Difference between Proof of Work and Proof of Stake mining cryptocurrencies

Cryptocurrency mining isn't simply a matter of telling the machines to start mining. Given the importance of a decentralized blockchain functioning under the control of its constituent nodes, and with all nodes aligned, a mining algorithm is essential to keep the blockchain active and reward those who maintain it. Currently, the two most popular algorithms are Proof of Work and Proof of Stake.

But… What does each one mean? Which is better? What does house one imply? With Ethereum moving from Proof of Stake to Proof of Work imminent in August, if there are no issues, it is necessary to understand what each of these algorithms does.

Proof of Work, explained in a simplified way

To mine blocks on the blockchain of a cryptocurrency whose algorithm is based on proof of work, the goal is for the blockchain miners, not its users, to perform complex mathematical operations in order to validate the transactions made on the blockchain.

One advantage of Proof of Work for those who want to mine the cryptocurrency in question is that it doesn't require purchasing the token to be mined. Mining involves using equipment that utilizes the computing power, or hash rate, of your PC's components to mine cryptocurrency blocks and receive tokens as a reward.

Physical scalability for increased mining profit is inherent to Proof of Work algorithms. This is why large cryptocurrency mining operations take place in industrial warehouses . These spaces can accommodate meters of length and height with motherboards dedicated to mining, along with numerous graphics cards and processors mining cryptocurrencies. These operations aim to maximize profit as much as possible.

It's not uncommon for large-scale cryptocurrency mining operations using Proof of Work to take place in countries where electricity is very cheap or subsidized. Sometimes, these operations have even been set up in power plants to dedicate all their energy to mining. China is one such country, and as a result, it has become a mining hub in itself, despite the country's restrictions on cryptocurrencies due to their polluting effects from energy consumption.

Proof of work, explained in detail

This explanation will focus on proof-of-work using the Bitcoin blockchain. The Bitcoin blockchain is a ledger that contains a record of all Bitcoin transactions , organized into sequential blocks. This ensures that no user can spend their cryptocurrency twice. To prevent manipulation, the ledger is public, or "distributed," among multiple nodes or users. An altered version would be quickly rejected by other users . By distributing it among many users who each have a copy to ensure the ledger's integrity, manipulation is prevented.

Users detect tampering through hashes, which are long strings of numbers used as proof of work. If a dataset is subjected to a hash function, a hash will be generated. Due to the "avalanche effect ," even a small change to any part of the original data will result in a completely unrecognizable hash.

The hash is a one-way function. It cannot be used to get the original data. It is used to verify that the data that generated the hash coincides with the original data.

Since generating a hash for a set of Bitcoin transactions is a trivial task, to make the process feel like " work ," the Bitcoin blockchain establishes a certain level of " difficulty ." This setting adjusts the " mine " of a new block to be added to the blockchain and generate a valid hash approximately every 10 minutes. The difficulty setting is done by establishing a " target " for the hash. The lower the target, the smaller the set of valid hashes and the harder it is to generate one . In practice, this means a hash that starts with a very long string of zeros.

Since a given data set can only generate one hash, miners ensure that they generate a hash below the target by altering the input by adding an integer, called a nonce. Once a valid hash is found, it is broadcast to the network and the block is added to the blockchain.

Mining is a competitive process, more akin to a lottery than a race . On average, a valid proof of work is generated every ten minutes, but no one knows who will get it. Miners pool their resources to increase their chances of mining blocks . This generates transaction fees and, for a limited time, a reward of newly created bitcoins.

Proof of Work makes it extremely difficult to alter any aspect of the blockchain. It requires re-mining all subsequent blocks. It also makes it difficult for a user or group of users to monopolize the network's computing power, a tactic known as a " 51% attack ." The machinery and energy required to complete the hash functions are expensive. However, it's not impossible due to the snowball effect. This means that those with greater hash power increasingly benefit , potentially expanding their hash capacity more than lower-level users can.

In the case of Bitcoin, the hashing work is done using SHA-256 hashing algorithms. The " winner " of a hashing round aggregates and records the mempool's transactions in the next block. Since the " winner " is chosen randomly and proportionally to the work performed, all network members are incentivized to act honestly and only record legitimate transactions.

Can a part of the blockchain decide to change the mining algorithm?

