What is the Proof-of-Stake (PoS) consensus algorithm and why is it so prominent?

The majority of cryptocurrencies and blockchain systems, including Ethereum, Cardano, Solana, Tezos, and Algorand, are based on the Proof-of-Stake (PoS) consensus mechanism.

PoS has gained popularity due to the lack of the need to purchase expensive mining equipment and the potential for simple passive income by staking coins. The main advantage of Proof-of-Stake is that it uses less energy for block production and blockchain security than another well-known Proof-of-Work (PoW) method.

Development of Proof-of-Stake

Two important questions come up when designing the blockchain architecture: to whom and on what basis to grant the right to generate new blocks and how transactions will be approved to ensure protection against double spending and other abuses.

The solution of these problems has resulted in the establishment of a number of consensus mechanisms, or rulesets by which users of a decentralized network can agree on the specifics of which transactions can be authorized and added to future blocks.

The Proof-of-Work mechanism (also known as “proof of work”) was proposed by the anonymous author of the first cryptocurrency, Satoshi Nakamoto, in the white paper published in October 2008.

In accordance with PoW, users of decentralized network nodes (miners) search for a block hash by choice while using free competition to solve resource-intensive mathematical problems. If successful, the winning miner or pool has the chance to add the discovered block and is compensated with new bitcoins.

It was evident a few years after Bitcoin’s inception that the Proof-of-Work principle causes a continuous rise in mining power and, consequently, electricity prices. In addition, mining became less accessible as a result of the requirement to use powerful equipment.

Proof-of-Stake was presented as an alternative consensus method for bitcoin on July 11 2011, on the then-popular cryptocurrency forum Bitcointalk.

It was proposed that the right to vote in a decentralized network be granted to all participants in proportion to their share of the total number of coins owned.

This new consensus mechanism saw its first practical implementation in the PPCoin cryptocurrency in August 2012. Mining produced new coins, and transactions could be processed by any node that held the PPC cryptocurrency. Other early PoS projects, such as Gridcoin and Blackcoin, used the same hybrid consensus scheme. The Nxt blockchain, which launched on November 24, 2013, was the first “pure” PoS-cryptocurrency without mining.

The Proof-of-Stake consensus mechanism proved to be so successful and adaptable that it was adopted by hundreds of cryptocurrencies in subsequent years.

What Proof-of-Stake is about?

The right to manage the blockchain is granted to all its participants in proportion to the amount of coins they own, according to the original Proof-of-Stake concept.

In the Nxt cryptocurrency, for example, with its “canonical” PoS mechanism, all users who have at least 1002 NXT in the official NXT Client wallet during the previous 1440 blocks have a chance to form the next block. At the same time, each wallet functions as a full node (node), storing its own copy of the blockchain. This type of wallet can be run on a powerful server, a pc, or even in the cloud.

The more coins in the NXT wallet, the more likely it is to be granted the right to form a new block, in which case the user will receive all transaction fees that fell into this block. A wallet with 1% of the coins should form 1% of all new blocks.

The process of creating blocks in Nxt and other early PoS cryptocurrencies was dubbed “forging,” but the term is no longer commonly used.

Coin Delegation and PoS Performance

The Proof-of-Stake mechanism, which allows almost any cryptocurrency holder to be a block producer, enables a high level of decentralization and blockchain security. However, the blockchain trilemma states that performance comes at a cost. The throughput of the Nxt cryptocurrency network is only 4 transactions per second, which is significantly lower than the throughput of many other cryptocurrencies that use PoW consensus. Dogecoin, for example, processes 33 transactions per second.

To strike a balance between decentralization and performance, they proposed the concept of delegation, in which coins from multiple wallets can be transferred to a few computing nodes along with the right to vote.

This concept was used by Daniel Larimer, an American programmer and crypto entrepreneur, in 2013 to establish a Delegated Proof-of-Stake (DPoS) mechanism. It was first implemented in the BitShares blockchain platform, after which it appeared in multiple versions in the most well-known crypto projects such as EOS, Cardano, Tezos, and others. Today, the delegation function has become an industry standard, with almost all PoS implementations utilizing it.

In DPoS, cryptocurrency holders may not take an active part in network operation, but must instead transfer their coins to validators — professional participants who manage blockchain nodes. In return, they agree to award rewards to coin owners, often minus a small commission.

