Proof of Work VS Proof of Stake

With all the discussion about cryptos and blockchain networks, let's take a look at what powers a blockchain. So, what keeps a company running, the answer is its employees, and the employees work and make the company scale new highs because they are paid to do that. In the same way, miners keep a blockchain network up and running. They are the ones who make the networks safe, and they are incentivized to do so. They are rewarded, for the energy they expend on keeping the network running. Let's take a look at the two most prevalent mechanisms for validating transactions on the blockchain network.

Proof of Work

You might have heard of Bitcoin being a major cause of concern contributing to Global warming. This is because mining new bitcoins need a lot of computing power. Miners validate transactions and in return, they are rewarded with new bitcoins for doing the same. Before it was the banks who validated transactions, and without validation, no transaction made could be legally valid. So validation or proof of transaction plays a major role in daily transactions. So what is the proof of work algorithm?

Bitcoin tries to validate a transaction by achieving a consensus among the nodes in the blockchain network. This is done by a proof of work algorithm. Here, every node in the network is required to solve a cryptographic puzzle. This puzzle is solved by miners, and the first one to solve the puzzle will be rewarded with bitcoins. This is called bitcoin mining. A puzzle is solved by a miner's computer. And the time in which he can solve it is determined by the power of the computer. The computer starts guessing different values for the puzzle and starts substituting it, and after many guesses, it finds out the correct answer. So the power of the computer is something like the guessing power of the computer. The more number of guesses it can do in a second, the more likely it is to win the race(other nodes(miners) will be competing). We have quad-core CPUs, octa-core, and so on which maximize computational power. But from a few years, there has been tremendous development in GPU, and lower-end GPUs have more than 500 cores, so the guesses per second increase dramatically here, and hence the computational power is more. GPUs have more cores and therefore GPUs are used for mining. This uses a lot of electricity, and to produce the electricity we need coal and oil, and here comes the problem of global warming. Bitcoin miners alone consume about 121 TWh of electricity a year. To put it into perspective this is more than the energy consumed by the whole Washington State in a year, about seven times as much electricity as all of Google's global operation, and more than what Finland consumes in a year. That is is one major disadvantage of Proof of work. Moreover proof of work favors those with higher computational power. The higher your guessing power, the faster you can solve the puzzle. This guessing/computational power per second is called as Hashrate. This favors the ultra HNIs who can purchase and set up big mining farms. Adding to this miners can form groups and can pool their Hashrates, and then distribute their profits proportionately. Miners charge a certain amount on each transaction called the gas fee. The gas fee is charged according to the computational energy used to validate that transaction. And through gas fees miners try to cover some percentage of expenses.

Proof of stake Here, instead of the nodes competing to complete a given puzzle and thereby validate a transaction, a random node is chosen to validate a transaction. Here there are no miners, instead, they are called validators. For each transaction validated they receive rewards in the native cryptocurrency. Here new blocks aren't mined but they are forged or minted. And not everyone can become a validator. To become a validator a person has to deposit/stake a certain amount of coins in the network. And in case a validator approves a fraudulent transaction he is fined accordingly. Therefore a transaction worth 100 dollars can't be validated by a validator who has staked less than 100 dollars. Therefore the more coins staked, the more chances the validator has, to be chosen for validating the next transaction. Like the proof of work algorithm, proof of stake also favors the ultra HNIs. But it is still better than proof of work because, in POW miners use a lot of electricity, and the charge for electricity doesn't go up in a linear fashion. For commercial purposes the more electricity you buy, the less you will have to pay, so here the ultra HNIs who can set up huge farms are to benefit. And validators instead of charging a heavy gas fee like in the POW, charge a minimum amount as a transaction fee. This eliminates the huge gas fees charged on transfers. 51% Attack

There are shortcomings in both the POW and POS, where there are chances of fraudulent transactions being approved. And if fraudulent transactions can be approved, it is easy to steal and hack In the case of bitcoin which uses the POW algorithm, the Hashrates can be pooled. It is something like party alliances. And anybody who controls 51% of the hashing power, effectively controls the whole blockchain network.

Data as of 01/09/2022 here if the top 4 pools agree to merge their hashing power they can approve fraudulent transactions and control the bitcoin network eventually. Instead of decentralization, we see centralization of power in the case of POW which could be destructive if they start approving fraudulent transactions. In the case of POS, a person will have to achieve a 51% majority in the number of coins staked. Cardano a cryptocurrency that has adopted a POS mechanism has about 71% of its coins in supply staked. So to achieve the 51% majority, a person will have to buy tens of billions of dollars worth of coins. Cardano is relatively new and has a lower market cap of about 35 billion dollars, but if this was the case with bitcoin with a trillion-dollar market cap, achieving a 51% of the staked currency will at least take a 100 billion dollars(taking that 20% of the coins are staked i.e 200 billion dollars worth of staked coins). Therefore in a way, POS protects the blockchain from a 51% attack.