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The two main consensus processes used by cryptocurrencies to validate new transactions, add them to the blockchain, and generate new tokens are “proof of work” and “proof of stake.”
The two main consensus processes used by cryptocurrencies to validate new transactions, add them to the blockchain, and generate new tokens are “proof of work” and “proof of stake.” Mining is used to meet the aims of proof of work, and was invented by Bitcoin. Proof of stake, which is used by Cardano, the ETH2 blockchain, and others, employs staking to accomplish the same goals.
Without a central authority like Visa or PayPal in the centre, decentralised cryptocurrency networks would insure that no money is spent twice. To achieve this, networks use a method known as a “consensus mechanism,” which is a system that enables all computers in a crypto network to agree on which transactions are valid.
Most cryptocurrencies today use either of two main consensus structures. Proof of work is the older of the two which is used for Bitcoin, Ethereum 1.0, and several other cryptocurrencies. Proof of stake is a newer consensus system that drives Ethereum 2.0, Cardano, Tezos, and other (generally newer) cryptocurrencies. To understand proof of stake, first understand proof of function, so we’ve combined the two in this explainer.
What is proof of work?
Bitcoin pioneered the use of proof of work as a crypto consensus method. Mining and proof of work are concepts that are closely related. The network necessitates a large volume of computing capacity, which is why it is referred to as “proof of work.” Proof-of-work blockchains are protected and tested by virtual miners all around the world competing to solve a math problem first. The winner gets to refresh the blockchain for the most recent validated transactions and is credited with a predetermined amount of cryptocurrency by the network.
Proof of work has many powerful advantages, especially for a basic yet extremely valuable cryptocurrency like Bitcoin (learn more about how Bitcoin works). It’s a tried-and-true method of keeping a stable decentralised blockchain. When a cryptocurrency’s valuation rises, more miners are enticed to enter the network, rising its strength and protection. Because of the amount of computing power required, it is impractical for any person or community to tamper with the blockchain of a valued cryptocurrency.
In the other hand, it is an energy-intensive mechanism that will struggle to scale to handle the massive amount of transactions that smart-contract compliant blockchains such as Ethereum can produce. As a result, alternatives have emerged, the most common of which is known as proof of stake.
What is proof of stake?
Ethereum’s creators recognised from the start that proof of work would have scalability drawbacks that would ultimately need to be solved — and, indeed, as Ethereum-powered decentralised finance (or DeFi) protocols have grown in popularity, the blockchain has failed to keep up, causing fees to increase.
Although the Bitcoin blockchain mostly needs to process incoming and outgoing bitcoin transactions, similar to a large chequebook, Ethereum’s blockchain also has to process a wide range of DeFi transactions, stablecoin smart contracts, NFT minting and sales, and whatever potential developments developers come up with.
Their response was to create an entirely new ETH2 blockchain, which started rolled out in December 2020 and is expected to be completed in 2022. Proof of stake, a simpler and less resource-intensive consensus process, can be used in the upgraded version of Ethereum. Proof-of-stake consensus processes are used by cryptocurrencies such as Cardano, Tezos, and Atmos, with the aim of maximising speed and reliability while lowering fees.
Staking in a proof of stake method is similar to mining in a proof of work system in that it is the mechanism by which a network member is chosen to add the most recent batch of transactions to the database and receive any crypto in return.
The specifics vary by project, but in general, proof of stake blockchains use a network of “validators” that contribute — or “stake” — their own cryptocurrency in return for a chance to verify new transactions, upgrade the blockchain, and receive a payout.
The network selects a winner based on the amount of crypto each validator has in the pool and the length of time they’ve had it there — literally rewarding the most invested participants.
Once the winner has validated the latest block of transactions, other validators can attest that the block is accurate. When a threshold number of attestations have been made, the network updates the blockchain.
All participating validators receive a reward in the native cryptocurrency, which is generally distributed by the network in proportion to each validator’s stake.
Becoming a validator is a significant task that necessitates a very high degree of technological competence. The minimum amount of crypto that validators must stake is frequently relatively high (for ETH2, for example, it is 32 ETH), and validators will sacrifice some of their stake by a mechanism known as slashing if their node goes offline or if they validate a “bad” block of transactions.
And if it seems like too much responsibility, you can always engage in staking by entering a staking pool run by someone else — and win credits for crypto that would otherwise be sitting around. This is referred to as delegating, and resources provided by Coinbase exchanges will make it convenient and smooth.
What are some differences between proof of work and proof of stake?
The significant distinction between the two compromise structures is their use of energy. Proof-of-stake blockchains enable networks to run with significantly lower resource consumption because miners are not required to waste energy on duplicative processes (competing to solve the same puzzle).
Both consensus processes have economic ramifications that penalise network failures and deter malicious actors. The penalty for miners sending invalid material, or blocks, in proof of work is the sunk cost of computational power, electricity, and time. The staked crypto funds of the validators serve as an economic opportunity to behave in the best interests of the network in proof of stake. If a validator recognises a bad stone, a percentage of their staked funds will be “slashed” as a punishment. The sum by which a validator can be reduced is determined by the network.