Chapter 8: Proof of Stake

In this chapter, we will have a look at the Proof of Stake (PoS) consensus algorithms, how they works and how they differ from Proof of Work (PoW). Before we get into details, let’s just recap PoW very briefly

In PoW, the specific algorithm rewards miners for their contribution to the network. Miners solve complex cryptographic tasks (or “puzzles”) to create new blocks, validate transactions, and strengthen the network. Some of the most well-known PoW coins include Bitcoin, Ethereum, Dash, or Monero, for example.

PoS is a consensus algorithm utilizing a different approach to achieve consensus. Unlike PoW, there is no high amount of computation power needed to secure the network. The “mining power” in PoS depends on the proportion of coins held by an individual. Miners in PoS are referred to as validators, whereas the process of “mining” is mostly referred to as “minting” or “forging.” The more of the network’s native cryptocurrency an individual holds, the higher is the chance of winning a block (or actually winning the chance to validate a block). Since the user’s individual number of coins or wealth is defined as “stake,” the reason why the consensus algorithm is called Proof of Stake becomes apparent.

The concept of Proof of Stake was first introduced in the year 2012 by Sunny King and Scott Nadal.188 The driving force back than was to solve the high need of electricity to maintain PoW algorithms. Around $150,000 were needed to maintain the Bitcoin network back then, compared to several million right now.189 Sunny King created the first cryptocurrency to implement PoS, Peercoin (PPC), back in 2012.189, 190 Sunny King is often considered to be one of the pioneers of crypto. Besides Peercoin, he developed a coin called Primecoin (XPM), utilizing a new type of PoW based on searching for prime numbers as well.191, 192 With both being relatively old projects, he is now chief architect for a project called Virtual Economy Era (VEE).194, 195

Now, I would like to go a little bit more into detail about the way PoS works. We will start by having a look at the process of block creation in PoS and the way it differs from PoW. In PoW-based projects (e.g., Bitcoin), coins are created over time. In PoS, all coins are often created during the genesis event. Validators in those cases are rewarded by the network transaction fees. The coins are initially distributed in different ways. One of the most common ways would be an ICO. Other projects switch from PoW to PoS after a certain period. There are many kinds of consensus algorithms varying to some extent. One general principle is that a validator has to lock up their deposit to be able to participate in the process of block validation. This deposit or stake is not spendable for a certain period. (But you still remain the sole owner of your coins). This prevents users from validating fraudulent transactions and secures the network, as it prevents hard forks, for example. As the users could lose their deposit and the right to further participate in the validation process, the incentive for malicious actions is low. The principle underlying the process of block creation can vary depending on the different PoS using projects. For example, the method of block selection can be randomized. Another famous principle includes the “coin age.” Your coins mature for a certain period, and depending on the time your coins have been at stake (not transferred and actively staking), your stake weight is increased. The overall chance to get block validation is therefore dependent on the total number of coins multiplied by the time your coins are at stake. After forging/minting a block, the coin age is often reset and the user has to wait for a certain period again before being able to forge again.

As the minimum stake age is often defined as a certain period before you are able to start staking, the maximum stake age is often defined as well. (This prevents some people from closing the wallet for months just to open it up and receive their staking reward without actively securing the network). Note: The examples above, specifying the process block validation, are just to give you an idea of the underlying principle and don’t claim to be exhaustive. New factors are constantly worked on to further improve the PoS algorithm. A list with current well-known coins based on PoS, or a modified version from it, can be found below:

  • Ark
  • BitShares
  • Cardano
  • EOS
  • Lisk
  • Nxt
  • Stratis
  • Tezos
  • Waves
  • XSN

Some may wrongly expect to find NEO as part of the list above. Even though many people initially believe NEO uses PoS as well, it actually uses a consenus mechanism called Delegated Byzantine Fault Tolerance (dBFT).

Note: The list above is far from being complete. As Proof of Stake is famous, you will find a lot of projects using it. Those above are just some major examples that may be a good starting point to read about. A lot of the coins above are using PoS-based variants (e.g., delegated proof of work (DPoS)). We will get into detail later in this chapter.

