Proof of Work vs. Proof of Stake

Imagine yourself as a general in the Byzantine army, planning to launch an attack on an enemy city. Your forces, led by several generals, are encamped at different locations around the city. A coordinated attack from all sides will guarantee victory, but an uncoordinated effort will likely lead to defeat.

Illustrating the Byzantine Generals Problem

You have decided to attack at dawn, but without modern means of communication like walkie-talkies or cell phones, and traditional signaling methods like flags, torches, or smoke being visible to the enemy, how do you ensure that all the generals attack simultaneously?

You could send messengers on horseback, but what if a messenger is intercepted or killed before delivering the message? Worse yet, what if an enemy captures a messenger and sends back a fake confirmation? And even more dire, what if some generals are traitors who confirm they will attack at dawn but intend to retreat instead? How can you be certain that all battalions attack simultaneously?

The crux of the problem lies in maintaining coordination between parties that mistrust each other. Seems impossible, right? But Bitcoin's PoW consensus mechanism has managed to crack this thousand-year problem.

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Byzantine Generals Problem

Enter Bitcoin

A Solution to the Byzantine Generals Problem

In 2008, a mysterious figure named “Satoshi Nakamoto” introduced a peer-to-peer electronic cash system – Bitcoin – using a PoW scheme to prevent a digital version of treachery like spending the same coins twice (double-spending). This double-spending problem is an example of the Byzantine Generals Problem, where nodes in the network have to agree on the state of the network’s transactions, even though some nodes may be unreliable or malicious.

By eliminating double-spending, Nakamoto managed to solve the Byzantine Generals Problem.

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The Bitcoin White Paper

Bitcoin: A Shared Digital Ledger

Continuing from our previous example, think of the battalions as computers on a network and the generals as a computer program keeping track of a shared online book of records – a digital ledger known as the blockchain. This ledger uses computer power to record, confirm, and secure transactions in the order they occur. To maintain the integrity of this ledger, cryptography is used, ensuring that all transactions, once finalized, are immutable. In other words, they cannot be changed without invalidating the chain, which would result in a split or fork in the chain.

Proof of work

What is Proof of Work?

PoW involves computers, known as miners, racing to find a number called a nonce (number used only once), which must be less than a predetermined threshold that is periodically reset by the blockchain’s algorithm. This threshold, known as the difficulty target, ensures that all miners in the network will, on average, discover a winning number at a certain fixed time interval – for Bitcoin, this is every 10 minutes. The first miner to guess the winning number earns the right to add a new page of transactions, called a block, to a shared online book of records, the blockchain.

A Digital Needle Search

Picture PoW mining as a grand search for a needle in a haystack the size of a sports stadium.

Each miner is a dedicated searcher. But instead of magnifying glasses, miners use computers.

Their searching speed is measured in calculations per second (hash rate), just as we might measure a person’s searching speed in square feet covered per hour.

In this digital search, it is computers and electricity, not people and magnifying glasses, that set the pace.

Not your typical needle hunt, there is a catch...

As more people – miners – join the search, their collective efforts enable them to swift through the haystack faster, finding the needle – the number – quicker than the intended time interval set by the blockchain. To maintain the fixed speed of finding the needle, the blockchain decreases the size of the needle, making the hunt more challenging. In Bitcoin, this is known as the “difficulty adjustment.”

Ultimately, just as the individual that can search faster has a better chance of finding the hidden needle first, a miner with more advanced computers has a better chance of finding the winning number. And the reward for being first is the right to add a new block of transactions to the blockchain and earn newly minted tokens (i.e., bitcoin) and transaction fees.

But Wait!

Do not forget about the nodes, who are the referees of the Bitcoin network. Nodes verify the solution proposed by miners and ensure that the rules of the search are followed. Once the nodes agree, a new block is added to the blockchain.

In this digital search, miners and nodes work together to maintain the decentralized, secure, and fair nature of the Bitcoin network. The collective efforts of these participants keep the Bitcoin network running.

Nodes are individual computers connected to the Bitcoin network. They hold a complete copy of the Bitcoin blockchain and ensure that the blocks propagated by miners adhere to the network's rules. While running a node might not offer a direct financial incentive, it enhances user privacy, supports overall network decentralization, and provides a system of checks and balances.

The Advantages of Proof of Work

Maximum Decentralization

PoW encourages decentralization because anyone can participate in mining, provided they have access to the required hardware and energy. Operating a Bitcoin node is affordable and accessible and has an even lower barrier to entry than mining. The large number and global distribution of nodes balance out miners' control and prevent unchecked influence. This combination of miners and nodes ensures that the network remains democratic and free from centralization.

