Breaking down the differences between PoW and PoS
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In order to get a deep understanding of Staking and Proof of Stake in general, it makes sense to compare it to the closest and currently most popular consensus algorithm, namely Proof of Work.
It currently powers most of the public blockchains, however with Proof of Stake (PoS) gaining traction, its share is expected to grow with a flippening expected at some point in time.
Almost every newly launched public blockchain is PoS-based and even the second-largest blockchain Ethereum is shifting to Proof of Stake in the next major upgrade.
Why does Proof of Stake get all the buzz? Is it really better than Proof of Work?
Well there must be some serious advantages over PoW. Let’s find it out and compare the two across several dimensions.
1. Proof of Stake Definitions
First, let’s get the basic terminology straight.
Proof of Work and Proof of Stake are classes of algorithms that determine consensus in decentralized networks and reward the consensus keepers who participate with coins.
In other words, PoW and PoS describe how the issuance of new coins acts as a crypto-economic incentive for the network, rewarding the consensus keepers in relation to the resources they provide to the network. This puts a resource with a monetary value behind it (mining rig, ASIC, X number of coins, etc), alongside with honest behavior as a prerequisite for receiving said rewards, be it BTC, ETH, XTZ, you name it.
To some, providing or locking a certain resource in the network, exposing this to risk sounds awful a lot like Staking. And you are right, it does!
Proof of Work can be conceptually considered as Proof of Stake, where the Stake is expressed in cost of staking (mining) hardware and electricity bills. One can generalize even further and argue that Staking is a traditional form of economic activity, in order to achieve an ROI, one has to put forward capital to generate ROI on.
But before we start calling everything Proof of Stake, despite being correct in certain cases, let us get back to the definitions and their core differences.
In Proof of Work security comes from solving cryptographic algorithms. Here, probabilistically, the participants with the highest computational power at stake collect the most rewards (think Bitcoin miners and mining pools).
In Proof of Stake security comes from exposing economic value to a certain risk. Here, probabilistically, the participants with the highest value at risk/stake are chosen in a deterministic way and collects the most rewards. It is importnat elaborate on “probabilistically” as it refers to an element of randomness to how the validators are selected to avoid the one with the largest stake always being chosen.
There are many nuances to Proof of Stake. Even though it is not the same in every protocol, there are still some basic principles across which we can compare these to Proof of Work Protocols.
For simplicity purpose we are referring to Proof of Stake as an aggregation of its various implementations like Byzantine Agreement, Tendermint, Dfinity, Casper, Ouroboros, Stellar Consensus, all of which have some monetary incentive for holding or staking coins.
We are comparing the two across the following metrics: industry trend, community interaction, centralization, cost, incentives, attack factors, security, governance, ease of bootstrapping and environment.
Despite the relative novelty and relatively low adoption of Proof of Stake and “stakable” assets, as we discussed earlier, these are getting traction pretty rapidly, most under the radar.
Actually 13 of the Top 30 Cryptocurrencies by marketcap are already utilizing Proof of Stake or similar. These include EOS, Stellar, Tron, Dash, Neo, Binance Chain, Ontology, Tezos, NEM, VeChain, Waves, Qtum, Decred, Lisk. Another 3 major ones of them are moving to PoS (Ethereum, Cardano and OmiseGO).
This would mean that more than half of the market making using of PoS and additionally almost all layer-2 solutions are making use of some staking mechanisms. Even Bitcoin´s Lightning Network could be argued to be some type of Proof of Stake, whereas watchtowers “stake” Bitcoin to process transactions and earn the fees.
Now let’s look at the numbers.
- Total Staking marketcap: >$16 bio.
- Total Value Locked in Staking: >$5 bio.
- Proof of Stake Dominance: 9.80%
- Proof of Stake Dominance (without BTC & ETH): 26.6%
These numbers are increasing quite rapidly and many parties argue that about $50 billion will be secured by PoS chains by the end of this year. Shift of various projects to newer PoS blockchain protocols such as Binance Chain, Cosmos and Polkadot will likely boost that number in short to mid term as well. With the launch of ETH 2.0 this may even get much higher.
It seems Proof of Stake is slowly grabbing all the pieces of the pie.