The soon-to-be most prominent addition to the list is one of the best-known coins of them all: Ethereum. Even though it may seem irritating, since it is one of the most mined coins right now, Ethereum is supposed to switch to PoS. At this point, you my start wondering: What are the reasons for Ethereum to switch from PoW to PoS despite Ethereum enjoying so much success? And how will this potentially work out? The second question is actually quite important question, PoS aims to be a decentralized network. We will get into detail because it helps understand the idea of decentralization and explains how networks are still capable of evolving.

Blockchains are politically decentralized (no one controls them) and architecturally decentralized (no infrastructural central point of failure) but they are logically centralized (there is one commonly agreed state and the system behaves like a single computer)

The quotation above is by Vitalik Buterin,180 one of the founders of Ethereum. You should definitely follow him on Twitter or Medium since he regularly posts highly educational and interesting content, not solely focused on Ethereum. The quote sums up in general how decentralized projects have the possibility to evolve. Even though the network is decentralized, there is an agreement on what the best step or technical enhancement for the network can be. But how can someone actually make it work —especially, since migrating a PoW network to PoS is different from launching a PoS from scratch?

The answer is simple. There are a lot of different areas that need to be researched before later being merged into what is called “Ethereum 2.0.” As a big number of teams is actively developing and working on the necessary changes, the Ethereum Foundation released some specifications/reference implementation to help reach the consensus.181 This means that even if the development is decentralized, the plan is to end up with one single working product specified as the next generation network of Ethereum. Although a lot of work still needs to be done and the whole process of migration might not be totally smooth, there is good progress being made, and project is showing a lot of promise.

Now that we’ve focused on the “how,” the “why” still remains unanswered. Before we get into detail here, I would like you to have a look at the following screenshot:

The tweet above followed an article called “The Collapse of ETH Is Inevitable.”182, 183 It may surprise you that Buterin has a very critical view of Ethereum (and the whole sphere in its current state). But if you follow him for an extended period, you’ll see that Buterin has always expressed his very open and critical opinion on Ethereum, calling for major changes.

So what advantages does PoS have? To sum it up very briefly, PoS186, 187

  • is more energy efficient,
  • helps decentralization,
  • reduces the risk of centralization,
  • makes 51 percent more expensive and therefore more unlikely.

However, Ethereum will not just switch to PoS but will also implement other following features:84

  • further advanced PoS (Beacon Chain, Casper FFG)
  • sharding
  • eWASM

(I won’t discuss the features named above in detail due to the lack of time and space. You can find a lot of information provided by different sources online.)

Ethereum 2.0 is supposed to target one of the most discussed topics in the modern world of crypto: scalability. There are various ideas and approaches to enable scalability, in addition to a high number of transactions per second (TPS). In the current state, for example, Ethereum is able to achieve up to 15 TPS per second. Features like sharding are supposed to increase the level of TPS to even 15,000 TPS. The changes are needed to ensure Ethereum stays competitive and is prepared for future needs. Ethereum 2.0 will be developed in parallel to the current running Ethereum version. The current blockchain will be incorporated into the new network at some point in the future.185

Now let’s have a look at the advantages PoS can provide, in detail.

8.1 Energy efficiency

The need for large amounts of electricity to secure a network is often regarded as the key disadvantage of PoW. The energy consumption of the Bitcoin network, for example, is the main topic discussed in the mainstream media. The Bitcoin network, and therefore PoW, is always considered to be something bad, wasting precious resources for no reason at all. Even though PoS is certainly more energy efficient, it is not the answer to all the problems. I will try to put this topic into perspective.

First of all, and most importantly, the electricity used is not wasted as many especially crypto-critical articles want you to believe. It can be seen as a tax needed to pay for the features and especially the security the network provides. A study from earlier this year estimated the Bitcoin network to consume somewhere between 2.55 and up to 7.76 gigawatts per hour.196 This is a considerably large amount of electricity compared to the total power consumption of countries like Ireland (3.1 gigawatts/h) or Austria (8.2 gigawatts/h).196, 197 Those numbers are often compared to the cost of goldmining (estimated to be around 132 TWh per year199) or the whole fiat banking system, but they are really hard to measure and estimate correctly. Still, the cost of sustaining the traditional banking system, for example, is much higher than the cost of the whole the Bitcoin mining structure. But energy consumption isn’t everything. Many more variables need to be considered.

