What is Proof of Stake, and why have blockchain developers decided to implement it in Ethereum 2.0? Does it really scale better than Proof of Work, and if so, will staking ultimately replace mining?
In December 2020, Ethereum launched a new Proof of Stake (PoS) network that works side-by-side with the existing Proof of Work (PoW) network. While the full version of the new network has yet to launch, users now at least have a glimpse of the future.
Why Proof of Stake? Because it has the potential to turn all blockchain networks scalable and thus ready for global adoption. We might view blockchain technology as a system that is far superior to legacy tech systems, yet the real truth is that most blockchain networks cannot support the same workload that centralized systems process.
Ethereum co-founder Vitalik Buterin intended to switch over to Proof of Stake a long time ago. However, not even a single developer in the entire blockchain industry had an idea of how to implement the upgrade in a practical way.
There are many issues with PoS, most of which completely disable the three fundamental features of the blockchain trilemma (decentralized, scalable, secure.) Although the central premise of PoS networks is simple, the solutions themselves are awfully complicated.
Interested in finding out what the next stage of blockchain evolution is all about? Continue reading our extensive yet simple to understand walkthrough of Proof of Stake.
What is Proof of Stake? When was it introduced?
Proof of Stake is a consensus mechanism that Ethereum developers sought to implement ever since the original network launched. In fact, the concept is far older than Ethereum, as PoS was mentioned for the first time in 2012.
Sunny King and Scott Nadal, the creators of Peercoin, published a co-written paper at the time that introduced PoS as an alternative to PoW. Their line of thinking was that there should be a more cost-efficient way to mine Bitcoin, a method that does not require high energy consumption.
At that point in time, the Bitcoin network was so small that all of the users combined spent only around $150,000 on energy per year. Today, statistics suggest that miners spend more than $5 billion on annual electricity costs. With how expensive mining is and the degree of influence it has on the environment, there surely must be a better way to maintain the network, right?
In PoS, validators would confirm transactions by staking instead of mining. The blockchain network prioritizes individuals who stake more coins, and the largest holders would have an easier time earning rewards.
Since the process does not involve solving complex mathematical problems over a long period of time, staking brings a more energy-efficient way to maintain blockchains. After all, the process is almost entirely virtual, involving only the act of locking up digital currencies. If not better at scaling, it should at least save costs and energy expenditure.
Four reasons why Proof of Stake is hard to implement
There are four main reasons why PoS is hard to implement in a real network without turning it into a complete failure. As we have previously mentioned, staking works fine in theory. However, the trouble starts when we take a realistic look at how individuals might attempt to harm the network, take it over, or attack it in other ways.
One staker to rule them all
In PoW, a miner increases his reward potential by contributing more power to the network. In PoS, the same is done but with staking (locking up) tokens. If a single staker (or a group of stakers) accumulates a large number of tokens, he will receive a major portion of all future tokens that will be distributed.
Due to their virtual design, tokens are obviously easier to accumulate and later on represent a user’s power within the network. This is not the case with PoW. Miners have to allocate physical space to their rigs, find a suitable power source that can support the mining farm, and even potentially deal with government regulations and bans.
While enough money can turn both PoW and PoS participants into the rulers of a network, mining objectively takes much more steps and risks in comparison.
Easier 51% attacks
Just like in the case above, a user can take over the network by amassing more than 51% of its power. In the previous case, we have explained why it is easier to accumulate power within a PoS network.
With that in mind, we see yet another limitation that prevents developers from implementing Proof of Stake.
No method of token distribution
When Bitcoin first arrived, users would set up a node and a wallet. Then, they would utilize their computer for the mining process. When a miner would successfully solve the next block in the Bitcoin blockchain, the user would receive a payment for that work. With each payment, the network slowly distributes Bitcoin.
Let’s say that an individual named John Smith launched a PoS-based blockchain network called Project Proof of Stake. New users arrive at the network, set up a wallet, and prepare themselves to start staking. But which tokens do you use to stake?