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Distribution of Hash Rate

Distribution of Nodes

Maximum Security

PoW ensures strong security by requiring computational power and electricity to mine blocks, which makes it infeasible for malicious actors to take control and launch an attack. Bitcoin, which has been around since 2009, has never been hacked. It is the only monetary network in history that has successfully prevented the circulation of counterfeit currency.

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The 51% Attack

From Bitcoin’s Innovation, Emerges PoS

Thanks to its innovative solution to the Byzantine Generals Problem, Bitcoin experienced a meteoric rise to success. This innovation sparked a wave of developers to propose alternative consensus mechanisms with the promise of being better. One such contender that emerged was PoS. This new entrant claims to offer a more efficient, secure, and sustainable solution, sparking an intense debate between PoW and PoS supporters.

Proof of Stake

A Digital Lottery

In this digital lottery, validators serve the role of ticket holders. Validators are akin to miners in a PoW system. However, they do not compete using computational power to add a new block to the chain.

Instead, to participate in the validation process, a user must first lock up a certain amount of the network's native cryptocurrency (e.g., ETH in Ethereum) in a deposit contract. This contract is called a “stake.”

Once a user has staked their tokens and become a validator, the next step is for the PoS protocol to select who gets to validate transactions and propose new blocks. This process can be likened to a lottery system. However, instead of each participant having an equal chance of winning, the odds are weighed in favor of those with the largest stakes. The more tokens a validator stakes, the higher their chances of being chosen.

To ensure the network’s security and discourage dishonest behavior, PoS systems implement “slashing.” If a validator is found to be acting maliciously, attempting to manipulate the validation process, or breaking the consensus rules, a portion or all of their stake could be confiscated or slashed.

The Advantages of Proof of Stake

Tradeoffs

The Blockchain Trilemma

Like any technology, blockchains have a balance of advantages and tradeoffs that influence their utility. Blockchains face a common problem known as the “blockchain trilemma,” which states that a blockchain can only prioritize two of three elements: decentralization, security, and scalability. Bitcoin optimizes for decentralization and security at the expense of reduced transaction speeds (scalability). Meanwhile, Ethereum opts for scalability and security at the expense of decentralization.

Security

Scalability

Decentralization

The Tradeoffs of Proof of Work

The Tradeoffs of Proof of Stake

Comparing PoW and PoS

Two Methods, One Objective

While PoW and PoS strive to achieve the same objective - establishing consensus within decentralized networks - they differ in how they balance the key elements of the blockchain trilemma: security, decentralization, and scalability.

PoW networks, like Bitcoin, prioritize security and decentralization over scalability. By requiring computational power and electricity, PoW makes it economically infeasible to coordinate a successful attack. Additionally, PoW enables anyone with a spare computer to participate in validating transactions, creating a high degree of decentralization. This focus on security and decentralization comes at the expense of scalability, resulting in slower transaction speeds. However, layer-2 networks, like the Lightning Network, address Bitcoin’s scalability without sacrificing security and decentralization.

On the other hand, PoS networks, like Ethereum, prioritize scalability and, to an extent, security over decentralization. This prioritization allows PoS networks to handle more transactions and enables the development of various smart contract platforms. PoS also achieves high levels of energy efficiency by replacing miners and computational power with validators and staking, but this introduces financial barriers as validators must stake tokens to participate in adding new blocks. This requirement can result in centralization, as users who wish to participate must resort to staking pools, giving up their rights to validate blocks to pool operators. As a result, the risk of a 51% attack increases, especially if a few large pool operators decide to collude. Although pools also exist in PoW, miners retain control in validating blocks and can easily switch between pools.

So, Proof of Work or Proof of Stake?

When it comes to choosing between PoW and PoS, it all depends on what the blockchain network needs and wants. Factors like security, decentralization, scalability, and other specific use cases play a major role in determining which consensus mechanism is best.

PoW

PoW is the more established method with an excellent track record, making it a better option for applications requiring high levels of security, decentralization, and immutability. This is especially true for financial systems, healthcare databases, and telecommunications, where data integrity is vital.

PoS

PoS is better suited for experimental purposes, especially for private corporations looking to create custom networks with unique governance structures enabled by smart contracts. The scalability and programmability of PoS allow for tailored solutions. But before saying PoS is better because it uses less energy, it is important to consider the tradeoffs compared to PoW. Also, many of the blockchain networks that use PoS are equity-like in nature, which attracts regulatory attention.

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