What Is A Proof Of Stake And Why It Matters In Business

A Proof of Stake (PoS) is a form of consensus algorithm used to achieve agreement across a distributed network. As such it is, together with Proof of Work, among the key consensus algorithms for Blockchain protocols (like Ethereum’s Casper protocol). Proof of Stake has the advantage of the security, reduced risk of centralization, and energy efficiency.

Aspect	Explanation
Definition	“Proof of Stake” (PoS) is a consensus mechanism used in blockchain networks to validate and secure transactions and create new blocks. In PoS, validators (participants who validate transactions and propose new blocks) are chosen to create new blocks and verify transactions based on the amount of cryptocurrency they “stake” or hold in the network. Unlike “Proof of Work” (PoW), which relies on computational power and energy-intensive mining, PoS is considered a more energy-efficient and environmentally friendly alternative. PoS aims to achieve consensus while reducing energy consumption and centralization risks.
Key Concepts	– Staking: Participants (validators) lock up a certain amount of cryptocurrency as collateral to be eligible to validate transactions and propose new blocks. – Validator Selection: Validators are chosen to create new blocks based on their stake and other factors (e.g., randomness or seniority). – Slashing: Validators risk losing a portion of their staked cryptocurrency as a penalty for malicious behavior or network downtime. – Energy Efficiency: PoS consumes significantly less energy compared to PoW, making it more sustainable.
Characteristics	– Energy Efficiency: PoS requires much less computational power and energy than PoW, making it environmentally friendly. – Decentralization: PoS aims to distribute block validation among a larger number of participants, reducing centralization risks. – Incentives for Honest Behavior: Validators have a financial stake in the network, providing an economic incentive to act honestly and maintain the network’s integrity. – Security: PoS networks use cryptographic techniques to secure transactions and blocks. – Slashing: Validators can lose their staked assets if they engage in malicious behavior.
Implications	– Energy Savings: PoS reduces the environmental impact associated with energy-intensive PoW mining. – Decentralization: It encourages a wider distribution of validators, potentially reducing the risk of centralization. – Security: PoS networks maintain security through economic incentives and cryptographic techniques. – Participation Accessibility: PoS may allow more individuals to participate in block validation due to lower hardware requirements. – Stakeholder Involvement: Holders of the cryptocurrency have a say in network governance based on their stake.
Advantages	– Energy Efficiency: PoS is more environmentally friendly compared to PoW. – Decentralization: It aims to prevent excessive centralization of block validation. – Security: PoS networks use cryptographic security measures. – Accessibility: PoS may require less specialized hardware and attract more participants. – Economic Incentives: Validators have a financial stake in the network’s integrity.
Drawbacks	– Initial Distribution: The initial distribution of cryptocurrency among participants can impact decentralization. – Long-Term Security: Some argue that PoS may be less secure in the very long term compared to PoW. – Complexity: Implementing PoS can be complex, and network upgrades may be required. – Slashing Risk: Validators risk losing their staked assets for malicious behavior or downtime. – Regulatory Uncertainty: Legal and regulatory frameworks for PoS vary by jurisdiction.
Applications	PoS is widely used in various blockchain networks and cryptocurrencies, including: – Ethereum 2.0 (ETH): A major upgrade of the Ethereum network transitioning from PoW to PoS. – Cardano (ADA): A blockchain platform using PoS for secure and scalable smart contracts. – Polkadot (DOT): A multi-chain network enabling interoperability between different blockchains. – Tezos (XTZ): A self-amending blockchain platform with on-chain governance. – Algorand (ALGO): A PoS blockchain known for speed and scalability.
Use Cases	– Secure Transactions: PoS ensures secure and tamper-resistant transactions within blockchain networks. – Smart Contracts: PoS networks like Ethereum 2.0 enable the execution of smart contracts. – Governance: Holders of staked assets often have a say in network governance decisions. – Interoperability: PoS networks like Polkadot facilitate communication between different blockchains. – Delegated Staking: Some networks allow users to delegate their stakes to validators in exchange for rewards. – Tokenomics: Staking can be part of a network’s tokenomics, providing incentives for participation.