When we talk about scalability, it is important to consider the transaction throughput of a given blockchain as well as its transaction finality.
The on-chain transaction processing capacity of a blockchain network is limited by the average block creation time and the block size limit. Both of these jointly constrain the network’s throughput.
Bitcoin’s Proof of Work has a 10 minutes block time. Protocols such as Ethereum have reduced it to 15 seconds. This leads to a slightly increased transaction throughput.
A limited number of validators in Proof of Stake Networks makes it possible to achieve the higher transaction throughput.
As already mentioned, transaction finality is an important factor in terms of how scalable blockchains are, especially in business and commerce context. Major Proof of Stake chains offer faster, and in some cases near-instant finality. This is not only common to “traditional” PoS blockchains though, DASH masternodes for instance can have similar finality properties.
4. Network Security
The first implementation of Proof of Work as we know if has been with Bitcoin in 2009, which is functional already through more than 10 years. Since its inception many other coins have adopted Proof of Work and since then it has become the unchallenged way of designing public blockchains. Bitcoin’s Proof of Work has gone through many attack attempts and has proven to be reliable and secure.
PoW chains are systems which require external commitment, meaning that the resources and value comes from outside the system (hardware, electricity), which unlike intrinsic PoS might have some advantages. This way PoW avoids some potential game-theoretic situations, where the benefit of attacking the system outweights the loss in stake (getting slashed).
In the short term, Proof Of Work chains could be challenged by mining cartels or hashpower buying through services like Nicehash, which may lead to 51% attacks. As the hashpower buying to execute such an attack is impossible for Bitcoin, it is feasible for smaller Proof of Work Chains, which we have seen lately with Verge (link) and ETC (link).
To estimate the cost for a 51% attack on Bitcoin we have to look at the total hardware and electricity cost to reach such an 51% advantage in hashing power.
- Total Hashing Power: 50,000,000 TH/s
- Current Price for Antminer S9: $300
- Antminer S9 Hashing Power: 13 TH/s
- Hardware Cost for 51% Attack: $1,153,846,153 USD (1.11% of network value)
Disclaimer: this is a very rough idea of what the cost could be, but still it is obviously not as easy to determine.
Proof of Stake and Staking is a still very new. Even though Blockchains such as PeerCoin or Ardor have been live for a long time, it has not been until summer 2018 when the first major Proof of Stake Blockchain went live with Tezos.
None of them has ever really been critically stress tested, so we do not know about the possible problematics we may face.
There are a few possible attack vectors for Proof of Stake such as:
Long Range Attack
A Long Range attack is a scenario where an adversary creates a branch on the blockchain starting from the Genesis block and overtakes the main chain. This branch may contain different transactions and blocks and is also referred to as Alternative History or History Revision attack.
Nothing at Stake Attack
One issue that can arise with PoS networks is the “nothing-at-stake” problem, wherein block generators/validators have nothing to lose by voting for multiple blockchain histories, thereby preventing consensus from being achieved. Because unlike in PoW systems, there is little cost to work on several chains.
You may think that a total of 51% of the network value is required to run such an attack, but in some PoS network the amount of stake necessary to conduct such an attack is estimated to be as low as 33%. And with delegations or votes the attacker doesn’t even need the stake himself, but is fine with third party network support, which he may be able to gain through vote buying or bribery. It is important to point out that the attacker doesn´t need ⅓ of the total supply, but rather ⅓ of the active stake, which could be significant lower.
Low Staking Participation (Stake Ratio)
It is important to point out that the 51% attacker doesn´t need ⅓ of the total supply, but rather ⅓ of the active stake, which could be significant lower. E.g. with a Stake Ratio of 25% the required amount is only 1/12 of the total supply (⅓ * 25%)
Private Key Attack
While Staking the private keys are always online and therefore exposed to the network in order to proof ownership of the stake and sign transactions. With the constant connectivity to the network, the keys are more vulnerable to attacks. Even if the private keys do not directly control all the funds of the total stake: Gaining control of the keys gives access to validation and staking rights, to run an attack.
So a big security risk in PoS is actually the transfer of network value (stake) to validators, which may lead to high centralization and possible attacks on the network. Big corporations may have a lot of resources to achieve a successful attack by buying votes (even indirectly with unfair marketing) or forming validator cartels.
