Proof of Stake Consensus Mechanism
What is a consensus mechanism?
With cryptocurrency, there needs to be a way to prevent users from spending the same unit twice (or more) in different places before the system can record the transactions. This system, or way of preventing malicious uses, is called a consensus mechanism.
Every cryptocurrency blockchain uses a consensus mechanism, also called consensus algorithm, which allows users of the blockchain to agree on the legitimacy of transactions, with no centralization or central authority needed. The consensus mechanism used by a blockchain influences the way transactions are verified, how much energy is used, transaction speed, and transaction fees.
What is Proof of Stake and how does it work?
Blockchain networks such as Ethereum 2.0, Cardano (ADA), Algorand, EOS, Solana, Polkadot and Tezos use Proof of Stake. The PoS consensus mechanism originated in 2012 with the first proof of stake cryptocurrency, Peercoin.
PoS switches out the importance of computational power for staked ETH, and replaces miners with validators and improves scalability. Validators stake their crypto (ETH) to activate the ability to create new blocks. Staking consists in agreeing to lock up an amount of crypto in exchange for the chance to validate new blocks. There are dedicated staking platforms, but crypto exchanges such as Binance, Coinbase and Kraken offer the feature as well.
They don't compete to create blocks, they are chosen at random by an algorithm. Their odds of being chosen as the next block producer are determined by the quantity of crypto assets they have staked. If two to three validators agree on the state of a block, it is considered final.
Because validators are selected at random instead of miners competing to solve a puzzle, Proof of Stake consumes a lot less energy than PoW. Validators also don't need any special tools and equipment that require huge computational power, as validator nodes can be run on a normal laptop. Staking pools allow users to stake without having 32 ETH.
With Proof of Stake, validators can only validate blocks if they have a security deposit or "stake", meaning if they attack the blockchain, try to double-spend or steal coins, they can't do so without losing their investment (also known as slashing).
Ethereum, the second largest crypto by market cap, used to be on the main alternative to Proof of Stake, which is Proof of Work. To maintain security and decentralization, Ethereum consumed large amounts of energy. This led to the Ethereum Merge, with Ethereum switching to the Proof of Stake consensus mechanism (PoS).
Proof of Work vs Proof of Stake
Proof of Work and the Proof of Stake system don't quite work in the same way, even though they share the same end goal.
The Bitcoin blockchain was designed for crypto mining, leaving out smart contract functionality. But the Ethereum blockchain, however, also has to process DeFi transactions, NFT sales and minting, and many other smart contracts and apps across the crypto ecosystem, so a scalable mechanism is crucial.
With Proof of Work, miners need specialized and expensive hardware to solve very complicated algorithms. The mining process can be very energy intensive, which has led to critiques of the consensus and its environmental impact, with Bitcoin (BTC) mining using more electricity annually than Finland and Belgium. Proof of Stake's energy consumption is much lower, and Ethereum founder Vitalik Buterin believes the shift to PoS could solve environmental woes.
Although the idea of the Proof of Work consensus mechanism existed before the creation of the Bitcoin blockchain, it was implemented for the very first time for blockchain technology. A majority of cryptocurrency networks use the Proof of Work (PoW) mechanism, including Bitcoin, Litecoin, DogeCoin, Bitcoin Cash and more.
Overall, Proof of Stake comes with some improvements to PoW, including better energy efficiency, lower barriers to entry, economic penalties for misbehaviour and a reduced risk of centralization. However, it is a younger consensus mechanism and is more complex to implement, as well as being less battle-tested.