Proof of Stake (PoS) is a way to keep a blockchain secure by letting people who own cryptocurrency help verify transactions. In more technical terms, it’s a consensus mechanism utilized by specific blockchain networks to validate transactions and secure the blockchain.
Unlike the Proof of Work (PoW) system, which relies on computational power to validate transactions, PoS offers a more energy-efficient and scalable alternative. In PoS, the more cryptocurrency you own and are willing to lock up, the more chances you have to be chosen to check and approve new transactions. If you do this job well, you earn more cryptocurrency as a reward.
How proof of stake works
In a PoS system, validators are selected based on the number of tokens they are willing to “stake” or temporarily lock up in a secure wallet. The more tokens a validator stakes, the higher their chances of being chosen to validate transactions and create new blocks.¹,²
This approach incentivizes participants to hold onto their tokens, thereby reducing market volatility and securing the network against attacks. A bad actor would need to control a majority of the staked tokens to compromise a PoS network, which is both costly and impractical.¹,²
When a validator is chosen to create a new block, they are rewarded with transaction fees or newly minted tokens. If the validator behaves dishonestly or tries to manipulate the network, they risk losing their staked tokens. This “skin in the game” concept ensures that validators are financially motivated to act in the network’s best interest, maintaining its security and integrity.¹,²
Proof of work (PoW) vs. proof of stake (PoS)
Proof of Work was the original consensus mechanism and algorithm that underpins many blockchain networks. It requires participants, known as miners, to engage in a computational race to solve intricate mathematical problems.³
When a person successfully “proves their work” or solves these problems, the miner has the right to add a new block of transactions to the blockchain and earn rewards.³ The core idea is to make it computationally expensive to alter any part of the blockchain, thereby ensuring security and integrity.
Proof of stake offers a new fintech approach to validating transactions in a more sustainable, incentivized way than PoW systems. PoS significantly reduces the energy consumption associated with blockchain operations, while PoW requires a lot of computational mining and electricity.⁴
Ultimately, PoS achieves consensus through a less resource-intensive process.⁴ This shift not only makes blockchain technology more sustainable but also enhances its accessibility, broadening its potential applications and adoption.
Notable transitions to PoS
Many of the top cryptocurrencies, like Solana, Avalanche, and Cardano, have transitioned from PoW to PoS.⁵ One of the most notable implementations of PoS was Ethereum’s transition from PoW to PoS through the Ethereum 2.0 upgrade.⁶
The shift in 2022 was meant to improve the network’s scalability and reduce its carbon footprint, addressing some of the key criticisms of blockchain technology. Since then, Ethereum has reduced its energy consumption by over 99.95% by switching from the PoW to the PoS system.⁶
Pros and cons of proof of stake
There are benefits and drawbacks to this mechanism.
Pros:
- Passive income: Crypto savings from staking rewards can vary quite a bit, with some networks offering annual yields between 5% and 14%.⁷
- Lower entry barrier: Participate with a small amount of cryptocurrency without needing specialized hardware.
- Reduced energy costs: Save on electricity expenses as PoS is less energy-intensive than PoW.
- Incentivized security: Validators have a financial stake, promoting honest behavior and network security.
- Potential for appreciation: Increased demand for staked cryptocurrency can lead to price appreciation.
- Diversification: Gain exposure to various blockchain projects, spreading investment risk.
- Long-term strategy: Encourages long-term holding, providing steady income and reducing market volatility.
Cons:
- Wealth concentration: Larger stakeholders have more influence, potentially leading to centralization.
- Initial investment required: Need to own and stake a significant amount of cryptocurrency to become a validator.
- Liquidity issues: Staked funds are often locked up and cannot be easily accessed or traded.
- Network vulnerabilities: Smaller or less popular PoS networks may be more susceptible to attacks if a few entities control a large portion of the stake.
- Complexity for new users: Understanding and participating in staking can be complex and may require technical knowledge.
- Potential for low returns: Staking rewards can be lower than expected if the network’s inflation rate is high or if there are many participants.
Understanding proof of stake: a sustainable approach to blockchain
Proof of Stake represents a significant advancement in blockchain technology, providing a more energy-efficient and potentially more democratic way to achieve distributed consensus. Its potential to make blockchain more sustainable and scalable could accelerate its adoption across various sectors.
Whether you’re new to cryptocurrency or experienced, PoS is one way to possibly earn passive income through staking, contributing to the security and efficacy of the blockchain networks you support.