What is Proof-of-Stake (PoS)?

Introduction

Proof-of-Stake (PoS) is a crypto consensus mechanism for processing transactions and creating new blocks in a blockchain. Participants stake tokens to become nodes. A node has the opportunity to become a validator who verifies transactions and receives rewards based on the amount of staked tokens.
All transactions on a blockchain are recorded in a database known as the Distributed Ledger (DLT) , which is written and replicated by multiple nodes. To ensure that all data in the ledger is correct, a consensus mechanism is required to prevent malicious data tampering.
Proof-of-stake is favored by many blockchain projects in recent years, it eliminates the need for hardware and energy consumption that exist in the proof-of-work (PoW) while securing the blockchain by mandating validators to stake a certain amount of tokens.

What is a consensus mechanism?

A consensus mechanism is a method for all participants in a distributed system to reach a consensus on a single source of information. A centralized system does not require a consensus mechanism because whether the given data is valid or not is solely determined by the entity in charge. For example, in a centralized database, only the administrator has the right to add, delete, and modify data, and users who query the database passively receive information from the administrator.
A distributed system relies on the cooperation of a large number of autonomous entities (nodes) to maintain the network, and the authenticity of information is jointly verified by all. By contrast, any node can create new block records and verify transactions in a blockchain network. However, information from different nodes may be contradictory due to device failures, network latency, attacks and so on. Therefore, a consensus mechanism is needed to make data records consistent.
In the development of blockchain, the earliest adopted consensus mechanism is Proof-of-Work (PoW), where the validity of data is endorsed by the highest CPU computing power. Due to its energy cost, Proof-of-Stake (PoS) has been created as an alternative. Under PoS, the validity of data is endorsed by validators who stake the most tokens, enabling different nodes in the network to reach a consensus.

What is PoS?

The idea of proof-of-stake was first put forward in 2011 on Bitcointalk by a member named QuantumMechanic, and was later conceptualized with the help of other members including Scott Nadal and Sunny King.
On a PoW blockchain, transactions are verified by nodes (also called “miners”) that provide computing power to solve complex mathematical problems in order to verify a transaction and get rewards for new blocks. In a PoS network, network nodes (also called “validators”) provide cryptocurrency deposits as collateral, and the more collateral the node has, the better the chance of obtaining accounting rights and block rewards.
In order to prevent validators with highest collaterals from becoming a fixed node for creating new blocks, other parameters are also considered to select validators, such as the number of staked tokens, coin age, and random block selection. Coin age refers to how long it has been since the tokens were staked (the last time the validator created a block). Validators with older coin age are more likely to be selected to create new blocks. The coin age parameter allows nodes with lower collaterals the opportunity to create new blocks and obtain rewards.
Generally, Proof-of-Stake (PoS) works as follows:

1. Transactions that are yet to be verified will be processed by nodes. These pending transactions are always stored in a pool waiting to be processed by validators who have staked cryptocurrencies.
2. The algorithm selects a validator to create a new block based on certain parameters, such as the number of token staked, coin age, random block selection, etc.
3. After the selected validator verifies these pending transactions, a new block is created and these transactions can be packed.
4. Other unselected nodes confirm that the new block is valid.
5. Once the transactions in the new block are verified by other nodes, the new block will be added to the blockchain network. Conversely, the new block will not be added if it has invalid transaction.
6. When a new block is added, the validator can retrieve the staked tokens and obtain the block reward. If the validator selection algorithm considers coin age, the coin age of this validator will then be reset to 0. If a new block is refused to be added, the tokens staked by the validator may be slashed as a penalty.
   
   Source: coinsentinel.io

Pros of PoS

PoS is considered by many to be a better consensus mechanism than PoW with the following reasons:

1. No need for expensive equipment
   It is easier for the general public to participate in PoS blockchains than in PoW ones because even regular PCs can be used as PoS nodes, while under PoW, specialized computers with high computing power are a must.

2. Energy Efficient
   Proof-of-stake blockchain do not require much energy. In a proof-of-work network, miners need to compete with each other to be the first one to discover new blocks, a lot of energy is needed during the competition brought by hashing.

3. High scalability
   The cost of hardware and energy is the main limitation on PoW blockchains when it comes to scalability, and the cost of additional equipment and energy consumption will increase exponentially as the network scales. Proof-of-stake blockchains eliminate this problem effectively .

4. Friendly to non-tech-savvy people
   Mining requires considerable expertise. Therefore, proof-of-work is designed more for institutions and professionals. However, even ordinary personal devices can function as nodes under PoS.

5. More decentralized
   Proof-of-stake ensures that all nodes, regardless of the number they stakes, are able to effectively participate in the blockchain network through algorithms. However, under PoW, most of the block generation, transaction verification and reward allocation are monopolized by mining pools, and smaller nodes can barely compete with them. Proof-of-Stake is a better choice in long-tail markets.

6. Greener
   PoS blockchains are more eco-friendly than PoW blockchain as they do not come with huge energy consumption or intensive computing competition, thus having less negative impact on the environment.

Is PoS Secure?

