Will Proof-of-Stake Save Cryptocurrency's Future?

Will Proof-of-Stake Save Cryptocurrency's Future?

Proof-of-Stake consensus algorithms are the key to scaling cryptocurrencies and powering mass adoption.

Since Bitcoin's launch in 2008, Proof-of-Work has been the de facto consensus mechanism for many blockchains. The security and decentralisation of PoW is unrivalled, which is why it remained the industry standard for years.

However, research reveals an ugly fact about Satoshi Nakamoto's consensus protocol:

Proof-of-Work cannot work any longer—at least if we want to cryptocurrencies to become widely accepted.

In light of the problems with Proof-of-Work, a new consensus algorithm called Proof-of-Stake has become the popular choice for newer blockchains. Proof-of-Stake blockchains promise faster transactions, higher scalability, a lower carbon footprint, among other benefits.

This article attempts to make sense of the Proof-of-Stake vs Proof-of-Work debate and why it matters. We'll consider the potential benefits of a PoS blockchains and risks associated with this novel consensus mechanism.

The Problem With Proof-of-Work

Last month, the US Congress held its first hearing on the topic of regulating cryptocurrencies. The question before the House Committee on Energy and Commerce was simple: How do we make cryptocurrency environmentally sustainable?

It is no longer news that the electricity consumption of cryptocurrency is comparable to many countries. If anything, high energy usage and its attendant environmental impact is the major complaint levelled against cryptocurrencies like Bitcoin and Ethereum.

The blockchain technology powering Bitcoin, Ethereum, and dozens of altcoins relies on a Proof-of-Work consensus mechanism to secure the system and prevent malicious actions, such as double-spending of funds.

Proof-of-Work (PoW) is the original solution developed by Bitcoin's original founder, Satoshi Nakamoto, to confirm the validity of transactions in the absence of a trusted intermediary.

An explanation of the PoW mechanism would fit into an entire article, so we'd stick to the basics here.

PoW consensus systems require network participants to solve complex cryptographic equations before validating new blocks and adding them to the blockchain. Also called mining, this activity demands enormous computing power from miners.

Because the network rewards whoever solves the problem first, miners can invest in higher computing power to increase their chances of getting mining rewards. Unsurprisingly, this leads to greater energy consumption, which is why criticism of cryptocurrency's energy usage is rife.

What is Proof-of-Stake?

Proof-of-Stake (PoS) is an alternative consensus mechanism that fixes many issues with the PoW system. Created in 2012 by Sunny King and Scott Nadal, the developers behind Peercoin, Proof-of-Work is used by blockchain networks including Solana and Cardano, with Ethereum planning to join the party soon.

Here's a basic ELI5 introduction to Proof-of-Stake:

Unlike Proof-of-Work, the Proof-of-Stake system doesn't require network participants to solve cryptographic problems before adding a new block. Rather, the system relies on "validators" who stake funds for the right to confirm new blocks.

The selection of validators is one of the biggest differences between Proof-of-Work and Proof-of-Stake.

A pseudorandom process is used in Proof-of-Stake validator selection to choose who gets to validate a new set of transactions. Other factors like the size and age of the stake also influence who ends up as a validator in this system.

In a Proof-of-Stake blockchain, validators receive transaction fees, but don't get rewards for confirming blocks. As a result, there's little reason to expend excessive computing power since it's not a race-to-the-finish like Proof-of-Work systems.

Benefits of Proof-of-Stake Consensus

A Proof-of-Stake system is a better proposition for Bitcoin and other cryptocurrencies, especially if the energy consumption problem is to be solved. As explained already, the Proof-of-Stake protocol uses less energy and is considered greener.

Network participants receive rewards according to funds staked, not computing power spent on solving cryptographic equations. With regulators and the wider community questioning cryptocurrency's viability due to high energy usage, PoS may well be crypto's trump card.

But the advantages of Proof-of-Work go beyond making cryptocurrencies greener. A benefit of Proof-of-Stake systems that rarely comes up in discussions is their promotion of decentralisation.

Current Proof-of-Work mechanisms reward miners with the greatest computing power. As such, large mining collectives invest in high-grade Graphical User Interfaces (GUIs) and Application Specific Information Computing Systems (ASICS) to increase their chances of earning block rewards.