The number of validators involved in the production of blocks varies significantly across blockchains, depending on their architecture: Polkadot – up to 16; BNB Chain and EOS – 21; Near – 100; Cardano – around 3200; Avalanche – around 1200; Solana – more than 3400. More than 400 thousand Ethereum.

In general, running a validator necessitates special equipment with constant Internet access, as well as a significant amount of the network’s native coins. A validator on the Ethereum network, for example, must have at least 32 ETH, whereas a validator on the Tezos network must have at least 8,000 XTZ.

Proof-of-Stake and Staking

Staking is the process of storing cryptocurrencies in a wallet in order to receive rewards for participating in network security. Sending coins for staking in many PoS-cryptocurrencies today means blocking them in a special smart contract with the inability to move for a set period of time, ranging from several hours to several days.

Most PoS blockchains provide a reward in native coins of this network to compensate for the costs of computing nodes for verifying transactions and generating new blocks. The size of each block is usually fixed, but it can vary depending on the current network parameters.

In the Tron blockchain platform, for example, a super representative (or validator) who generates the next block and processes transactions receives 32 TRX. He distributes a portion of this sum to users who staked their TRX and thus voted for him.

Staking profitability is determined by two factors: emission rate, which is determined by a fixed value of coins issued for each new block; and the share of coins in circulation that are locked in staking (Staking Ratio).

For example, if 1 million coins are issued through staking each year from a total supply of 100 million coins, the annual profit from staking with 50% locked coins is 2%. If 25% of the supply is blocked in staking, the yield doubles, reaching 4% per year.

Types of Proof-of-Stake

Many consensus mechanisms have been developed based on the principles of PoS and delegation, which differ in a number of nuances, such as the distribution of roles among participants in a decentralized network.

Here are a few examples:

Leased Proof-of-Stake (LPoS, “leased proof of stake”) – a method used in the Waves blockchain in which users rent their coins to a validator in exchange for a fee.

Nominated Proof-of-Stake (NPoS) – used in the Polkadot blockchain platform and assumes the presence of so-called nominators who pay deposits for validators and are responsible for their good faith;

Pure Proof-of-Stake (PPoS, “pure proof of stake”) – used in the Algorand network, where the next block validators are secretly and randomly chosen from all wallets with more than one ALGO balance.

Effective Proof-of-Stake (EPoS) – used in the Harmony blockchain platform. Has a unique reward distribution mechanism that encourages the launch of many small validators rather than a few large ones, promoting decentralization;

Proof-of-Authority (PoA) is a hybrid algorithm that combines proof of stake and validator reputation, both of which must be approved by developers. The validator in PoA must go through an identity verification procedure similar to KYC. This algorithm makes use of the BNB Chain.

Proof-of-Stake for Bitcoin and other cryptocurrencies

For many years, the high energy consumption of mining cryptocurrencies based on the PoW algorithm has been a point of dispute. According to a recent Cambridge Center for Alternative Finance study, bitcoin mining accounts for 0.1% of all anthropogenic CO2 emissions.

After the Ethereum network successfully transitioned to Proof-of-Stake consensus on September 15, 2022, the network’s power consumption decreased by nearly 2000 times, or 99.95%. In this regard, the debate over the conversion of popular PoW cryptocurrencies to PoS has resurfaced.

The Dogecoin meme-developers cryptocurrency’s announced its impending switch to the Proof-of-Stake algorithm in December 2021. Ethereum co-founder Vitalik Buterin decided to assist them in this process.

The Electric Coin Company, the creator of the anonymous Zcash cryptocurrency, is also discussing the possibility of switching to PoS with the community.

According to the company’s founder, Zuko Wilcox, this will not only improve the blockchain’s security and energy efficiency, but will also help attract ZEC owners to manage the protocol.

In the case of bitcoin, the greatest uncertainty is the possibility of switching to PoS. Firstly, there is no single developer for the first cryptocurrency. Several independent development teams are debating all of the proposed innovations, so even the smallest of them causes fierce debate and takes years to implement.

Secondly, the transition to PoS will not be supported by mining pools, which will lose income as a result of this step. It is worth noting that a group of developers launched a fork of BitcoinPoS in 2020, which the crypto community simply ignored.

PoW supporters, on the other hand, point to a higher level of security for this algorithm: with the bitcoin network’s current, extremely high level of decentralization, it is practically impervious to external attacks.

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