We are experiencing this with LISK, where validators have formed groups that control and suppress the reward share fee markets. And also EOS validators have set up the EOS constitution, which does not allow any rewards to be shared with voters.
Please consider the above mentioned attack factors are addressed and being prevented in some PoS implementations. Still it is clear that they have not been stress tested yet.
There are several hybrid approaches like e.g. Elastos, which uses merged mining with Bitcoin to utilize its security, while having an EOS-like dPoS consensus algorithm on top. Such hybrid options are worth exploring as well.
The security aspects lead us directly to the topic of Centralization.
5. Centralization / Decentralization
The underlying consensus machinery in Proof of Work is the mining hardware. This hardware is hard to access and the technology is licensed by single corporations.
Mining is a tough business, as buying ASICs is always a very long-term investment which is not exchangeable or as liquid as a Proof of Stake assets.
Proof of Work mining nowadays is a very low margin business and only profitable for large corporations with exclusive access to premium resources such as hardware technology and cheap electricity.
Unlike PoW, the underlying consensus machinery in PoS are the native assets. Proof of Stake assets are freely available and can be acquired at any exchange or even OTC market in bulk without much hassle. Thus, in order to participate in staking there is usually a low to non-existent hurdle.
Blockchain Nodes, however, which stabilize and decentralize the network and are rewarded for it are required to be set up and run to participate. The incentives to run those nodes are high.
While not everyone might be willing or capable to run these nodes, the mechanisms like Stake Delegation are crucial in decentralization as these allow even the smallest investors to make their votes and participate in consensus without running nodes themselves.
Wait! But isn´t it that in Proof of Stake only the rich get richer? It seems to converge with time to a highly centralized state…
Yes, this is a valid argument, but in comparison to Proof of Work it might actually not be.
In Proof of Work the power laws of “rich get richer” is even more pronounced, whereby wealthy miners can simply ASIC devices in bulk. They are the ones with exclusive resources and high compounding effect and it is easier to stay ahead of competition by licensed technology. There are massive economies of scale for large miners, whereas there are zero economies of scale and linear reward development for PoS stakers (see below).
Looking at the cost we have to consider three aspects:
- Blockchain transaction costs
- Capital required to maintain the blockchain
- Inflation cost to compensate Validators/Miners
Blockchain Transaction Costs
Storing data on public blockchains is extremely expensive. Each byte needs to pass on to every node in the network and all nodes have to store it.
As for PoW, Bitcoin transactions cost currently about $1.91 each (source) and Ethereum transactions are priced at roughly $0.1 (source), both of which can vary greatly with the price of the underlying coin. At some point during the peak of the bull market, the transaction costs reached $54.9 and $5.5 for Bitcoin and Ethereum respectively.
In Proof of Stake the cost is usually much lower. In Tezos for example, transaction costs are around 0.01 $. Others like Cosmos currently have costs within similar price dimension.
Now let´s look the the capital required to secure and maintain those blockchains.
Capital required to maintain a blockchain
Proof of Work requires expensive hardware and a lot of electricity, whereas in Proof of Stake the cost for every validator is simply a solid and secure hardware infrastructure (without a need for a lot of computational power) with thus a small cost for electricity.
In Bitcoin the cost to secure the network is roughly about $2 billion in hardware per year (which has average lifespan of 18 month) and about $4 billion in electricity cost per year (considering average $0.08 per kwh).
This would lead to a total of about 6.5% of network value is required each year to maintain a Proof of Work blockchain.
In Proof of Stake the capital required is only about 0.1% of Network Value.
Inflation cost to compensate Miners/Validators
Average rate of Inflation in PoS network is 6%, whereas average inflation in Proof of Work networks is 4% (rough estimate).
As blockchain incentive design tends to lower the inflation over time, we may say that the inflation costs to compensate miners/validators are about equal. This is due to the fact that Proof of Work has been around longer already and the Proof of Stake inflation will likely be dropping over time as well.
BUT in Proof of Work all investors, not engaged in mining, do effectively have a dilution of their investment for the percentage of inflation, whereas in Proof of Stake the investors can mostly without much effort participate in staking, even receiving a return on their investment.
