Proof-of-Stake: how it works and why it is so popular

03.10.2022

Beginner

#consensus #Proof Of Stake

Key points

Proof-of-Stake (PoS) is the most popular blockchain consensus algorithm, underpinning many cryptocurrencies and platforms, including Ethereum, Cardano, Solana, Tezos and Algorand.
Its popularity stems from the absence of costly mining hardware and the ease of earning passive income via cryptocurrency staking.
Compared with the other widely used algorithm, Proof-of-Work (PoW), PoS consumes far less energy to generate blocks and secure a blockchain.

Why and how did Proof-of-Stake emerge?

Designing a blockchain—a decentralised payments protocol with a constantly updated database—raises two key questions:

who gets to produce new blocks, and on what basis;
how transactions are approved to prevent double-spending and other abuses.

Answering these questions produced several consensus mechanisms: rule-sets by which participants in a decentralised network agree how transactions are finalised and included in new blocks.

In October 2008, bitcoin’s creator, Satoshi Nakamoto, proposed the Proof-of-Work mechanism in the first cryptocurrency’s white paper.

Under PoW, network nodes (miners) compete to solve resource-intensive puzzles—searching for a block hash by brute force. The winner adds the block and receives a reward in newly minted bitcoins.

Within a couple of years it became clear that PoW’s dynamics led to relentlessly rising hashrate and electricity consumption. The need for powerful equipment also reduced the accessibility of mining.

On July 11, 2011, a post on the then-popular Bitcointalk forum proposed an alternative consensus mechanism for bitcoin: Proof-of-Stake.

The idea was to grant voting rights in a decentralised network to all participants in proportion to the share of total coins they hold.

By August 2012 the new mechanism had its first practical implementation in PPCoin. New coins were distributed via mining, and any node holding PPC could process transactions. The same hybrid scheme was used in other early PoS projects, such as Gridcoin and Blackcoin. The first “pure” PoS cryptocurrency without mining was the Nxt blockchain, launched on November 24, 2013.

The Proof-of-Stake mechanism proved so effective and flexible that in subsequent years it was adopted, in various forms and modifications, by hundreds of cryptocurrencies.

How Proof-of-Stake works

In the original conception of Proof-of-Stake, the right to govern the blockchain is granted to all participants in proportion to the coins they hold.

In Nxt, with its “canonical” PoS, any user with at least 1,002 NXT in the official NXT Client over the past 1,440 blocks has a chance to form the next block. Each wallet is effectively a full node with its own copy of the blockchain. It can run on a high-performance server, a laptop, a Raspberry Pi or even in the cloud.

The more coins a wallet holds, the greater the probability it will be selected to create a new block, in which case the user collects all transaction fees included. In the ideal case, a wallet that owns 1% of coins will form about 1% of all new blocks.

Early PoS networks called block creation “forging”, a term now rarely used.

Holding cryptocurrency in a wallet to earn rewards for helping secure the network is called “staking”. Today, in many PoS systems, staking locks coins in a smart contract for a set time—ranging from hours to weeks—during which they cannot be moved.

How delegation changed PoS performance

Using Proof-of-Stake in which virtually any holder can produce blocks achieves high decentralisation and security. However, according to the blockchain trilemma, this sacrifices performance. In Nxt, throughput is only 4 transactions per second, below many PoW cryptocurrencies. Dogecoin, for example, handles 33 per second.

To strike a balance between decentralisation and performance, developers proposed delegation, whereby coins—and associated voting rights—are assigned from many wallets to a smaller number of computational nodes.

In 2013 Daniel Larimer, an American programmer and crypto-entrepreneur, used this idea to create Delegated Proof-of-Stake (DPoS). It was first implemented in the BitShares platform and later, in various forms, in well-known projects such as EOS, Cardano, Tezos and others. Today delegation has become an industry standard used in almost all PoS implementations.

In DPoS, coin-holders can avoid running nodes themselves and delegate their stake to validators—professional operators of blockchain nodes. In return, validators share rewards with delegators, often minus a small fee.

