Blockchain networks are governed by consensus mechanisms that decide which node validates transactions and receives the mining reward. In recent years, Proof-of-Stake has become the most popular approach. This is how it works.
POS is a type of consensus mechanism that is increasingly being used in cryptocurrency networks. The goal, like with any other consensus mechanism, is to produce more blocks for the blockchain. Each of these blocks contains transaction data. Once a new block is created, network participants who created the block will receive coins as a reward.
In POS networks, those participants who own coins can “stake” these coins to validate new transactions. That means users can only validate transactions – or mine coins – if they own a certain amount of coins. Essentially, the more coins you own, the more you can stake.
How does PoS differ from POW?
Other crypto networks validate transactions using different consensus mechanisms. Bitcoin, for example, makes use of Proof-of-Work (POW), which means miners have to use computational power to solve a mathematical puzzle to create new blocks. The miners who solve the puzzle first creates the block and receives the mining reward.
On the contrary to POS systems, users can validate transactions without owning any coins. It solely depends on computational power.
How does POW Work?
POS protocols allow users to validate blocks when:
- the user stakes a large number of coins on their own or
- creates a staking pool with other users.
Users who want to stake but don’t have enough coins available can team up with other users to stake a higher amount of coins within a so-called “bound wallet.” In this case, each mining node creates a block that is proportional to the percentage of the staked coins. For instance, if one node staked 5% of the pool’s coins, the node mines 5% of every transaction in every new block.
Energy efficiency is the key advantage of POS
In POS protocols, those users who stake bigger amounts stand a better chance to become the next validator and receive the mining reward. Thus, users are incentivized to make a more direct investment in the network’s cryptocurrency, instead of investing in expensive mining hardware which is required in POW networks.
Moreover, POS tackles a major issue of POW networks, which is their lack of scalability. Already today, Bitcoin’s POW mechanism requires large amounts of computational power, which means the network will soon hit a growth ceiling. POS systems are far more energy-efficient, allowing for more growth potential.
Miners are also more incentivized to stay invested in the network. By holding their coins, they can generate passive income, unlike in POW networks, where only the most powerful computing systems get the coins.
Many of today’s cryptocurrency networks are using POS instead of POW, mostly due to its improved energy efficiency. That’s also why the Ethereum network has decided to change from POW to POS.
Also, existing protocols are being improved and developed further. Delegated Proof of Stake (DPoS), for example, is an alteration of the POS mechanism which presents a form of voting system where block producers are elected. Since DPoS systems are maintained by its voters, every delegate becomes more efficient and honest at the risk of being voted out.
All the first cryptocurrencies started using POW, but by today, many of them switched to POS or a similar consensus mechanism. As blockchain is developing fast, it’s likely that there will be an even better system coming out at one point.