The result is a highly centralised system where a few rich individuals and organisations control access to the blockchain. Satoshi imagined the blockchain as a decentralised system, so the inherent centralisation in PoW creates problems for the future of cryptocurrencies.

In a PoS network, literally anyone can stake funds for the right to validate transactions. Plus, validators don't need expensive computers when server-grade devices will perform the task. The system is open to a larger collection of participants, which promotes decentralisation and improves network security.

Despite claims to the contrary, Proof-of-Stake improves blockchain security. In fact, PoS networks disincentivise malicious activity better than traditional Proof-of-Work consensus mechanisms.

Imagine someone tries to validate a wrong transaction to game the PoW system. While other node operators can quickly spot the problem and reject the block, the bad actor never gets punished.

With a PoS system, anyone who validates a wrong transaction risks losing money they staked. The smart contract is programmed to automatically freeze funds if malicious activity like validating bad transactions is detected.

A PoS system would also disincentivise a 51% attack. A 51% attack occurs when bad actors take over more than half (or 51%) of nodes on a blockchain. In this situation, such people can alter the blockchain ledger for nefarious purposes, like double-spending funds.

Controlling 51% of validators on a PoS blockchain requires locking up over half of the total cryptocurrencies in a smart contract. This is impractical for many reasons.

First, hackers would need to spend their money to take over the network. Second, they risk losing the money staked even if they obtain control since the smart contract automatically freezes funds of bad actors. Lastly, no one is likely to attack a system that holds 51% of their money, as it would affect the value of the currency.

Perhaps the biggest upside to adopting Proof-of-Work blockchains is the scalability they promise. For starters, a PoS network is likely to have more node operators since the barrier to entry is low.

Besides, there are no complex calculations to solve before confirming blocks—so validation of transactions is faster. This will exponentially increase the throughput on blockchains and help them scale to accept more users.

An increase in throughput is excellent for cryptocurrencies since poor scalability is a huge stumbling block to their adoption. Already, Proof-of-Stake coins like Solana and Cardano are proving popular because of their lower gas fees.

Risks of Using Proof-of-Stake in Blockchain

A section of the blockchain community, particularly Bitcoin maximalists, believe Proof-of-Stake will fail. While this view may be extreme, the disadvantages of Proof-of-Stake certainly need to be discussed.

Some believe a Proof-of-Stake blockchain is centralised because it allocates power to participants based on the quantity of the tokens they hold. As such, anyone can buy up a large amount of cryptocurrency to increase their chances of getting selected as validators.

This would end up concentrating validation capacity in a few hands, which is the same problem Proof-of-Work systems face.

Besides, PoS systems are relatively new and data on their reliability is scarce. In contrast, PoW blockchains have been the industry standard since Satoshi went live with Bitcoin in 2012.

Many also criticise Proof-of-Stake for the perceived barriers to entry it creates. This has to do with the high fees demanded by Proof-of-Stake blockchains to approve validators.

Ethereum 2.0 requires prospective validators to pay 32 ETH (around $96,000 at current market prices). Solana requires even higher fees—between 5,000 SOL and 50,000 SOL per various sources. Binance Smart Chain, which uses just 21 validators, asks for 10,000 BNB (around $4,200,000).

Still, it's important to say here that it's possible for different individuals to combine funds into a "stake pool." Stake pools allow individuals to contribute towards a particular validator and receive a share of the rewards. Services like ANKR and Rocketpool already provide these services.

Bottom Line

Is Proof-of-Stake the key to scaling cryptocurrencies and revolutionising the future of money? Yes. All the signs to the growing need for a scalable, secure, and efficient infrastructure for crypto, which Proof-of-Stake offers.

Proof-of-Stake cryptos would promote faster transactions, which may encourage more businesses to accept cryptocurrency payments. So, yes, you can now buy coffee with crypto!

More importantly, staking will improve access to blockchain networks and advance mass adoption. Even institutional investors may be willing to buy crypto now that it has long-term sustainability and better chances of mass adoption.

While it has flaws, Proof-of-Stake remains the best bet for future of cryptocurrencies. If crypto is to achieve widespread adoption, become environmentally sustainable, and scale to accept more users, moving to PoS blockchains is a no-brainer.