Considering a 6% inflation with a 50% Staking Participation, stakers effectively have a positive surplus of 6% network yield.
Whereas in Proof of Work the investors effectively have a negative dilution of around 4%.
Protocol Governance in Proof of Work is split over many parties:
- Miners: decide which transactions are confirmed and which chains to mine on
- Users: decide which protocol to accept as the original and which services in the ecosystem to use
- Foundations: decide fund allocations to certain development teams, who are working on different protocol proposals or such
- Nodes: decide which software to run and serve to users through APIs
It is not possible to determine who holds the most votes across the different parties as voting power in PoW is hard to measure. However, in order to maintain the blockchain and govern all its vast physical resources and network value at stake, there still needs to be a consensus between the parties. The lack of clarity and transparency around governance in Proof of Work leads to a very slow progress of protocol design and upgrades.
Proof of Stake Governance is distributed between all the parties mentioned above as well, however the governance mechanism is often far more structured, as we can vote and make choices according to a simple rule of 1 Coin = 1 Vote.
Furthermore, in Proof of Stake we are able to conduct On-Chain Governance. (Note: actually it is possible in Proof of Work too with a separated voting mechanism, but no one has implemented it as of yet). It allows to create and suggest proposals for changes to the protocol as well as vote on those on-chain. Upon positive outcome of the on-chain vote, such proposals can be automatically implemented on-chain. Such on-chain governance mechanism is currently applied in Tezos.
Examples for other governance voting in Proof of Stake are:
- EOS (https://eosvotes.io/)
- Decred (https://proposals.decred.org/)
- Dash (https://www.dashcentral.org/budget)
- Cosmos (https://hubble.figment.network/cosmos/chains/cosmoshub-2/governance)
The governance in Proof of Stake with a clear and transparent voting design favours fast implementation of protocol changes in a streamlined process.
8. Community Interaction and Engagement
Miners in Proof of Work often have a traditional business mindset. They are comfortable investing in a mining business because is shares many facets with a traditional Factory Manufacturing business. Mining Hardware would be the Technology how to produce the goods, whereas the ones with the better technology are always the most efficient. Cheap electricity is a very important resource for both mining as well as for a factory. Such businesses depend on the market prices of the goods they produce in the same way traditional factories which produce e.g. steel, are also dependent on the steel prices.
So of course there is a certain risk attached. If the cryptocurrency price drops, mining could become unprofitable. But in most cases it is a profitable business even when selling all coins immediately at market prices.
The people who become miners nowadays are mostly the ones who have exclusive access to hardware and electricity. They don’t have many incentives to get involved with the community.
If they would truly believe in the value of the underlying asset, they would always be better off by just investing into the asset directly. Investing in Bitcoin directly has ever since outperformed investing in mining and we expect this to continue in the long run.
On the other hand, the validators in Proof of Stake are seen more as investors rather than factory bosses. They need to have deep understanding of the underlying asset’s technology, be contributing and further growing the protocols. The large ones in most cases have exclusive access to talent and research. They need to be smart.
In most protocols they are required to hold big stakes themself in order to accept more delegations from other investors. By staking and operating staking services, the funds are tied up in the protocol for a certain lock-up period and in case they would decide to liquidate some funds, they might not be able to serve all their existing customers (e.g. in Tezos each delegation requires a small percentage of own funds).
This turns validators into long-term investors in the underlying native assets. Thus, they get strong incentives to drive the technology and value forward. With these incentives we see high engagement.
It is comparable to early stage start-up investments, where VC’s support their portfolio companies. This narrative has been mostly popularized by Coinfund and generalized mining investment thesis.
Speaking about the best way to launch a public blockchain we have to consider the public access to the coin which drives adoption and also the development funding.
Launching a Proof of Work Blockchain is very simple. The cryptocurrency starts with a supply of 0 coins and everyone has equal participation rights and access to the coins via mining (assuming no premine). This process is seen as relatively easy, fair and transparent.
To finance the ongoing protocol research & development, a development subsidy could be implemented such as in Zcash, where small percentage of the block rewards goes directly to the developers.
The bootstrapping of Proof of Stake networks is however far more complex. As we require several parties to hold stake from the start, initial coin distribution has to be determined before launch.
