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Proof-of-Stake (PoS): the main concept and principles

The popular Proof-of-Stake (PoS) is a consensus algorithm, which requires staking of blockchain tokens in order to become a validator, to add new blocks to the blockchain, to confirm the legitimacy of transactions and receive rewards.  

Such popular blockchains as Solana, Cardano, Toncoin, BNB Chain, BNB Smart Chain and others use Proof-of-Stake. Ethereum, the second in market capitalization blockchain, switched from PoW to PoS in September 2022.

Consensus mechanism: what it is and why it is so important

A consensus mechanism is a set of rules for blockchain participants (validators) to form new blocks of transactions. Blockchains do not have a universal governing body for transactions validating as they are decentralized. Consensus protocols are designed to secure the network and ensure that all participants agree on one version of the blockchain.  

To put it simply: a consensus algorithm is a set of rules by which a blockchain lives, works and evolves. These rules are applied for adding new block in the chain.

There are various consensus protocols: Proof of Work (PoW), Proof of Stake (PoS), Practical Byzantine Fault Tolerance (PBFT), Proof of Burn (PoB) and others. PoW (Proof of Work) and PoS (Proof of Stake) are the best known among them.

Development of PoS

PPCoin first used PoS in August 2012 as a hybrid version: new coins were mined, but transactions could be processed by any node that stored PPC. In November 2013, Nxt became the first real crypto on PoS.

The Proof-of-Stake algorithm turned out to be very successful and flexible, so many blockchains adopted it in different forms.

Proof-of-Stake: how it works

So then, the PoS algorithm does not require the network participants to solve complex mathematical functions, while a validator receives the right to generate a new block in a pseudo-random way, depending on the number of coins staked. This mechanism is also called forging or minting, and block generation is called coining.

To put it simply: forging is creation of new blocks based on the PoS algorithm with the opportunity to receive a reward.

Principle of PoS:

1. As soon as nodes lock coins, a blockchain considers them ready for work. The minimum entry threshold is different in each blockchain. For example, you need to stake 32 ETH in Ethereum for validating.
2. All validators compete for the right to add a new block to the distributed ledger chain.
3. A blockchain randomly chooses a node to add a block based on several criteria. There are several options for selecting a computational device to forge a block:

  • Coin age: taking into account how long and how many coins were staked. After a node is selected by the validator, the age of the coins is reset to zero. 
  • Staking rate: the number of coins sent to the hash, and the hash value. The higher the stacking value and the lower the hash value, the more chances a node has to create a new block.

4. A validator verifies transactions in the block, signs it, other nodes confirm its legitimacy, and if most of them consider it valid, it is added to the blockchain.

If validators find a block to be illegitimate, the selected node loses all staked coins and the whole process is restarted, and the forger can not generate blocks in the future.

5. Nodes receive rewards in the form of a transaction fee. The reward and the stake of the node are blocked for the network to double-check the legitimacy of the transactions.

Pros and cons of Proof-of-Stake

Among the main advantages of Proof-of-Stake are:

  • expensive equipment is not involved;
  • significantly lower power consumption compared to PoW;
  • high security level (51% attack would require possession of more than half of the entire network cryptocurrency, which is a lot of money, and even if attackers gather that amount, the attack will be unprofitable);
  • high transaction speed;
  • it is enough to unblock and sell the coins for cessation of validator's activity; 
  • the rewards can be reinvested and its profitability will increase in the long term, in PoW it is more difficult to do this, as miners have to invest in equipment.

Proof-of-Stake has disadvantages as well. The main one is, in a way, a centralization approach, because the more coins the validator has, the more weight his vote has. Plus, despite the fact that a 51% attack is unprofitable, it is quite probable.

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Proof-of-Stake Types

Traditional PoS developed a variety of different consensus algorithms, which differ in some aspects. Here are some of them:

  • Delegated Proof-of-Stake (DPoS): blockchain participants use their tokens to select validators. For example, Bitshares rely on it.
  • Leased Proof-of-Stake (LPoS): validators rent from blockchain participants their crypto for a fee. For example, Waves uses it.
  • Nominated Proof-of-Stake (NPoS): so-called nominators among blockchain participants who stake for validators and are responsible for their actions. For example, Polkadot uses it.
  • Pure Proof-of-Stake (PPoS): used in the Algorand network. A validator of a new block is randomly and anonymously chosen from crypto owners with more than 1 ALGO.
  • Proof-of-Authority (PoA): each validator must be approved by blockchain developers. That is, it is proof of stake + reputation. Validators are verified. The algorithm is used in the BNB Chain network.

Staking Types

There are different ways to  participate in maintaining a PoS blockchain:

  1. Traditional Staking (autonomous technical) where a user is a validator. The biggest problem here is the minimum amount for locking coins in the wallet. It is difficult for many to block a large sum. For example, 32 ETH in Ethereum is approximately $44,600 as of the article date. 1,000 DASH in DASH blockchain is $47,820; 10,000 XTZ in Tezos is $8,400. As for staking period, it can range from a few days to a few years. A validator will be fined for offline status.
  2. Cold Staking. Coins are blocked in a cold wallet: no need to be online all the time, rewards are immediately ceased after unfreezing and withdrawal of coins.
  3. Delegated Staking. Coins are transferred to an intermediary who stake them together with other clients crypto. If there are a lot of clients, the intermediary accumulates a large number of coins and, accordingly, has high chances for the right to generate a block and receive reward.

Conclusion

The proof-of-stake consensus algorithm has a great deal of potential. It is much more accessible to people who want to become validators than proof-of-work is to would-be miners.

Its most important advantage, however, is its environmental friendliness. Because it doesn’t require heavy-duty equipment, energy costs remain low.