Depending on architecture, blockchains vary widely in the number of validators participating in block production:

Polkadot — up to 16;
BNB Chain and EOS — 21;
Near — 100;
Cardano — about 3,200;
Avalanche – about 1,200;
Solana — more than 3,400.
Ethereum – more than 400,000.

Running a validator typically requires special-purpose hardware with always-on internet access, as well as a significant amount of the network’s native coins. For example, an Ethereum validator must have at least 32 ETH, and a Tezos validator at least 8,000 XTZ.

Proof-of-Stake and staking

To compensate nodes for verifying transactions and generating new blocks, most PoS blockchains pay rewards in their native coins. Per-block rewards are usually fixed but can change with network parameters.

In the Tron blockchain platform, the super representative (the validator) that produces a block and processes transactions receives 32 TRX. A portion is shared with users who staked TRX and thus voted for that validator.

Staking yields for validators and coin-holders depend on two factors:

the issuance rate, determined by the fixed number of coins granted for each new block;
the share of circulating coins locked in staking (the staking ratio);

For example, if 1m coins are minted via staking each year out of a 100m supply, the yield with 50% staked is 2% annually. If 25% is staked, the yield doubles to 4%.

What variants of Proof-of-Stake exist

Many consensus mechanisms build on PoS and delegation, differing in details such as the roles of participants in the decentralised network.

Examples include:

Leased Proof-of-Stake (LPoS, “leased proof of stake”) — used in the Waves blockchain, where users lease coins to a validator for rewards;
Nominated Proof-of-Stake (NPoS, “nominated proof of stake”) — used in the Polkadot platform and featuring nominators who bond stake on validators and vouch for their good conduct;
Pure Proof-of-Stake (PPoS, “pure proof of stake”) — used in Algorand, where validators of the next block are secretly and randomly selected among wallets with a balance above 1 ALGO;
Effective Proof-of-Stake (EPoS, “effective proof of stake”) — used in the Harmony platform. It has a special reward-distribution mechanism that encourages many small validators rather than a few large ones, promoting decentralisation;
Proof-of-Authority (PoA) — a hybrid algorithm that combines stake and validator reputation, with each validator approved by developers. In PoA, validators undergo identity verification akin to KYC. BNB Chain uses this algorithm.

Could bitcoin and other cryptocurrencies switch to Proof-of-Stake?

The high energy consumption of PoW-based mining has drawn criticism for years. According to recent research by the Cambridge Centre for Alternative Finance, bitcoin mining is responsible for 0.1% of all anthropogenic CO2 emissions.

This has become a key argument in efforts to ban mining in various countries. By late 2021, China had banned cryptocurrency mining. In March 2022, the European Parliament put a crypto ban to a vote. Although the bill failed, it signalled a trend towards pushing PoW out of the legal domain.

After the successful transition of the Ethereum network to Proof-of-Stake on September 15, 2022, the network’s energy consumption fell by nearly 2,000 times, or 99.95%. Debate about moving popular PoW cryptocurrencies to PoS intensified.

In December 2021, the developers of the memecoin Dogecoin announced its imminent switch to Proof-of-Stake. Vitalik Buterin, Ethereum’s co-founder, offered to help.

Electric Coin Company, developer of the privacy coin Zcash, is also discussing a transition to PoS with the community. According to founder Zooko Wilcox, this would not only improve the blockchain’s security and energy efficiency but also bring ZEC holders into protocol governance.

The biggest doubts concern the possibility of bitcoin moving to PoS.

First, the original cryptocurrency has no single maintainer. Several independent groups of developers debate any proposed change; even minor ones provoke fierce arguments and take years to implement.

Second, mining pools would not support a move to PoS, which would threaten their revenues. Notably, in 2020 a group of developers launched a fork, BitcoinPoS, which the crypto community simply ignored.

PoW supporters, for their part, point to the algorithm’s higher security: given bitcoin’s extremely high level of decentralisation, the network is practically impervious to external attacks.