The most common way are Token Sales (ICO’s, IEO’s, you name it), where the initial token supply is sold and distributed to investors, developer groups, foundations, advisors and such.
With sometimes high requirements to invest and large bonuses for big investors, those token sales are often seen as unfair and restrain access to the public blockchain for communities.
Vesting Periods of tokens are rarely transparent and sometimes get changed afterwards. This means that investors are kept in the dark about their real dilution (inflation through release schedules).
An alternative token distribution mechanism are the airdrops, where people or communities receive tokens without directly investing. As tokens are often distributed without prior consent of the recipient and in very tiny amounts, big parts of the total supply are easily forgotten or lost. Again with a lack of transparency, this does not seem like the best way to bootstrap a cryptocurrency.
There are others blockchain bootstrapping mechanisms emerging, but they are still very new to draw conclusions. One is the idea of a something like a “cross-chain airdrop” via a Hard Spoon introduced by Cosmos (in the making until IBC is live). It replicates account balances of a any PoW or PoS chain to a new PoS Blockchain, where the new tokens are equipped with interoperability and staking features.
“Hard spoon: a new chain that takes into account state from an existing chain; not to compete, but to provide broad access.” — Jae Kwon of Tendermint, Cosmos Network
When we looked the cost of securing a public blockchain we saw that Proof of Work is much more expensive, because of the hardware and electricity cost. Obviously this means Proof of Work also has negative impact on environment.
Despite that, we believe this amount of electricity is tiny compared to the value we get for it, which is a trustless, global, immutable ledger with a very high degree of security. Various comparisons to gold mining, costs associated with existing financial systems, put PoW in a not so negative light.
But just looking at environmental impact alone we have admit the environmental advantage of Proof of Stake, as it is way more environment-friendly.
In this post we compared Proof of Work and Proof of Stake across several dimensions. There are both advantages and disadvantages for each one, and the future will not be one consensus algorythm to rule them all.
We strongly believe that there is a need for at least one PoW chain, most prominent of course being Bitcoin. A PoW blockchain like Bitcoin provides unrivalled level of security and immutability as well as can act as global settlement layer and a single source of truth. There are multiple visions and debates around what Bitcoin is envisioned and/or most suitable to be.
Whatever the vision for Bitcoin is, it is hard to argue that there is no demand for a more flexible and composable blockchain frameworks enabling development and deployment of higher order applications on top of it.
Most of the new prominent blockchain protocols pursuing exactly that vision are being launched using PoS security model, which combined with the shift of Ethereum to PoS will drastically increase the overall share of PoS in the blockchain space. Most of the Layer 2 solutions implement some variation of PoS as well, which makes the topic of staking an integral and increasingly growing part of the blockchain space.
If we account for the future of blockchain interoperability and application-specific blockchains, powered by such PoS protocols such as Cosmos and Polkadot, the relevance of PoS might touch even such classic PoW blockchains like e.g. Bitcoin, Monero, zCash, as these might want to interoperate and require own Zones/Parachains/Bridges, making them indirectly a part of the staking ecosystem as well (e.g. “pooled security” of Polkadot).
To sum it up, here is the short and generalized summary of the benefits which could be the reason for such significant shift towards PoS:
- Ability to earn staking rewards and not getting diluted by inflation
- Lower barrierrs of entry for consenus participation
- On average more scalable due to a healthy trade-off between number of consensus keepers and thransaction throughput
- Abscence of economies of scale for large investors and infrastructure providers, which arguably leads to lower centralization over time
- Lower costs to maintain the blockchain
- Arguably a higher degree of security against 51% attacks
- More transparent governance due to 1 Coin = 1 Vote rule
- Better incentive alignment between consensus keepers (e.g. validators) and the overall community
It is worth noting that aforementioned advantages come at a certain cost and most of PoS blockchains do not have a track record of the PoW chains… yet. In the future as the overall space matures we will see both PoW and PoS grow and become more effective as we go collectively through a steep learning curve. There is no single chain to rule-them-all, much in the same way as there is not going to be one consensus algorithm to rule-them-all. Hybrid systems might rise to the popularity such as keeping elements of both worlds (Lightning Network, Elastos merged mining, Decred PoS+PoW etc.)… but this topic is worth a whole another article.