When part of a mining network begins accepting an alternative proof-of-work, it's known as a "hard fork." If this happens, a fork is created from the original network , and this new part cannot interact with the original.

In practical terms, a new cryptocurrency is created, which is why there are variants of Bitcoin and Ethereum. One of the most recent is Ethereum's transition from Proof of Work to Proof of Stake. Since many users want to continue using Ethereum's features but not switch to Proof of Stake, possibly to avoid parting with their large investments in mining hardware, they created a fork called Ethereum Classic. This Ethereum Classic fork continues to use Proof of Work.

Proof of Stake, explained simply

Proof of Stake is a blockchain transaction validation algorithm that allows users to stake their tokens as collateral for a transaction. This demonstrates their stake and commitment to the validity of the transactions . All users must sign a contract and purchase escrow tokens to begin trading, thus preventing unauthorized access.

Proof of Stake explained in detail

Proof of Stake is a consensus mechanism that randomly assigns the node that will mine or validate block transactions based on the number of tokens that node holds. The more tokens a wallet has, the more mining power it is granted. Some drawbacks include a higher risk of a 51% attack on smaller altcoins . It also incentivizes accumulating tokens instead of using them as currency, as doing so would mean losing future mining power.

Proof-of-stake is a type of consensus mechanism used by blockchains to achieve distributed consensus. The big difference of the essence of each algorithm is as follows:

• In the Proof of Work, miners prove that they have capital at risk by expending energy.
• In Proof of Stake, validators explicitly stake their capital on a smart contract. These staked tokens act as collateral that can be destroyed if the validator behaves dishonestly or lazily.

The validator is responsible for checking that new blocks being propagated over the network are valid, and occasionally for creating and propagating new blocks themselves.

Proof-of-stake comes with a number of changes from the Proof-of-work system:

• Higher energy efficiency, so it is not necessary to use a lot of energy in the calculations of the proofs of work
• Lower barriers to entry having lower hardware requirements. You don't need hardware with a huge CPU and multiple GPUs to have the opportunity to create new blocks.
• Reduced risk of centralization because proof-of-stake should lead to more nodes securing the network
• Less ETH issuance required to incentivize participation
• financial penalties for misbehavior they make 51% attacks exponentially more expensive for an attacker compared to proof-of-work, which can fall on those with more money to buy more expensive materials.
• The community can resort to honest chain social recovery if a 51% attack gets past crypto defenses.

What are Proof of Stake validators?

To participate as a validator, at least as planned for the Ethereum Merge, a user must deposit 32 ETH into the deposit contract and run three distinct pieces of software: an execution client, a consensus client, and a validator. By depositing their token, the user joins an activation queue that limits the rate at which new validators join the network. Once activated, validators receive new blocks from peers on the Ethereum network . The transactions delivered in the block are re-executed, and the block's signature is checked to ensure its validity. The validator then sends a vote in favor of that block across the network.

While in Proof of Work, the time of the blocks is determined by the difficulty of the mining; Proof of Stake have a fixed rhythm. For Ethereum, it is divided into 12-second slots and 32-slot epochs, about 384 seconds per epoch, just over six minutes. A validator is randomly selected to be a block proponent in each slot. This validator is responsible for creating a new block and sending it to other nodes on the network. Each slot randomly chooses a committee of validators, whose votes are used to determine the validity of the proposed block.

Purpose of a transaction in Proof of Stake

A transaction has "finality" in distributed networks when it is part of a block that cannot be changed without burning a significant amount of ether. In Ethereum, this is managed through "checkpoint" blocks. The first block of each epoch is a checkpoint. Validators then vote on the checkpoint pairs they deem valid.

If a checkpoint pair attracts votes representing at least two-thirds of the total staked ether, the checkpoints are updated. The more recent of the two becomes “justified,” while the older of the two is already justified because it was the “target” in the previous epoch. It is then updated to “finalized.”

To reverse a finalized block, an attacker would commit to losing at least one-third of the total staked ether supply. Since this requires a two-thirds majority, an attacker could prevent the network from reaching finality by voting with one-third of the total stake.

There is a mechanism to defend against this: the inactivity leak. It is triggered whenever the chain remains inactive for more than four epochs . The inactivity leak diverts staked ether from validators who vote against the majority, allowing the majority to regain a two-thirds majority and finalize the chain. This ensures that only those interested in the blockchain's continued operation and integrity will want to stake their capital.

