technology. Improvements—including all-new consensus mechanisms—are in the works and might join PoS and PoW as top dog.

References

• Cryptocurrency’s Dirty Secret: Energy Consumption | news.climate.columbia.edu
• Cambridge Blockchain Network Sustainability Index | ccaf.io