Regardless of which consensus mechanism is used, in addition to the effectiveness of the nodes to reach a consensus, security remains one of the most significant considerations in a networkOtherwise, the network might be paralyzed by malicious attacks.
In PoW networks, consensus is reached through computing power. If you can control over 51% of the computing power within a blockchain network, you have the dominant control of the whole network. Attackers are able to get profits via double-spend, refusing or altering transaction records, or preventing others from mining. This is known as the 51% attack.
However, as the scale of the proof-of-work blockchain expands, the probability of a 51% attack decreases. To implement a 51% attack, a large amount of mining equipment is required to provide computing power and high energy costs will occur. If the reward for a successful attack is less than the cost of implementing the attack, the 51% attack will become unfeasible in this regard. Taking Bitcoin as an example, there has never been a 51% attack in over a decade since the creation of the genesis block. It is the Bitcoin mining nodes across the world providing extensive CPU computing power that ensures the security of the Bitcoin network.
It should be noted that proof-of-stake networks may also suffer from the 51% attack. As long as a malicious node obtains more than half of the total number of staked tokens, it gains control of the blockchain network and may forge blocks and transaction records. That is to say, an attacker can launch an attack by acquiring a large number of tokens.
However, such an attack is impractical. The action of acquiring a large number of tokens will push up the price due to increased demand. And an attack will have a significant impact on the blockchain network and cause a panic among users, resulting in a dip in price. Therefore, the cost of acquiring tokens will be far greater than the profits you could gain from an attack.
A more possible method to attack the proof-of-stake consensus mechanism is to collude with other nodes to control over 51% of the total number of staked tokens . This method is an alternative to achieve the goal of controlling the network without prohibitive costs.
In order to prevent nodes from colluding with each other, the proof-of-stake blockchain introduces penalties. If false blocks and transactions are reported by other validators, the attack node may lose part or even all of its staked tokens. This solves the Nothing at Stake problem of previous PoS nodes and makes collusion between validators more difficult as it is difficult to determine whether other nodes are willing to take the risk of losses.
As long as the value of the staked tokens is higher than the rewards, then the losses caused by cheating will be greater than rewards brought by honest operation. Considering this, the nodes prefer to operate honestly, which ensures the security of PoS blockchain networks. Therefore, a 51% attack is almost impossible to happen, especially in cryptocurrencies with higher market caps.

What are the potential problems of PoS?

Despite the advantages of the PoS consensus mechanism, it also has some potential problems. PoS is often criticized for making the rich richer and the poor poorer. Nodes staking a greater amount of tokens will have a higher chance of creating blocks to get rewards. This makes validators holding a large number of tokens to get wealth, hence exacerbating wealth inequality.
However, PoS proponents believe that, in all capital markets, the rich are endowed with a stronger competitive advantage. Even under the PoW consensus mechanism, the same problems exist. Compared with the PoW network that has higher requirements to participate, PoS, which benefits everyone, proves to be a better solution.
Another common problem is the unpredictable supply of tokens as the number of nodes that are unable to stake may change This leads to additional issues. For example, when the market price of tokens keeps falling, the rewards of the staked nodes may not be able to make up for the loss of holding them, resulting a large number of nodes to un-stake and sell the tokens , hence endangering the security of the blockchain network.
In addition, if the number of staking nodes increases significantly, it may cause a shortage of token supply and push up the price, which is a price manipulation tactic often used by malicious development teams before selling off their holdings. In comparison, PoW mechanism provides a more stable token supply and is less likely to suffer from similar problems.

What are other consensus mechanisms besides PoS and PoW?

Proof-of-work and proof-of-stake are the two most popular consensus mechanisms in distributed networks, but are not the only two. After more than ten years of development, blockchain technology has seen many novel consensus mechanisms being proposed. Here is a brief introduction:

1. Proof of Space
   Under the Proof of Space consensus algorithm, nodes in the network must have considerable hard disk storage space before they are qualified to verify transactions and obtain rewards. Verifiers will challenge the nodes that provide storage to ensure that the nodes continue to provide the storage. Chia Network is an example that adopts this algorithm.
   
   source: Chia Network

2. Proof of Authority (PoA)
   Under the Proof of Authority consensus algorithm, nodes in the network will not stake tokens , but instead stake their own reputation to be qualified for validating transactions. Validators need to disclose their identity information before participating. This reduces the risk of selecting suspicious validators and encourages long-term participation. An example of the PoA algorithm is VeChain.

3. Delegated Proof of Stake (DPoS)
   DPoS is an advancement of the fundamental concept of proof-of-stake in which token holders entrust their tokens as votes to witnesses. These witnesses have different levels of reputation based on the number of tokens entrusted. The selected witnesses are regarded as the most trusted ones and have the right to create blocks by verifying transactions. An example that adopts DPoS is EOS.

Conclusion

Proof-of-Stake algorithm is usually considered as an advancement on Proof-of-Work. PoS users can stake their tokens to become validators and create new blocks to get rewards. They can also cooperate with other nodes to jointly verify transactions and to secure the blockchain.
Proof-of-Stake eliminates the capital-intensive and energy-consuming mining, and is more accessible to the normal users. It is regarded as a consensus mechanism that is both environmentally friendly and decentralized. Proof-of-Stake also outperforms Proof-of-Work in terms of scalability. Currently, Proof-of-Stake has been adopted by more and more blockchains, such as Cardano, Tezos, Avalanche, and GateChain.
Ethereum, the second-largest blockchain by market cap, is to transition from PoW to PoS in its ETH 2.0 upgrades, which is scheduled to complete in September, 2022. Though nodes running ETH 2.0 need to stake at least 32 ETH, the unprecedented transition of the consensus mechanism demonstrates that Proof-of-Stake is indeed the future of blockchain technology.
While PoS seems to have solved many problems faced by PoW, it is still a new technology. It takes time to detect whether there are other unknown problems and defects.