Initially distributing cryptocurrencies on PoS networks is a catch-22 paradox for which there is no easy solution. To receive tokens, one must lock existing tokens. How do you then stake when there are no tokens at all?
One solution some projects have used is to premine the tokens. In a premined project, a number of tokens already circulate in the market. However, that is not the best solution as it just raises the question of how decentralized such a network is.
Nothing at stake?
Last but not least, we have a peculiar situation where network participants can double spend.
As a reminder, double spending is the process of using the same coins/tokens more than once. PoW systems use the process of timestamping transactions to solve this problem.
PoS has one hypothetical situation in which users can have ‘Nothing at Stake’ (NoS). Every time a node meets certain conditions for staking, the network will add a block. The problem is that two nodes can meet the conditions at the exact same time.
When this happens, the token forks. Nevertheless, nodes solve the problem by signing the transaction on only one of the two forks.
The specific problem that NoS brings is that a large majority of nodes can decide to sign the transaction on both of the forked networks because it would cost nothing to verify both of them. As a result, certain network participants have the opportunity to double-spend by spending tokens on one network and verifying them on another.
How it works
In one of our previous articles, we have explained Proof of Work and how it works. You might already understand what a consensus mechanism is and why distributed and decentralized systems need it if you have read it. If not, here is a quick summary:
Blockchain networks store and permanently record transaction information to ensure the validity and spendability of coins. For the network to work smoothly and for all the information to remain intact without any manipulation, all participants have to reach a consensus and agree to a certain version of the network.
Just like PoW, Proof of Stake is also a consensus mechanism. However, the methods of validation and consensus are entirely different.
As a reminder, miners spend electrical energy when solving complex mathematical problems to mine blocks (and in the same act create them). On PoS, miners are replaced by validators who stake assets in order to validate blocks and therefore form them into a chain.
Proof of Stake requires the user to run a validator node that verifies and confirms blocks. By staking tokens, the node has a chance to be selected by the network and propose a block. The selection process is partially randomized, but it also prioritizes nodes based on wealth and staking age.
Once the proposed block has been validated enough times, the network will officially add it to the ledger. The previously selected node will receive rewards both for proposing the block and for verifying it. All of the other validators will only be rewarded for verifying.
The economic basis of staking
Proof of Stake has a different economic incentive built into it compared to its older brother PoW. Validators face much harsher consequences for malicious behavior as they deposit personal funds when participating in the network.
On PoW, miners only need to pay electricity costs to participate actively. On PoS, validators have to stake a large number of valuable tokens. For example, the requirement on Ethereum 2.0 is exactly 32 Ether.
At current market prices, the staking investment amounts to $40,000. Moreso, a part of these funds can be taken by the network if the actor behaves unfairly or does not properly validate transactions.
In the case that it is the turn for a specific node to validate the block, but he is offline, he must pay penalties. Imagine that you run a node and you lose electric power in your building or online access. How will you participate in the network? In such cases, the only thing that a validator can do is pay the penalty and participate more frequently.
But the penalty of not being online is considerably lower compared to directed and intentional malicious activities. If a node tries to trick the system by proposing false or manipulated transaction data history, the network will take a large portion of the node’s staked assets. In some situations, the malicious actor can lose everything.
With the aforementioned facts in mind, it is easy to tell why PoS features better economic incentives. While validating might be easier than mining, it carries far harsher risks and penalties.
Advantages of Proof of Stake
If PoS is properly implemented and all (or a majority) of the limitations are removed, then the new consensus mechanism features plenty of advantages compared to PoW. As a matter of fact, the new system even removes certain bad traits that PoW networks have.
While the PoS system does not inherently improve scalability, there are certain features based on the same technological infrastructure that achieve this. Developers have created sharding to scale PoS as it allows them to improve the network’s speed while retaining a secure environment.
Sharding basically divides chains into multiple shards, where each one is capable of processing and forming blocks. Since nodes simultaneously validate blocks across multiple shards/chains, the main blockchain network works faster.