For example, all current estimates are based on the existing hardware. As the technology is rapidly changing, so is the hardware. It is almost certain that future mining equipment will be way more energy efficient than the current one. With increasing mainstream adoption and therefore overall usage, a substitution effect is definitely to be considered as well. Credit card institutions like Visa, for example, need to sustain large data centers to be able to function properly. Crypto currencies gaining market shares in this sector will eventually lead to lower levels of energy consumption by traditional institutions.198 Another very important point many crypto-critics don’t like even to consider is the fact that Bitcoin mining could be a driving force for sustainable and green energy production and innovation. Many people disliking the principle of PoW or Bitcoin in general tend to make false assumptions to strengthen their arguments. They tend to believe that the enough electricity needed to secure the network can’t be produced in the first place. This is followed by the assumption that all consumed electrical power is produced for solely mining purposes and therefore decreases the world’s overall resources. Even though this is right to a certain extent, since the technical abilities to store electrical energy effectively are still limited, the electricity used for mining would have been produced either way. It can even be beneficial for some companies or countries to have a strong mining community, as they potentially can sell some of the energy that is going to be wasted otherwise. This is especially significant in regions with a surplus of produced energy by hydroelectrical solutions, for example.

What happens when you build a 50 megawatt plant in a place where they only have 15 megawatts of demand? In some cases, if it’s alternative energy, like wind, solar, or hydro, you can’t turn it off or turn it down. You’ve built it, and it will produce, and then what? You’re basically wasting energy.

—A. Antonopoulos200

Alternative energy is an important phenomenon in the world as we know it today. But it still has some flaws—the question on effective storage being the central one. In some European countries, where electricity cost is the main profit-influencing point, miners tend to look for alternative energy production to fit their needs. Old and otherwise unused hydroelectrical facilities are restored, and solar panels are installed, for example. More energy-efficient mining equipment in the future could therefore even lead to a supply back into the power grid. That’s why PoW and Bitcoin mining might not actually be that bad as various mainstream media or crypto-critics want you to believe.

I hope the provided examples will help you develop a more critical view on the articles out there that are related to not just PoW or mining. Nevertheless, there is absolutely no doubt that PoS is much more energy efficient than PoW. It is definitely one of the key advantages PoS can provide alongside with some other points discussed in the next paragraphs.

8.2 Increasing decentralization

If you’ve read every previous chapter of this book, you should already know how important the principle of decentralization really is. A really important fact underlying PoS is that there are no real economies of scale. In PoS, every validator gets the same rate of return on their initial investment whether you stake with ten thousand or one million worth of coins. All gains are proportional to the initial amount. This is something you have to keep in mind when you compare PoS and PoW.

In PoW, there are different factors influencing potential gains. The best example would be the cost of electricity. Someone paying a significantly smaller amount for electricity is more likely to scale his mining business faster than someone paying a premium price.201 The same applies to the availability and possible discounts on mining equipment, for example. In addition, big mining farms are more likely to be able to further centralize the network, since they control a lot of mining power and, therefore, returns as well. For a beginner, it is difficult to challenge the already-existing mining companies, which could lead to the aimed decentralization of the network. Another aspect is that PoS discourages the formation of mining cartels that strive to further centralize and combine the network hash rate. PoS therefire limits the possibilities of harming the total network for sake of fulfilling any personal needs.202

Another point often not considered when comparing these two consensus algorithms is the fact that PoS is much more newcomer friendly. Especially considering further variants of PoS (e.g., DPoS, which we will focus on that later in this chapter), it is much easier to stake and participate in the network than it is in PoW. This is especially important, since staying profitable while mining Bitcoin is quite hard. Even though many newcomers might be interested in mining, there is often some barrier when it comes to buying mining gear (even if we leave out the financial aspect completely). New mining equipment often renders older generation equipment unprofitable, which also reduces the proportionally contributed hash rate. These are some very important facts, since the equipment barrier and running costs are significantly lower in PoS.

