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21.09.2018

What is POW and POS in cryptocurrency?

Blockchain technology is often described as a decentralized, distributed ledger. Key to its disrupting function, blockchain’s distribution across a network of computers across the world ensures that it escapes the compounding issues of centralization that lead to manipulation or abuse. But operating a distributed ledger requires a certain degree of community cooperation, known as consensus.

In fact, community consensus is necessary for inputting data onto the blockchain at all, and without it, the contents would be unreliable at best and no better than the centralized ledgers blockchain improves. How does consensus work? Just what is a consensus mechanism in the first place?

 

Consensus Mechanisms

 

Behind each blockchain is a consensus mechanism. The purpose of a consensus mechanism is to verify that the information being inputted into the blockchain is legitimate. While centralized ledgers, such as those currently operated by banks delegate this task to a centralized authority, blockchain has created a new innovative way of ensuring that inputted information is valid. Blockchains still require authority to validate information, however that authority is distributed among the actors involved in its maintenance. Consensus mechanisms are necessary for preventing abuse such as double spending while providing protection from unnecessary forking.

 

The most common consensus mechanisms are Proof of Work (POW) and Proof of Stake (POS). Both Bitcoin and Ethereum use POW as their consensus mechanism, although the latter is working to shift to a POS mechanism because of certain limitations to POW.

 

Proof of Work

 

In Proof of Work, computers on the network work to solve complex cryptographic puzzles consisting of repetitive fixed-size alphanumeric strings. The brilliance of POW is that the puzzles are asymmetric, meaning that while they are difficult to solve, they are easily verifiable by the network. Bitcoin was the first implementation of POW, and POW has become synonymous with crypto mining. Crypto miners seek to earn cryptocurrency by directing their computers to solve the cryptographic puzzles for a reward. For example, the first computer or mining pool to find the correct hash is rewarded with Bitcoin every ten minutes. Solving the cryptographic puzzle by finding the matching hash is the proof used to verify whether all transactions in a block are valid, only after this process is completed is the block added to the blockchain.

 

Proof of Work is extremely secure, as the only way to manipulate the data inputted into the blockchain is to gain 51% of the total network hashrate. Known as a 51% attack, this is the core vulnerability of POW. Fortunately, due to the increasing difficulty of proof’s in proportion to the computational power directed at solving them, a 51% attack remains an unlikely event. Given the massive amount of energy needed to engage in a 51% attack, it is nearly impossible for any one actor to gain the sufficient proportion of the hashrate necessary for validating a fraudulent transaction or attacking the network in some other way. Thus POW is seen as one of the most secure consensus mechanisms.

 

How POW Bitcoin mining works

  1. Transactions are bundled into a memory pool.
  2. Miner’s verify each transaction in the memory pool by solving its corresponding cryptographic puzzle.
  3. The first miner or mine pool to solve the puzzle is rewarded in newly minted Bitcoin and transaction fees.
  4. The solved and verified memory pool is added to the blockchain.

 

One of the downsides of POW is its massive energy use. As more computational power is allocated to solving proofs, the difficulty of the proofs increases proportionately. As computational difficulty has risen, retail miners are increasingly priced out of the competition, which has lead to creeping centralization as only those with massive resources can afford to mine. Aside from the environmental damage of allocating increasingly massive amounts of energy towards maintaining a POW blockchain, creeping centralization of POW mining has lead other cryptocurrencies to seek alternative consensus mechanisms.

 

Proof of Stake

 

Proof of Stake systems have the same purpose as POW: verifying and adding blocks to the blockchain. The difference lies in their mechanics. Instead of utilizing miners to solve energy inefficient cryptographic puzzles, POS requires users to stake some of their crypto assets in order to become network validators. Validators take turns proposing and voting on which block to add next to the blockchain, with the weight of their votes corresponding to the number of coins they have staked. Block rewards are issued to stakers in proportion to the amounts they have staked.

 

Proof of Stake is gaining in popularity for several reasons. For one, it doesn’t require massive amounts of energy to maintain, making it much more environmentally friendly. Another is that validators are thought to be properly incentivized to maintain the blockchain, as they have a significant amount at stake. Unlike POW, where miners can profit without having to own the underlying asset, POS ensures that every participant is engaged and incentivized to maintain the network health of the currency they are staking. A final key distinction between POW and POS is that under POS, no new coins are minted to reward validators. Instead, POS validators are rewarded in transaction fees alone, meaning that unlike POW. All coins in a POS system must be created in the beginning.

 

As noted earlier, POW has many concerned with creeping centralization. On the other hand, POS has evolved to remedy this issue by offering fair and truly proportional rewards. Whereas the POW miner with the highest hashrate contribution can capture the full block reward, leaving less powerful miners with nothing, POS validators can only capture a reward in direct proportion to what they have a stake.

 

The Last Word

 

Centralization is the antithesis of blockchain, and reducing centralization is critical for maintaining the security of blockchain’s distributed architecture. Thus a good consensus mechanism is one which does not allow for too much centralization. In order to maintain the immutable and distributed components of blockchain, maintaining decentralization is key.

 

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