The proof of stake concept steps that an individual can mine and validate depending on how many coins they hold. So, the more coins you own, the more mining power you have.
The Proof of Stake is a consensus algorithm that was first introduced in the Bitcoin talk forum in 2011, as a method of solving the problems presented by the proof of work method. The goal for both these methods is the same; to reach consensus in the blockchain.
The only thing that differs when you compare them is that each has a different way to reach the set goals of consensus.
The most important things to keep in mind when we talk about proof of stake include:
- You can mine and validate block transactions based on the number of coins you hold
- The proof of stake concept is an alternative to proof of work. Blockchain technology originally used the Proof of work algorithm to confirm transactions while adding new blocks to the blockchain.
- Proof of work requires a lot of energy where sometimes the Miners will have to sell their coins to foot the bill. Proof of stake gives you power based on the number of coins you have
- Proof of stake is less risky in terms of the potential of the miners to attack the network. It structures compensation in a way that makes an attack less helpful for miners
In proof of stake, we use the term ‘forged’ instead of ‘mined’. In proof of stake, cryptocurrencies start by selling already mined coins or they launch the currency with a PoW algorithm that later changes to proof of stake.
The system of using proof of work creates more and more cryptocurrency as a reward for the miners. However, in proof of stake systems, the transaction fees are the reward.
Understanding the Proof of Stake
The proof of work had its flaws and needed replacing. Instead of replacing it, they created an alternative. To understand the proof of stake, we need to get into the details.
Each block has a maximum capacity of 1MB (megabyte). We duplicate this data across multiple computers in the network. We have learned that the users are the administrators of the network.
They verify each block’s legitimacy. Verification requires that the nodes and all the Miners solve the mathematical puzzle. It is the one we know as proof of work.
Whoever decrypts the block first gets a coins reward. Verification is the last step before they add a block to the blockchain.
The Wastefulness of Proof of Work
In 2015 we estimated how much it costs to verify one bitcoin transaction. The findings said it was equal to the amount of electricity 1.57 American households would need in a day. Paying for the bills would force miners to sell their coins for Fiat Money. This would normally lead to a downward movement in a cryptocurrency price.
Proof of stake is the logical solution for the problems created by the POW method. The system will assign power to each miner depending on how many coins they hold.
Instead of using too much power solving puzzles, mining will now only be proportionate to the portion of stake you have. If you have a 5% stake, you will only mine 5% of the blocks.
The Tragedy of Commons (The 51% Attack Problem)
In cryptocurrency, we have something we call the tragedy of Commons. Bitcoin uses the proof of work and that makes it susceptible to this tragedy of Commons. To explain what it is we have to look into the future. A time will come when there will be fewer bitcoin miners available. This will be an effect of little or no rewards for mining.
The only way to make any money or profits would be from transaction fees and they too will dry up over time because users will want to pay lower fees for the transactions.
This will expose the network to a 51% attack.
The 51% attack happens when a miner or a mining pool controls 51% of the power of the network. This gives them the power to create a block with the sole purpose of committing fraud. They will not stop there and will most likely invalidate other people’s transactions within the network.
How PoS Curbs the Tragedy of Commons
With the proof of stake method, an attacker will need to get 51% of the cryptocurrency to orchestrate anything like that. This tragedy is avoidable by making it a disadvantage of the miner who owns the 51% stake to launch an attack against the network.
It would not only be very difficult and pricey to get to a point where someone has 51% of the stake, but the miner would also have a hard time attacking the network. As he/she holds a majority of the stake, an attack on the network would mean a depreciation in the currency’s value and that translates directly to losses for the holder.
As a 51% holder of the stake, one would realize that with PoS in place, it would be in their best interests to preserve the security and stability of the network.
Bitcoin and Litecoin use the PoW method. Nxt or NXT is one of the cryptocurrencies that use PoS. Other cryptocurrencies like Peercoin use a mixed system where both methods are eligible. At the moment, Ethereum is making the shift from PoW to PoS.
Breaking Down PoS Forging
It requires any user who wishes to be a part of this forging system to lock a certain amount of coins in the network to represent their stake. The size of your stake determines your opportunities. The bigger the stake, the higher the chance that they may select you to validate the forging of the next block.
You would think maybe a system like this might fall into the trap of favoring only the wealthiest nodes. However, there is a solution for that which uses two methods.
- Randomized block selection
- Coin age selection
In randomized block selection, the validators are chosen by finding a user with the combination of the lowest hash value and the highest stake. The sizes of the stakes are public and that means the next forger is predictable to the other nodes.
In the coin age selection, nodes are chosen based on the length of time their tokens have been staked for. To obtain the coin age, we multiply the number of days they have held the coins as a stake by the number of coins staked.
Once the node forges a block, their coin age resets back to zero and they have to wait a certain amount of time to forge again. This is a system that prevents the large stake nodes from being too dominant in the blockchain.
NOTE: Each of the proof of stake systems has its own rules to ensure fairness and how things work may differ from one cryptocurrency to another.
Anyone in the system who tries fraudulent transactions is detectable and will lose a part of their stake, besides losing the right to take part in future transactions.