8.3 Rendering 51 percent attacks more unlikely

A very brief recap: A 51 percent attack is the biggest threat to all networks out there. As one person or group begins to control more than 50 percent of the total contributing network hash rate, they could potentially prevent transactions from being confirmed or double-spend coins.

In PoW, there are some factors facilitating the possibility of a 51 percent attack. Just think about the economy of scale, for example. But there is more to consider. Such an attack is much easier to organize if you consider projects other than Bitcoin. Just look at the screenshot below:

The provided data above is taken from the website: <https://www.crypto51.app&gt;. It lists the estimated costs of a 51 percent attack per hour. Although the calculated costs above are in most cases fictitious, the provided information is really interesting. As NiceHash rental prices are used for calculation, the last column is especially important. The cost of a 51 percent attack on the Bitcoin network, for example, is estimated to be around $450,000. But only ONE percent of the required hash rate could be actually rented via NiceHash. It would therefore take much more effort than just buying the computation power with a few clicks (not to mention the required funds). Hence, this is one of the reasons rendering the risk for the Bitcoin network considerably low. But that is not the case for many other digital currencies out there.

If you look at Bytecoin, for example, all of the hashpower needed could simply be rented via NiceHash. As the costs are quite low, this is actually dangerous for some other bigger projects as well. This becomes especially noteworthy for SHA-256–based coins, as high-level miners could use their strong Bitcoin-mining gear to gain control of a large share of the overall hash rate. This might create a higher chance of organizing a successful attack. Bitcoin Gold, for example, was the subject of 51 percent attacks earlier this year, leading to some high-level losses. And Bitcoin Gold isn’t the only one affected. Other currencies like Verge, for example, were attacked not long ago too.204

But why may PoS be a possible solution to the problem? The answer is quite simple. To successfully carry out a 51 percent attack in PoS, you would need to own at least 51 percent of all coins in circulation. This is especially unlikely, as even the attempt to buy such a high number of coins would simply lead to a major price increase in the market. More importantly, this would simply require more than half of all the coins to be up for sale in the first place, which is fairly unlikely. Besides that, depending on the project and the requirements to be a validator, for example, there would be a possibility of economic penalties. All those factors render a 51 percent attack basically impossible. Even though a 51 percent attack is unlikely to spell danger for Bitcoin, PoS could still be a good solution for many other projects.

8.4 DPoS, LPoS, TPoS

Now, that we’ve talked a lot of the general advantages PoS can provide, we will have a look at further PoS variants. Let’s start with Delegated Proof of Stake (DPoS). DPoS was developed and first introduced by Daniel Larimer, well known as “bytemaster,” in 2014.205, 206 It was therefore the underlying consensus mechanism for Bitshares (BTS) and is now utilized in various other projects, including Lisk, EOS, or Steemit.208 But what was the idea behind DPoS? Let’s have a look at the “rationale behind DPoS”:207

  • Give shareholders a way to delegate their vote to a key (one that doesn’t control coins “so they can mine”)
  • Maximize the dividends shareholders earn
  • Minimize the amount paid to secure the network
  • Maximize the performance of the network
  • Minimize the cost of running the network (bandwidth, CPU, etc.)

Let’s have a look at the idea and concept behind DPoS in detail.

In traditional PoS, you need to keep a computer or other device up and running as long as you want to participate in staking. Even though you could use an old laptop if you had one, you would at least have the cost of electricity to bear.

In DPoS there is no need for that. One key feature of DPoS is the existence of delegates. The underlying idea is that there is a certain amount of possible delegates that you can vote for. You can vote by delegating your coin to your favorite delegate by still keeping the ownership.. The important part is that instead of everyone staking their own coins, the delegates will do this job for their voters. As only delegates are able to create new blocks, they get rewarded for their contribution to the network, which is indeed very attractive. Those delegates will return a certain percentage of their rewards back to their voters in exchange for their vote. The more votes in the form of delegated coins a delegate receives, the higher is his voting power and therefore the chance to be “elected.” As only a certain number of delegates receive the rewards, the incentive to behave in favour of the community and the network is high. If someone doesn’t behave as expected, voters can easily delegate their coins to a different delegate or applicant. This has many advantages, as you don’t need to keep a laptop or any other device running to receive rewards. Your coins can be stored securely offline, and still they are contributing to the network.209, 210

