I don’t want to be the only one experiencing true financial freedom in 2022. That’s why I try to spread the word about crypto to my friends, so we can all be free together.
As I try to impart my crypto wisdom to the world, there’s one thing that gets in my way. Terrifying terminology. Like ‘consensus mechanism’.
People hear ‘consensus mechanism’ and they immediately glaze over. That’s when I know I’m going to be the loneliest of Lambo drivers. But, honestly, it’s not that complicated.
A consensus mechanism is just a way for a decentralised network (like Bitcoin) to agree on the validity of a transaction. Consensus must be reached before the next transaction can be processed. This, in essence, is how a blockchain operates and remains secure.
Not all consensus mechanisms are created equal, however, and different blockchains tend to use different methods. Proof of Work (PoW) and Proof of Stake (PoS) are the two most popular consensus mechanisms in crypto. Bitcoin uses PoW, while many newer projects, like Cardano, use PoS.
Proof of Work
The concept of PoW was first discussed in 1992 as a method of combatting junk emails. Cypherpunk Adam Back built upon this with Hashcash – a countermeasure for denial of service attacks and email spam. The idea really only began to seep into the public consciousness in 2008, however, when Satoshi Nakomoto had the bright idea of implementing the algorithm to secure a digital payments network. And, just like that, Bitcoin was born.
To validate a transaction on the Bitcoin network a computer (or node) needs to solve a computational puzzle. The solution to the puzzle is called a hash. The more hashing power a node has, the more likely it is to solve the puzzle and produce a bitcoin block.
To incentivise people to join the Bitcoin network (or any PoW crypto blockchain) miners earn fees from the transactions in each block plus a block reward in BTC. Every time a computational puzzle is solved, a new block is minted. A new puzzle is then created which must be solved to mint the next block.
The Bitcoin network uses difficulty adjustment to help to deter data manipulation. Higher difficulty means that it will take more computing power to mine the same number of blocks, making the network more secure against attacks and ensuring the average time between each block remains approximately 10 minutes.
To disrupt the Bitcoin blockchain a miner or group of miners would need to control more than 50% of the network’s mining power. This is known as a 51% attack. The PoW algorithm makes this almost impossible because the amount of hardware and energy resources required would be prohibitively expensive.
The point of PoW isn’t to demonstrate that “work” was carried out or that a puzzle was solved. The puzzle itself is arbitrary. Rather, PoW creates a beautiful balance whereby the effort required for honest and valid mining is worth the reward, while malicious data manipulation is nigh on impossible and not economically worthwhile.
Sounds perfect, right? Not quite. Advances in mining technology have made it increasingly difficult to turn a profit as a miner. Huge amounts of computational power and resources are required to profitably mine BTC, which has resulted in the proliferation of mining pools. This, in turn, has contributed to centralisation as a small number of mining pools have a monopoly on computing power.
In summary, PoW has proven highly effective in securing a network, but it consumes substantial amounts of energy and incentivises mining pools which result in a more centralised network. But, can this be improved upon? Possibly; that brings us to PoS.
Proof of Stake
In response to energy-consumption concerns, the crypto community set about devising a less energy-intensive consensus mechanism and, in 2011, Sunny King and Scott Nadal announced PoS to the cryptosphere. PoS seeks to securely validate transactions just like PoW without all the puzzle-solving and energy consumption. Instead of solving a puzzle, crypto is staked (locked) on the blockchain in order to earn the right to process transactions.
The minimum amount of stacked coins required and the length of time for which they must remain locked can vary but, essentially, the more crypto you stake, the more likely you are to successfully process transactions and create a block. The PoS algorithm selects block validators at random while also taking into account the number of tokens staked and the length of time for which they have been staked.
Where PoW uses hash rate adjustment to disincentive malicious data manipulation, PoS employs slashing. Slashing is a process whereby, if a computer on the network breaks the rules, some of their staked coins are destroyed. The amount staked always exceeds any potential rewards and this is how honest mining is encouraged and data manipulation is deterred.
PoS ticks a lot of the same boxes as PoW minus the necessity for a whole bunch of hardware and computing power. You might be asking yourself at this point, “The more you stake, the more you make? Doesn’t this mechanism favour the rich?”. And, you’d be right. PoS does favour those who can afford to stake more tokens. To address this issue, delegated staking was proposed.
Delegated Proof of Stake (DPoS)
Delegated staking is an evolution of PoS first developed in 2014 on the EOS platform. DPoS allows users who can’t (or simply don’t wish to) run a node, to lend their crypto to a staking pool. This pool has a nominated participant known as a delegate who validates the next block. The delegate earns the transaction fees for validating the block while the lenders benefit by earning a cut of the block reward.
This process is comparable to mining pools in PoW, except staking pools share capital where mining pools share computing power. DPoS is arguably a more fair iteration of PoS as it allows almost anyone to get involved and doesn’t favour the rich to the same degree.
So, let’s get to the point. Which is better? PoW or PoS? Let’s break it down.
Energy consumption and the environment
PoW is often criticised for its impact on the environment. For example, whenever new mining technology is developed the old computers get dumped. This isn’t great, but clogging up the planet with obsolete hardware is just the start of it. As discussed, bitcoin mining uses massive amounts of energy too.
This has become an increasingly popular argument against PoW and one that is frequently trotted out by the anti-bitcoin brigade. Yes, PoW is energy-intensive, but what gets overlooked is that the energy consumption of bitcoin mining pales in insignificance when measured alongside the traditional monetary system. The energy required to run bank branches worldwide dwarfs that of bitcoin mining. And that’s before we even begin to account for the wider framework such as ATMs, corporate offices, and the vast regulatory infrastructure.
While Bitcoin’s energy consumption isn’t nearly as harmful as the alarmists in the mainstream media might have led you to believe, the central thesis behind PoS, to begin with, was better energy efficiency. So, it will come as no surprise that Round 1 goes to PoS for less energy consumption and overall impact on the environment.
Manipulation and centralisation
In terms of centralisation, both PoW and PoS have issues. The growth of mining pools means PoW is set to continue becoming more centralised. As for PoS, pre-mining has resulted in a lot of projects having a high degree of centralisation right from the jump. Further, any entity with enough capital can buy a massive stake and start calling the shots. That’s not good.
The resources required to manipulate a PoW network the size of bitcoin’s would be astronomical. Furthermore, anyone who did manage to get their hands on the requisite computational power would probably be better served simply mining bitcoin for profit rather than disrupting the network. All things considered, PoW wins the battle of resilience to manipulation and centralisation.
Governance and innovation
Bitcoin and PoW projects are often criticised for their slow development. Why is this? PoW hampers innovation because it doesn’t facilitate on-chain governance like PoS. This makes it harder to reach consensus and push projects forward. Unless consensus is reached by all stakeholders, a PoW protocol must either remain static or fork into two separate projects.
PoS is superior in this category for the ease with which it facilitates on-chain governance. This allows network participants to vote on the development of a project in an efficient and democratic way. As long as the project remains reasonably decentralised, PoS is far preferable to PoW in this regard, which is why many new cryptos use PoS and why cryptos like Ethereum are trying to transition from PoW to PoS.
While PoW and PoS both have their relative merits, many believe that PoS, by facilitating innovation and enterprise, will become the favoured consensus mechanism. If PoS can establish a fair way to distribute token supply to prevent centralisation and governance takeovers, it truly would be a force to be reckoned with and might end this debate once and for all.
Ultimately, as long as you’ve got one of these consensus mechanisms securing your favourite crypto’s blockchain, you are one step closer to true freedom.