There are two main methods usd to mine cryptocurrency – proof of work, the original method outlined in the Bitcoin white paper, and proof of stake, the ambitious upstart trying to take it all over.

Proof of stake is becoming more widely used, and was arguably popularized by Ethereum when the platform switched from PoW after last year’s hard fork. To understand PoS we need to understand PoW first, so lets do that.

What is Proof of Work?

Blockchain is such a Big Deal largely because the information a blockchain system stores is distributed across a wide network of computers that all have to “agree” on the information. In order to alter the information, you need to have access to every node, which makes hacking or censoring the blockchain ledger pretty much impossible – even moreso when the nodes are in different countries.

With the PoW method, powerful computers called mining nodes use GPU or CPU power to solve complex math problems, basically trying to guess a certain number. Bitcoin for example uses SHA-2 (secure hashing algorithm 2), a set of crptographic hash functions that need to be solved by the mining nodes.

Yes, it’s complicated – the main thing to remember is that the mining nodes are actually verifying transactions when they try to solve the puzzles. This is what I mean when I say the nodes need to “agree”. Once a certain amount of nodes have come across the same transaction enough times, it becomes verified and the transaction is entered into a new block of data – when enough transactions are queued, the block is entered into the blockchain, and life goes on.

Now, this all consumes quite a lot of energy. In fact, Bitcoin mining alone currently consumes more electricity than the nation of Denmark, and it’s becoming even more expensive. Miners can’t do this for free, and they don’t – they get rewarded for each block added to the chain. Bitcoin currently rewards miners 12.5 BTC for every block.

In theory, the process is community based and decentralized. The idea is that anyone can mine, so no one entity is controlling the hash rate and deciding which transactions do or don’t go through. In practice, it’s more complicated – mining pools actually control a significant percentage of the Bitcoin hash rate, leading to concerns that it’s not as decentralized as advertised. On to proof of stake.

Proof of Stake

PoS is a game changer, although it’s not without its own issues.

With PoS, currency isn’t mined with computer power. The system requires users to prove that they own a certain number of crypto tokens in order to create a new block. Essentially, the more funds you have, the more likely you are to be randomly (well, “pseudo-randomly”) selected to be the creator of the next block, and because its such a different system its often referred to as “forging” instead of mining. Your wealth is the stake in the currency.

With newer currencies, the tokens are created at the launch and the number is fixed. Generally the forgers are rewarded with transaction fees instead of rewards. To do validate transactions and add new blocks to the chain, a forger has to “stake” their own funds, like a deposit. This is designed to keep them honest and provide a reason for them to mine the right transactions.

Because the token amount is fixed, the system doesn’t really have a way of distributing coins at the launch of the system, and there are two ways around that. One is to pre-mine coins, launch with an ICO, and sell the pre-mined coins in exchange for contributions. This works fine, although the community is really not fond of pre-mined currencies as a general rule. If the development team end up in possession of a disproportionate amount of tokens they can very easily manipulate the market by “pumping and dumping”, suddenly buying/selling large amounts to cause the price to rise or crash and capitalizing through trading.

The other way is to simply begin with the proof of work system to get things going and then switching over to proof of stake, which is what Ethereum did. That’s a basic run-down of how it works. Ready to dig a little deeper?

Block selection

Here’s the thing. It would be very uncool, to say the least, to just select people based on the size of their wallet alone. The more you have, the more you get? That’s the kind of thing many community members are trying to escape by turning to crypto. Allowing the rich to control the show would result in total centralization, which is a no no.

Yes, you need to have funds you can stake in order to get your block reward, but the process can be randomized as well through randomized block selection. With randomized block selection, the stake size and the hash value are both factors. The stake sizes are public and users can generally predict which user will forge the block.

Coin Age based selection chooses forgers based on the how long the stake has been in the user’s possession. Actually, the number of days the coins have been held is multiplied by the number of coins being staked! Coins have to be held for 30 days before they can be staked, and users staking higher numbers of coins that they’ve had for a long time stand a better chance of winning. After forging a block, the coin age is reset to zero and the user has to wait another 30 das before forging more blocks to aid decentralization.

The longer you wait to create a block, the higher your chance of being awarded one becomes, creating a relatively fair system. Because users have to hold currency to create blocks and verify transactions, a 51% attack where a group takes over more than half the network to control the decision making process would be very difficult and expensive.

These systems charge transaction fees to pay for the operation of the blockchain, and typically these fees are rewarded to forgers instead of new coins. The PoS system is significantly more environmentally friendly. Energy costs are lower, and the users don’t need fancy mining rigs stuffed with graphics cards worth thousands of dollars to create blocks, which is something the gaming community will be happy to hear.

Because it’s cheaper to run a node this way, more people are able to afford it, which contributes to decentralization as well.

Dash, Neo, and Stratis all use PoS. EOS, on the other hand, uses DPoS – Delegated Proof of Stake. This is a variation that allows the commnity to vote for delegates called Witnesses, members of the community selected to create blocks. With this system, voting power is determined by stake size, which isn’t very decentralized. The more money you have, the more power you have. Just like in real life!



Which one is more decentralized?

Unfortunately, you could argue that true decentralization isn’t possible with the methods mentioned above. While PoS is better in many ways (efficient, cheap, etc), both systems benefit and incentivize the rich. PoW mining costs scale over time, meaning it gets more difficult and expensive to operate a mining node. This will result in more nodes bowing out as time goes on, leading to a smaller number of more powerful nodes (and by nodes I mean warehouses full of millions of dollars worth of equipment), and a more centralized system.

PoS isn’t so dramatic, but the issue remains. While the system doesn’t outright grant whales block creation rights every time, they can afford to stake more money for longer and leave funds untouched for the required 30 days, putting more power in their hands.

Both systems are have centralized elements, and some projects like Peercoin and Hcash are working on hybrid PoW/PoS systems to try and combat this problem.

Interested in other cool crypto posts….check out Mining Wars: Bitmain vs Dragonmint and The Price of Bitcoin vs Cost of Mining.

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