Blockchain technology is secured and regulated by consensus algorithms, which are rules that govern the network. Of the various consensus algorithms, proof of work and proof of stake are the most popular. They both regulate transaction validation.
Cryptocurrency Mining
Cryptocurrency mining using the proof of work consensus algorithm is how new coins are created on some blockchains. Bitcoin, Monero, Ethereum 1.0, Litecoin, and Dogecoin are among the cryptocurrencies that mine their own coins.
The proof of work consensus algorithm existed long before Bitcoin, having first been introduced in the 1990s to help address the problem of spam email. In the early 2000s, Hal Finney applied it to secure digital money, and in 2008, Satoshi Nakamoto used it in his Bitcoin white paper, making Bitcoin the first blockchain to extensively use the proof of work algorithm.
It is called proof of work because nodes (devices and individuals present in the blockchain) are required to perform work that is necessary to validate a transaction. This involves solving a complex mathematical equation to unlock a transaction secured in a block. Blockchains that use proof of work algorithms are secured and verified by virtual miners with sufficient computational resources.
This algorithm helps prevent users from spending their cryptocurrency more than once in the blockchain (double-spending). The first block is hardcoded into the blockchain network to form the Genesis Block. New blocks reference the previous block and contain a copy of the ledger.
A miner must possess a rig with sufficient computational energy and hash rate to win the race to update the ledger. This will enable them to propose valid blocks according to the rules guiding the blockchain. The validation of transactions is carried out by devices running mining software that determine if the new block should be added to the block.
In the proof of work algorithm, miners combine their computational resources with public-key cryptography to reach a consensus and validate transactions. The process involved in creating a new block is called hashing, which involves guessing a random set of characters and numbers (a hash) and combining it with the available data in the block. It is then passed through a hash function computer (for Bitcoin, it is SHA-256) to attain a result that agrees with the conditions set by the algorithm.
The hash that wins is published on the network for other miners to confirm its accuracy. It is added to the blockchain upon confirmation, and the miner is rewarded with the block reward. The block reward is in the form of new cryptocurrency, which is given to the miner by the blockchain for every valid and accepted block.
A breach in consensus leads to the creation of a fork, as has been seen with Bitcoin (Bitcoin Cash and Bitcoin Gold). This consensus has helped create a trustless system. The proof of work algorithm also helps protect the blockchain from cyber-attacks.
Proof of Stake
The proof of stake algorithm is the second most popular consensus algorithm, having been launched in 2012 as an alternative to its proof of work counterpart. Unlike the proof of work algorithm, it has no need for miners, and instead uses validators. Participants are required to have a sizable stake so that they can partake in validating transactions and creating new blocks.
However, they can only create blocks that are proportional to their stake in the blockchain. Most blockchains today, including Cardano, Polkadot, Tezos, and Atmos, use different variants of this algorithm. It requires no computational power and, as such, is entirely virtual. Validators are chosen based on their stakes.
The proof of stake algorithm randomly selects validators with a specific amount of staked cryptocurrency to validate transactions. This serves as cryptographic proof of their ownership and vested interest in the project. These selected nodes are responsible for verifying a valid transaction, signing it, and proposing the block for validation.
Unlike proof of work blockchains, new blocks are minted or forged. To participate, a validator must have locked a certain amount of the blockchain’s native coin into a special contract. However, staked cryptocurrencies can be lost if users breach the network’s consensus. This algorithm uses the time of stake and randomization to make node selection unpredictable.
As in the proof of work algorithm, proof of stake validators are rewarded for their contribution to the blockchain, and they get block rewards for proposing valid blocks. There are staking services that allow users to stake their coins with exchange platforms for regular payouts. With this algorithm, anyone can run a node with little capital or join a staking pool.
A Better World
Proof of stake is more decentralized and allows for secure sharding. To cheat on a proof of stake blockchain, a user would have to hold over 50% of its cryptocurrency. This in itself is a challenging feat, thereby making it very cumbersome to cheat on the proof of stake algorithm.
Delegated proof of stake is a variant of the proof of stake algorithm that is widely in use. It allows users to select a certain number of delegates to represent them in the blockchain and enables decentralization. These delegates verify transactions and create new blocks. The rewards they earn are distributed to their delegators as they choose. There is also the nominated proof of stake algorithm, among others born from proof of stake.
The proof of stake algorithm was introduced as an eco-friendly alternative to its energy-consuming proof of work counterpart, which still has a strong following due to it being the first algorithm. Moreover, attacking the proof of work algorithm remains very hard due to the very high technological and economic requirements for doing so.
Proof of stake is, nevertheless, as expensive as running a proof of work algorithm. However, it has opened the door to being a part of the validation process, directly or indirectly. It makes the network scalable while also reducing transaction costs. It also makes the network faster and more efficient.
On the other hand, it has the problem of nothing at stake, which involves users minting in competing branches of a blockchain to increase their rewards. Currently, there are over 400 cryptocurrencies that use the proof of stake algorithm, and most of those using the proof of work algorithm are also planning a move to proof of stake. It is likely to continue playing a pivotal role in the future of blockchain.
Blockchain, Cryptocurrency, and Digital Asset Law