What is a 51% attack on a blockchain?

A " 51% attack " refers to an attack on a blockchain by a group of miners who control more than 50% of the network's mining hash rate or computing power. It's a digital version of a hostile takeover bid , where several shareholders from the same group buy shares of a publicly traded company to gain control. For this to happen on a blockchain, a group of miners must agree to seize control of the blockchain for their own benefit by massively acquiring mining resources to monopolize the hash rate in Proof of Work, or by purchasing tokens in Proof of Stake.

It is speculated that, in the event of a 51% attack, new coins could not be created nor could old blocks be altered , as the majority would block them. They could also stop payments between some or all users. They could reverse transactions completed while they controlled the network. This would mean they could spend their tokens twice.

With Ethereum's move to Proof of Stake, it is hoped that this possibility will be further limited. The first reason is because by having many more participants, it is more difficult for a group to control 51% of all Ethereum tokens and agree to control the blockchain.

What effects does a 51% attack have?

Should a 51% attack occur, it's inevitable that the token would lose significant value and utility, becoming less attractive for any commercial use. All participants in such a 51% attack would have deposited a considerable amount of tokens—approximately 32 ETH, or about $64.000 USD—which would be devalued. Users would lose their deposits and the value of the tokens in their wallets.

With all this, Proof of Stake hopes that Ethereum's validation power will not reside in a few massive mining operations . It wouldn't depend on mining in China, Russia, the United States, and other countries with cheap electricity, thus disadvantaging ordinary users who mine with home equipment. It's an attempt to democratize the blockchain, because it doesn't rely on the accessibility of motherboards and GPUs, which depend heavily on having biometrics and contacts with distributors.

What will Ethereum's move from Proof of Work to Proof of Stake mean?

In August, barring any unforeseen complications, Ethereum will transition from Proof of Work to Proof of Stake in an event called The Merge. This will usher in Ethereum 2.0 . Within the Ethereum network itself, this will require users to purchase ETH tokens as collateral for contracts, and then use additional tokens to guarantee blockchain transactions. This will likely lead to increased token sales due to their greater utility. This is expected to generate higher demand for ETH , thereby maintaining or even increasing its value.

One of its benefits will be the considerable reduction in energy consumption by the Ethereum blockchain. While data on Ethereum's pollution is difficult to find, if Bitcoin's blockchain were a country, it would rank among the 30 most polluting. This would mean a much lower cost per transaction, since one of the biggest drawbacks of a Proof-of-Work blockchain is its " gas fees ," given that miners with large cryptocurrency mining rigs—large warehouses with GPUs—must be paid a portion of their electricity bill.

Ethereum's change to Proof of Stake is a way of trying to secure its future.

By reducing its energy costs by 99%, the blockchain will theoretically become more sustainable and attractive to users with lower incomes . A small transaction won't have to see its price rise two or three times its original value solely due to " gas fees ." This energy cost is what's motivating China and the European Union to call for a ban. They hope that by switching to a less energy-intensive algorithm, they can maintain activity in many countries if they decide to regulate cryptocurrencies based on their energy costs.

Blockchain doesn't just record coins; the tokens themselves can contain smart contracts and small pieces of information, which is why it has been one of the most popular networks for issuing NFTs . NFTs marginally increased the popularity of other blockchains like Cardano, Solana, and Tezanos, due to their lower purchase and transaction costs. It is expected that NFTs will return to using the Ethereum network more frequently due to its lower associated costs.

Will the stock of graphics cards improve when Ethereum goes Proof of Stake?

For users less interested in crypto, Ethereum's move from Proof of Work to Proof of Stake this August should mean more graphics card availability. Ethereum has been the most popular cryptocurrency to mine due to its ease of mining. This would leave Bitcoin alone as the only major cryptocurrency operating with Proof of Work. Being Bitcoin a cryptocurrency with a limited number of tokens, and increasingly difficult to mine, the economic investment of electricity, motherboards, space and graphics cards becomes less and less profitable at any size of operation.

This is why, in theory, the low stock of high-end graphics cards hoarded by crypto miners should end . Most likely, miners will try to sell their mining equipment on the secondhand market. But this is difficult because constant Proof of Work mining damages graphics cards, and many stores won't want to accept them. It's very unlikely that the market will be flooded with used graphics cards in stores, but new graphics cards should become more accessible.