- Automated Market Maker
- Blockchain Explained
- Blockchain: Private vs Public
- Blockchain Oracle
- Cryptocurrency Trading
- Digital Assets
- Digital Banking
- Digital Currency
- Digital Securities
- Digital Wallet
- Directed Acyclic Graph
- Equity Crowdfunding
- Equity Tokens
- Hard Fork
- NFTs (Non Fungible Tokens)
- Proof of Work vs Proof of Stake
- Security Tokens
- Stablecoins Explained
- Stablecoins – How They Work
- Smart Contracts
- Token Burning
- Tokenized Securities
- Utility Tokens
- Web 3.0
Table Of Contents
If you have been following the developments in the cryptocurrency industry over the past year or more, you probably saw the term “Ethereum 2.0” at some point. This is basically an upgrade that will improve Ethereum by changing multiple aspects of the project, and improve it, allowing it to be a lot faster, cheaper, more scalable, and more modern in a number of other ways.
Of course, one of the biggest changes that Ethereum users will see is the switch from the Proof of Work consensus mechanism to a more advanced one known as Proof of Stake. If you don’t know what these mechanisms are, or why is Ethereum switching to PoS, then keep reading and we will explain everything you need to know.
What are Consensus Mechanisms?
Earlier, we said that Ethereum is planning to switch from one consensus or mechanism to another and to understand why this matters so much, you must first understand what these mechanisms are.
Essentially, the cryptocurrency industry and crypto networks are decentralized, meaning that there is no central authority that runs all the servers and has control of all the money in them. However, that also means that there is no one who would keep transactions in check, processing them, ensuring that no one spends the same money twice, or manipulates the funds in some other way.
In traditional finance, banks, Visa, PayPal, and other centralized services do this, but in crypto, we use consensus mechanisms. Essentially, these are the systems that allow the computers in a crypto network to agree about which transactions are legitimate and record them as true on the blockchain.
There are plenty of consensus mechanisms out there these days, with every other project developing its own in order to be unique and try to revolutionize the industry by bringing its vision of how the legitimacy of transactions should be established. However, the two main ones, or the biggest ones, are Proof of Work and Proof of Stake.
What is Proof of Work (PoW)?
Proof of Work is the oldest consensus mechanism out there. It was the first one that Satoshi Nakamoto himself developed in order to ensure that Bitcoin’s transactions would be confirmed, finalized, and true.
It is called proof of work because the network requires a lot of processing power in order to run the mechanism, process and verify transactions, combine them into blocks, solve those blocks, and record them as part of the blockchain.
Now, Proof of Work networks reward this work by releasing new coins into circulation, and the entire process is essentially what crypto mining is all about. These new coins are considered “mined,” and the individuals that processed transactions get them as a reward for their contribution to the network.
So, since all seem to be working quite well here, what’s the problem? Why did people come up with new mechanisms?
Well, the reason is the amount of processing power that is needed to run the mechanism. It is absolutely massive, and even considered wasteful. For all its benefits, this mechanism is not only too slow and unable to scale, but also quite wasteful when it comes to the electric power needed to run it, which makes it not that eco-friendly.
As a result, developers decided to use a different approach, and that resulted in a superior consensus mechanism called Proof of Stake.
What is Proof of Stake (PoS)?
As mentioned, Proof of Stake is the blockchain industry’s response to the flawed PoW mechanism, which is limited and energy-inefficient. The new system uses staking, which has a similar function to mining in PoW, meaning that it is used for processing the latest batch of transactions which are then grouped into blocks and eventually added to the blockchain.
Just as with PoW, the process results in rewards granted to the participants, which are the coins that are freshly released in circulation.
Now, each PoS system is slightly different from the other one, which makes it unique. However, in general, every PoS blockchain uses a network of validators who contribute to the project, not by adding electricity, but by funds. They stake their own cryptocurrencies in exchange for a chance to validate transactions and receive compensation for their efforts.
The network selects the winner on its own, based on the number of coins that each validator has added to the pool, as well as the amount of time that the coins spent there. So, those who add more crypto and keep it locked up in the staking pool for longer periods have the best chances to earn major rewards.
The process doesn’t stop there, however. Once the network selects the winner and they validate the block, other validators are required to confirm that the block is accurate. The new block is then added to the chain, the rewards are released, and the process starts over.
Obviously, this makes being a validator a very important job, and a major responsibility. As such, it requires a lot of technical knowledge, as well as plenty of staked coins.
Why is Ethereum switching to PoS?
The flaws of Proof of Work have been quite obvious ever since it was invented. It is limited in scalability, it consumes too much power, and it is quite slow. In fact, it was clear that the mechanism will need to be replaced by a more superior one at some point. The problem was that there were no other options back in the day, and so Ethereum had to use PoW.
Today, it is paying the price for that, but it is also working on developing its own PoS mechanism and switching to it. Of course, different projects have developed their own versions of PoS a long time ago, and many now use it as a go-to solution. PoW is no longer interesting to anyone, so developers usually have a choice of going to PoS or trying to come up with a unique and completely different mechanism.
PoS is what most tend to select, however, as it is a lot more scalable, with a minimum carbon footprint, and it is very energy-efficient thanks to the fact that it only requires stakers who would provide their coins, rather than vast amounts of power to solve complex mathematical equations.
PoS is already used by some of the biggest chains out there, such as Cardano or Tezos, with Ethereum being on its way to join up with them. It is especially important that ETH switches to PoS soon in order to reduce its tremendous transaction fees, which continue to grow due to the lack of scalability of PoW, which is currently still in use in the Ethereum network.
Other than that, PoS is just as safe as PoW, with major economic consequences that penalize any network disruption and work on thwarting malicious actors. In PoW, miners could get in trouble for submitting false info or blocks, and waste the power and time of the community.
In PoS, however, validators’ staked coins also act as an incentive for everyone to behave, or lose their coins as punishment for network disruptions and attempts to cause damage to the system. In the end, they do have different approaches, but they do the same thing. PoS is simply more efficient at it, providing better results while using fewer resources, which makes it a superior option.
Ali is a freelance writer covering the cryptocurrency markets and the blockchain industry. He has 8 years of experience writing about cryptocurrencies, technology, and trading. His work can be found in various high-profile investment sites including CCN, Capital.com, Bitcoinist, and NewsBTC.
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