In traditional financial markets, trusted third parties (custodians, clearinghouses, etc.) are responsible for maintaining records of ownership and the validity of transactions. Cryptocurrencies, however, rely on decentralized networks to confirm transactions and secure the system. Proof of work and proof of stake are the two main methods used to reach this consensus. Both systems provide the same result, but differ in methodology and use of resources. Below we explore the specifics of proof of work versus proof of stake.
Proof of Work (PoW):
Picture a race where participants must tackle a challenging puzzle. The first to crack it receives a reward. In the realm of cryptocurrencies like Bitcoin, this is the modus operandi.
- The Puzzle: Miners engage in a competitive pursuit to solve intricate mathematical problems using their computational resources.
- The Race: Miners strive to outpace others in deciphering these puzzles, aiming to append a new block of transactions to the blockchain.
- The Reward: The miner who cracks the puzzle first earns newly minted coins (e.g., Bitcoin) along with transaction fees.
- Power Consumption: This endeavor demands substantial computational power and energy, as miners continually grapple with solving puzzles.
Thus, in PoW, miners vie to crack puzzles, with the quickest solving computer seizing victory (i.e. a swiftness-based competition.)
Proof of Stake (PoS):
Now, envision a different race, one where the victor isn't determined by machine prowess but by vested interests. This encapsulates the essence of Proof of Stake.
- Ownership Matters: In PoS, the quantity of cryptocurrency one owns and is willing to "stake" (lock up as collateral) directly influences the likelihood of being selected to append the next block of transactions to the blockchain and reap rewards.
- No Puzzles, Just Stakes: Unlike PoW, there are no complicated puzzles to unravel. Instead, an algorithm elects the subsequent validator (a participant who creates a new block) based on their cryptocurrency holdings and willingness to stake.
- Less Energy Consumption: With no puzzles to untangle, PoS necessitates significantly less computational power and energy compared to PoW.
- Incentive to Play Fair: Validators who attempt to circumvent rules or validate erroneous transactions jeopardize the cryptocurrency they staked, instilling a commitment to adhering to protocol.
In PoS, the process of appending new blocks and validating transactions hinges on one's cryptocurrency holdings and readiness to stake, rather than computational might. It's akin to a contest where the wealthiest participant stands the best chance of triumph, albeit with substantial risks if they resort to foul play (i.e. “Skin in the Game”.)
