Bitcoin is the first cryptocurrency that was created back in 2008, and since then, over 7800 cryptocurrencies have been created. Transactions using these currencies are written in interconnected blocks and are maintained in a public blockchain, which is a digital ledger accessible to anyone.
Regarding Proof of Work (PoW) and Proof of Stake (PoS), both these systems are known as “consensus mechanisms” and are required to confirm transactions that occur on a blockchain without the need of a third party. This consensus and confirmation of trades without a third party is what gives blockchain-based systems the decentralization that makes them so revolutionary.
What Is Proof of Work?
When Satoshi Nakamoto was creating the first-ever cryptocurrency, he found a way for the transactions to be verified on the blockchain without the need of a third party, which he achieved by using the Proof of Work system.
Suppose you want to transfer a certain amount of money to a friend. You will transfer it with the help of the bank. On the other hand, Bitcoin is a trustless and distributed consensus where you don’t need to rely on any bank to transfer the money to your friend. All the transactions on the blockchain network are visible to everyone, which ensures complete transparency.
Proof of Work is a protocol designed to facilitate digital transactions without the involvement of third parties (for example banks). Miners use this protocol to verify transactions and create new blocks that are added to the blockchain network.
But how are the transactions verified? Let’s discuss the process of Proof of Work.
Process of Proof of Work
- Miners must solve mathematical puzzles to create a new block and add transactions to the blockchain network.
- The miner that solves the puzzle first can create a new block and is rewarded for doing so with a certain amount of Bitcoin.
- During this process, several miners leverage their computational power to solve these puzzles. The puzzles get more difficult as additional miners join the network.
- After the new block is created, the miner will show the Proof of Work of creating a new block and not a duplicate one, which other miners in the network verify.
- At least a 51% consensus is required to add a new block to the blockchain during the verification process.
Drawbacks of Proof of Work
- Due to the massive computational power required to solve complex puzzles, a lot of electricity is used. Several studies have shown that the energy used to run and maintain the Bitcoin network is equal to the electrical consumption of large countries.
- It provides an unfair advantage to people with higher computational power as they can solve the puzzles more quickly. The miners with more money and computational power will essentially rule the network, which goes against the decentralization concept of Bitcoin.
- The 51% consensus point can be used by criminals to change blocks for their benefit. A recent example of this is the attack that happened against the Verge Blockchain. The hacker obtained 35 million XVG coins, which amounted to $1.75 million during the attack!
To tackle the drawbacks of Proof of Work, some cryptocurrencies such as Ethereum are looking at Proof of Stake as a viable solution.
What Is Proof of Stake?
Unlike Proof of Work where the miner has to validate transactions and create new blocks by solving mathematical problems, a Proof of Stake system requires the miner to show ownership of a certain number of cryptocurrency units.
Under the Proof of Stake system, miners are called validators, and the new blocks created are forged, not mined.
Process of Proof of Stake
- The Proof of Stake system is designed in such a way as to select the validators of new blocks randomly.
- Validators are required to buy a certain amount of cryptocurrency and lock it up as their stake, much like a security deposit. Once the coins are locked, the validators can start validating the blocks and add them to the chain.
- When a new block is validated and added to the network, similar to the Proof of Work system, they receive rewards proportionate to their stake.
- Under this system, the amount kept as stake matters because the bigger the stake, the more likely you will be loyal to the system and the more you will benefit if the cryptocurrency performs well.
How Is Proof of Stake Better than Proof of Work?
- It solves the 51% consensus problem that’s required in the Proof of Work system. As a result, it prevents attacks similar to the Verge attack from occurring.
- The probability of creating a block in Proof of Stake isn’t dependent on computational power, and as a result, it saves electricity costs.
- The initial investment required to buy a stake in the Proof of Stake system is less when compared to the hardware costs required for participating in a Proof of Work system.
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