Proof of Work vs. Proof of Stake: Understanding Consensus Mechanisms

Satoshi Nakamoto, bitcoin’s pseudonymous founder, designed it as a peer-to-peer network, which means that counterparties can transact directly without the need for an intermediary like a bank. This system needed a way to keep a record of transactions and prevent double spending, where a holder spends the same coin multiple times, so Satoshi incorporated what’s known as a consensus mechanism.

A consensus mechanism relies on groups of participants, typically referred to as nodes, to maintain a ledger of all transactions, and it plays a crucial role in the security and scalability of a blockchain. As the technology is relatively unfamiliar to many outside the crypto ecosystem,  this article explains how the two most commonly used mechanisms work and explores their main differences.

Proof of Work (PoW)

PoW relies on two types of nodes to maintain the network.

Miners are responsible for validating transactions and adding new blocks to the chain. They compete for the right to process transactions by solving complex mathematical problems that require large amounts of computing power. In return, miners earn block rewards in the form of the protocol’s native currency, the primary way coins come into circulation. For example, after the recent halving, bitcoin’s block reward stands at 3.125 btc, worth $196,837 (as of the 27th of August 2024).  

The other type of nodes are the individual servers that form the blockchain. They verify each block, prevent double spending and make sure the entire network has the latest record of every transaction.

PoW is the consensus mechanism used by bitcoin, the original cryptocurrency with the largest market capitalisation. Others have also adopted it, including dogecoin (market cap $15.36 billion), litecoin ($4.74 billion) and monero ($3.08 billion). Ethereum launched as a PoW protocol before transitioning to proof of stake.

PoW’s biggest benefit is security. A malicious actor would need to control 51% of the blockchain, known as a 51% attack, to be able to alter transactions that have already been processed. The amount of computing power this would involve- currently estimated at $724 million per hour for bitcoin- makes this prohibitive. PoW consensus mechanisms are also highly decentralised because the barriers to entry for nodes are low- according to crypto payment app Bitpay, the bitcoin network had 18,000 in February of this year.  

There are disadvantages too. One of the biggest criticisms of PoW is the amount of energy used by miners. Research by the University of Cambridge ranks bitcoin at #27 among industries and countries for global electricity consumption and #67 for greenhouse gas emissions. However, miners are diversifying into alternative energy sources. The other criticism of PoW is a lack of scalability. In bitcoin’s case, Satoshi prioritised the network’s security and decentralisation, which slows down the processing of transactions (commonly referred to as the blockchain trilemma). Layer 2s are helping to address this issue.

Proof of Stake (PoS)

PoS nodes are validators that must lock up or ‘stake’ native tokens in a smart contract for the right to process transactions and verify blocks before they’re added to the chain. Getting selected is like a lottery, as the protocol randomly picks a validator for each block. That said, the higher the stake, the better the chances.

PoS protocols also pay block rewards in their native token. But they penalise nodes for malicious behaviour, such as being offline or approving invalid blocks, by confiscating or ‘slashing’ a portion of their stake. 

In some cases, the minimum stake required to participate in a PoS consensus mechanism may seem prohibitive. For instance, Ethereum validators need to lock up 32 ether, worth $99,185 as of 15th of November 2024. However, staking pools allow holders with smaller amounts of native tokens to pool their funds and earn a passive income. Some of the most popular ether pools include Lido and RocketPool, while exchanges such as Binance and Coinbase also offer this service.

Ethereum, the second biggest crypto by market cap, famously transitioned from PoW to PoS in September 2022, an event nicknamed ‘the Merge’. Many of the protocols that bring greater functionality to blockchain technology also use PoS, including Cardano (market cap $13.28 billion), Avalanche ($10.58 billion), Polkadot ($6.81 billion) and Near ($5.40 billion).

One of the key advantages of PoS is its scalability. The average time required for Ethereum to process a block of transactions is 12.06 seconds, compared with an average of 10.75 minutes for bitcoin, primarily because picking validators is relatively quick. Another is energy efficiency, as a standard laptop can run the software to validate transactions. The Merge reduced Ethereum’s energy consumption by 99.9%.

The main criticism of PoS is the potential centralisation caused by the dominance of a small number of validators with sizeable resources, which increases the risk of a single point of failure. Research by Dune shows that Lido and Coinbase currently account for over 40.7% of the total ether locked in the Ethereum ecosystem. PoS protocols also enable the biggest stakers to cement their dominance by earning the bulk of block rewards and allow early adopters to establish disproportionate influence. 

Conclusion

A consensus mechanism is a system that validates transactions on a blockchain and ensures all nodes have the latest state of the ledger. The most popular are PoW and PoS.

Satoshi created the PoW mechanism for bitcoin, the original and biggest crypto, and early coins such as dogecoin and litecoin followed suit. Ethereum, which issues the second-largest crypto by market cap, is the highest-profile PoS blockchain. Other protocols that have adopted it include Cardano and Avalanche.   

PoW and PoS take different approaches to how they select validators to process transactions and add blocks to the chain- PoW requires validators known as miners to solve complex mathematical problems, while PoS randomly selects validators that have staked a certain amount of the protocol’s native token.

The chart below summarises the other main differences between the two mechanisms.