Table of Contents

How does Proof of Stake work?

As pointed out on Ethereum:

Proof of Stake (PoS) is a category of consensus algorithms for public blockchains that depend on a validator’s economic stake in the network.

In short, in a PoS-based blockchain, the weight of each validator taking turn proposing and voting might depend for instance on the size of its deposit (the stake.

The workflow is:

The blockchain keeps track of a set of validators (someone responsible for verifying transactions within a blockchain).
Holding ether (the Ethereum’s cryptocurrency) gives the chance to be a validator.
When a special type of transaction is locked up into a deposit that determines a validator.
Validators participate in the consensus algorithm to reach majority.

The philosophy behind Proof of Stake

As pointed out on Ethereum the key advantages of a Proof of Stake are:

No need to consume large quantities of electricity in order to secure a blockchain.
The supply goes down over time as there is not as much need to issue as many new coins in order to motivate participants to keep participating in the network
Reduced centralization risks.

Disadvantages of a Proof of Stake

The main argument against Proof of Stake is the risk that the Blockchain protocol might be taken over by someone with a substantial stake in the protocol. While the protocol might have rules to prevent that, if those rules fail they make the network potentially centralized, thus prone to take overs.

As explained in the Steemit business model, as the network was taken over, and the way for the community to decentralize it was though a hard fork, which created a new protocol, called Hive.

As Vitalik Buterin pointed out, when the take over of Steemit happened:

One way to prevent this, of course, is to use hybrid models, that combine Proof of Stake with Proof of Work.

Or have a set of mechanisms to enable distribution of coins, prevent monopolizzano and 51% attacks (take overs).

Distributed consensus

The whole point of proof of stake is about enabling consensus in a distributed network, a Blockchain Protocol.

Types of Proof of Stakes

While there are many types of consensus algorithms. When it comes to Blockchain and Proof of Stakes, two main kinds have found applications:

Chain-based Proof of Stake

As pointed out on Ethereum, in a Chain-based Proof of Stake, “the algorithm pseudo-randomly selects a validator during each time slot (eg. every period of 10 seconds might be a time slot), and assigns that validator the right to create a single block, and this block must point to some previous block (normally the block at the end of the previously longest chain), and so over time most blocks converge into a single constantly growing chain.“

BFT-style (Byzantine fault) Proof of Stake

In a BFT-style (Byzantine fault) proof of stake for to proof of stake to be reliable, there has to be some fault tolerance of a system where, even though some of the parties, are not in agreement or act against the network’s rules, the network can still reach agreement and move on.

This mechanic draws from the Byzantine Generals Problem.

As the original paper on The Byzantine Generals Problem, of 1982, states:

Reliable computer systems must handle malfunctioning component that give conflicting information to different parts of the system. This situation can be expressed abstractly in terms of a group of generals of the Byzantine army camped with their troops around an enemy city. Communicating only by messenger, the generals must agree upon a common battle plan. However, one or more of them may be traitors who will try to confuse the others. The problem is to find an algorithm to ensure that the loyal generals will reach agreement. It is shown that, using only oral messages, this problem is solvable if and only if more than two-thirds of the generals are loyal; so a single traitor can confound two loyal generals.With unforgeable written messages, the problem is solvable for any number of generals and possible traitors.

In short, as long as the number of disloyal generals is less than one third of the generals. The impossibility of dealing with one-third or more traitors ultimately reduces to proving that the one Commander and two Lieutenants problem cannot be solved, if the Commander is traitorous.

Key takeaways

Consensus algorithms help Blockchain Protocols reach agreement among a distributed network. Among those consensus algorithm there are two main philosophies: Proof of Stake and Proof of Work. The Proof of Stake determines the consensus based on the stake of each user in the network.

The Proof of Stake solved an important problem, as it enabled an alternative mechanism to Proof of Work, primarily based on mining, with an impressive energy consumption.

Proof of Stake would enable the network to function even without much energy consumption, as the network can grow based on the stake of coins of each player in the network.

At the same time as the Steemit case showed, the network is vulnerable from take overs, thus risking to get centralized, which is what a Blockchain Protocol wants to prevent in the first place.