This concept is similar to computer technology, where processors own multiple cores (as well as threads), and each one works on powering the same process.
In this regard, we can view Proof of Stake networks as being more decentralized since they eliminate certain bad factors commonly found in PoW. The validator does not require expensive mining hardware, he does not need the storage space required to host mining rigs, and there are absolutely zero concerns about lowering power costs.
With only a small entry barrier, PoS is more decentralized since people of various backgrounds can join the network. To host a validator node, the user must only have access to the internet, a computer, and a certain amount of cryptocurrencies. Therefore, PoS is more decentralized compared to PoW.
The same benefits that we have mentioned above are also apparent when we talk about accessibility. Joining any PoS network requires the same tools as investing in cryptocurrencies or actively trading in the market. Compared to the older consensus mechanism, PoS is definitely easier to access and become a part of.
However, accessibility is partially limited by the staking requirement. We can say with certainty that a majority of people cannot afford the 32 ETH needed to stake on Ethereum 2.0, especially at current prices.
Nevertheless, we still might see newer PoS networks in the future that do not require such a high investment for staking. Furthermore, Ethereum 2.0 itself might see shared validator pools just like how Bitcoin miners share the same mining pools.
How does Proof of Stake work on Ethereum 2.0?
Developers from the blockchain industry tend to roll out updates from time to time instead of launching one major update. The same is applied with the launch of Ethereum 2.0, which will come out in multiple phases.
In November 2020, Ethereum launched a deposit contract for the new network. After collecting more than 500,000 ETH from future validators, the project’s smart contract automatically launched the first stage of Ethereum 2.0 Phase 0.
The beacon chain’s task is to slowly implement features such as staking and sharding into the network. Phase 0 began with collecting a list of all the initial validators that will join the new ledger.
To participate, a user must stake at least 32 ETH in order to become a validator. On Ethereum 2.0, validators are nodes that confirm transactions and form new blocks. One user can run multiple nodes, but he requires 32 Ether for each one.
Developers anticipate launching two more phases throughout 2021 if not three. Phase 1, Phase 1.5, and Phase 2 would slowly but surely implement all the features necessary to launch the final and complete version of Ethereum 2.0.
There is no concrete plan or timeline for the staging process. However, most community members expect that developers will launch at least Phase 1 and Phase 1.5 by the end of the year. The final phase may also be launched in 2021, but users are worried about how smoothly Ethereum 2.0 will progress.
By the end of this launch process, Ethereum 2.0 will replace the old PoW network. Until that moment, both chains will work side-by-side.
Proof of Stake is a conceptualized alternative to the original Proof of Work consensus mechanism. The idea first arrived in August 2012 when two developers discovered that the notion of coin age could replace PoW and increase energy efficiency.
Since 2015 Ethereum developers have worked hard on migrating their own network from PoW to PoS. After five years, the team has finally launched the first phase of Ethereum 2.0. We have yet to see whether the new network can support the workload of the older network. However, developers are confident that PoS will go as far as outscale the older model.
Proof of Stake replaces miners with validators who have to stake assets to participate in the network. The numerous features available in PoS architecture make it possible for blockchains to become more scalable, more decentralized, and accessible to everyone.
For a long time, PoS has served as a beacon of hope for blockchain enthusiasts who were uncertain about the industry’s future. Without any scalability in sight, it appeared as if blockchains would never be able to compete with centralized systems on an enterprise level.
Will Ethereum 2.0 once and for all clear those doubts and usher in a new era of decentralized finance?
About The Author:
The Shrimpy Team
The Shrimpy Team is comprised of highly experienced content writers who analyze and research the latest market trends, delivering content suitable for both beginner and veteran crypto investors.
The Merge is an upgrade that will unify the Ethereum mainnet with the beacon chain and transition the project to a Proof of Stake consensus model. Learn more about how the Merge changes Ethereum and what that brings to investors.