DPoS is often criticized for the lack of true decentralization, as the amount of delegates can be fairly low (51 delegates in ARK, 101 in Lisk, 21 in EOS)211–214. Even though the number of Block producers is fairly low, people claim that those networks are much more decentralized than the Bitcoin or Ethereum network, for example. If you have a look at EOS, the twenty-one block producers are theoretically in control of 4.8 percent each, compared to some Bitcoin mining pools controlling the hash rate equivalent of more than 20 percent of the networks total hash rate.215 Considering EOS, that would require to have an non-fakeable way of making sure that one person or entity does not control more than one of the twenty-one possible slots. As always, there is much more to consider comparing different consensus algorithms, than some people want you to believe. As the “perfect” solution for all current problems of the blockchain space might even be impossible to develop, DPoS offers a promising approach.

A fairly new approach to solve the problems of existing ecosystems, is Trustless Proof of Stake (TPoS). Stakenet (XSN) was the first project to introduce TPoS, aiming for an easy and secure way of offline staking. The Stakenet team summed up the principle very well:216

TPoS essentially allows users to own a stake in XSN, a Proof-Of-Stake currency, and have any other node (merchant nodes) do the staking for them using their high-bandwidth continuous connectivity (to ensure maximal rewards distribution) while not having to share any spendable balance or private keys with the node owner.

Other than in DPoS, for example, there are no votes needed to be collected or any other requirements to be a merchant and provide your service to others. Another important difference is that the merchant or any other 3rd party has no advantage in block creation or increased influence on the blockchain. The idea behind TPoS is to have as many coins as possible participating, which further helps keeping the network viable and decentralized.217

The last example we are going to look at in detail is LPoS. LPoS is the abbreviation of Leased Proof of Stake. This algorithm is used by the Waves platform to find distributed consensus.219 As with traditional staking, the chances of finding a block depend on only the amount of Waves you own. Since all the Waves were created in the genesis block, there is no real block reward like in PoW. You will be rewarded with the transaction fees and a predetermined amount of MRT (Miners Reward Token) for each block you created. But what’s the idea behind LPoS? In Waves, you are able to start creating new blocks only if you hold an amount greater than 1000 Waves.219 If you don’t have enough Waves, or just don’t want to stake for yourself, you could simply lease your Waves to someone staking. For a small fee, you will get rewarded for the blocks found without the need of staking yourself. The approach underlying LPoS is to have a clearly defined number of active nodes securing the network, which helps reducing latency and increasing block capacity. As it is claimed that an unlimited number of active nodes would lead to a reduction of performance, the waves platform tries to find balance between decentralization and usability.220

Note: Tezos (XTZ) is using the abbreviation LPoS for their utilized consensus mechanism as well. But here, LPoS is referred to as “Liquid Proof of Stake.” To become a validator (or often called “baker”) you need to own at least 10,000 XTZ. In total, there are 80,000 validator slots available, with no electoral process involved. If you don’t own enough XTZ to start staking (or “baking”) on your own, you can delegate your coins to some other validators. But other than in DPoS, the delegation is completely optional, as there are no delegates elected for the process of block creation.221, 222 In Tezos, the baking rights are assigned proportionally to the stake, unlike in DPoS projects (e.g., EOS) where the rights for block creation are split evenly between the given set of active block producers. Tezos therefore aims to lower the entry barrier for consensus participation as well as allowing a higher degree of decentralization.

As with all the discussed consensus mechanisms, every participation in the staking process, works without a transfer of token ownership, you are always the only one controlling your keys.223 If you want to put your stake at work, regardless of the concept or way you choose, make sure that you don’t fall for scams. Many people will try to trick you by sending your stake to one of their addresses and making you believe that this is a necessary step to take. Make sure that you follow only trusted official sources from the corresponding core project team at best. Either way, there is absolutely no need to send your coins to an address where you don’t hold the private keys. EVER.