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All You Need To Know About Proof of Stake

Blockchain 101: All You Need To Know About Proof of Stake (POS) Now

Proof of stake is a consensus mechanism used to verify new cryptocurrency transactions. Since blockchains lack any centralized governing authorities, proof of stake is a method to guarantee that data saved on the network is valid.

What Is Proof of Stake?

The increasingly popular ‘proof-of-stake’ system handles the approval of transactions in a different way, while also managing the distributed network in the blockchain technology. It is an alternative algorithm, whose objective is the same as the ‘proof-of-work’, but the way it achieves that is obviously different.

In the blockchain platforms utilizing ‘proof-of-stake’ consensus, the probability of creating a new block and receiving the reward is proportional to the number of tokens in the miner’s cryptocurrency holding account. In other words, the more cryptocurrency of a specific platform you own, the higher the chances of receiving the transaction fees as a reward. Essentially, it stands as an interest on your account balance.

What Is Staking?

What Is Staking? All You Need To Know About Proof of Stake (POS)

Staking, in general, refers to the process of locking up funds in secure smart contracts to benefit the network in some manner, and being rewarded in return. The rewards generated can be thought of as the interest that accumulates on capital over time.

In the space of cryptocurrencies, the idea of staking was first popularized by the consensus mechanism known as Proof of Stake (PoS), which was described in Ethereum’s earliest whitepaper in 2013. In PoS, participants on the network stake funds to gain the privilege of validating transactions and mining new tokens of the currency. The staked tokens serve as a proof that the incentives of the miners are aligned with those of the network. In case of any malicious actions on part of the miners (such as passing false transactions), their stake could be potentially slashed (i.e. destroyed) as a penalty.

Staking to verify transactions for a network is a technically complex and demanding task. This is known as Masternode staking, which requires computers with high specifications that run full-time. The minimum staking amount is also quite high and could be considered a serious business investment. Masternode staking also brings with it certain special privileges on the network such as governance voting rights.

Proof of Stake Benefits

Many long-term crypto holders look at staking as a way of making their assets work for them by generating rewards, rather than collecting dust in their crypto wallets.

Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions. (Some projects also award “governance tokens” to staking participants, which give holders a say in future changes and upgrades to that protocol.)

Proof of Stake Drawbacks

Staking often requires a lockup or “vesting” period, where your crypto can’t be transferred for a certain period of time. This can be a drawback, as you won’t be able to trade staked tokens during this period even if prices shift. Before staking, it is important to research the specific staking requirements and rules for each project you are looking to get involved with.

Proof of Stake vs Proof of Work

There are two consensus mechanisms that are generally used in cryptocurrency and defi applications: proof of stake and proof of work. Whereas the former employs staking, proof of work requires miners to solve complicated math puzzles in order to decide which network participants get to validate transactions and expand the blockchain.

Proof of Stake

  • Requires validators to hold some of the blockchain’s token or cryptocurrency.
  • Doesn’t require significant computing power for transaction validation.
  • It’s a newer approach than proof of work, with less adoption as a consensus mechanism.
  • Cryptos that use proof of stake might be more attractive for an ESG portfolio because of the lower environmental impact.

Proof of Work

  • Proof of work has a longer proven history of use as a blockchain consensus mechanism.
  • Miners don’t need to hold any of the blockchain’s assets, and only need computing power to validate a transaction.
  • May use a very significant amount of electricity. Cryptos using proof of work are often excluded from ESG portfolios because of the energy demands.

Is proof-of-stake safe?

As the answer to the question above highlights, the jury is still out on whether proof-of-stake is “safe.”

Critics argue the system risks leading to an oligopoly. While blockchains are supposed to not have leaders in charge, critics worry that proof-of-stake would unintentionally steer blockchains back in the direction of centralized control, since users who have the most ether have the most power over the system.

The Bottom Line

While proof of stake is still emerging as a consensus mechanism for blockchain, it holds significant potential. With lower energy demands and a higher level of accessibility for everyday people to participate as validators, proof of stake has many attractive features that could bring it to the mainstream for blockchain security.

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