One of the biggest criticisms facing Bitcoin is its proof of work consensus method, as proof of work involves using considerable power and therefore has a negative impact on the environment.
Elon Musk used this aspect of Bitcoin to downplay its potential as future legal tender and at the same time negatively affect the price of BTC. Ethereum also uses proof of work (for now), but it, along with many newer cryptocurrencies, is making the move to a proof of stake consensus method, which for the leading NFT blockchain means less of an environmental burden.
But what is proof of stake and why is it so beneficial compared to proof of work? We will look at that and much more in this proof of stake guide.
Bitcoin Uses Proof of Work. What's That?
In the world of blockchain technology there are two main types of consensus mechanisms used in order to validate and confirm transactions on the network.
Bitcoin, Ethereum (1.0), Litecoin, and Bitcoin Cash are all examples of networks that use proof of work. With proof of work consensus, the miners compete against each other to solve a mathematical puzzle. They need to solve it with proof. Generally this requires specialized equipment uses a large amount of energy.
The one who completes the puzzle first creates the next block in the chain and publishes it to the network. The other miners involved in the process turn validators and verify if the solution is correct. The miner who has successfully solved the puzzle receives rewards in tokens (Bitcoin or Litecoin for example).
What is Proof of Stake?
In contrast to proof of work, with proof of stake any person can validate block transactions based on the number of tokens held, rather than computing power. Holding more tokens implies more validating power. In proof of stake, a validator needs to stake or lock in a certain number of tokens native to that network in order to be considered. The network randomly chooses one of these validators to create blocks and confirm the ones that others have created.
In exchange for securing the network, the validator, along with any delegators (more on this in a moment) receive a payout in the form of the asset they are staking in proportion to the amount held. Some proof of stake networks require a minimum amount to stake, either as a delegator or validator, while others do not. For example, you need at least 8 ADA to delegate on Cardano, but there is no minimum to become a validator, whereas on Ethereum you need 32 ETH to be a validator.
What Are the Benefits of Proof of Stake?
There are a large number of benefits to the proof of stake consensus model including the following:
Staking (As Delegator)
The main benefit to proof of stake consensus method cryptocurrencies is the ability to stake that asset and in return receive a payout in that asset in proportion to your stake. For most users, this means they are going to delegate their stake to a validator or stake pool operator, rather than learn the technicalities and buying the hardware necessary to run a pool. Staking is a great way to earn a high yearly interest return on your assets, with many paying out around 5% a year.
When users delegate their assets to a pool, the assets do not leave their wallet, instead you are transferring the power of your vote to the operator, who in turn validates or votes on your behalf. Even though the assets do not leave your custody, it is important to pick a trustworthy validator, as there can be negative implications if you choose one who is not (see downsides to proof of stake).
Staking (As Validator/Stake Pool Operator)
A validator or stake pool operator receives even more benefit than a delegator does, as they generally receive more of a payout than the delegator in exchange for doing more work (running the node, keeping it online, verifying transactions).
Depending on the network a validator may need to stake a certain amount of an asset to participate, and most of them have commissions they charge that vary by the pool. Users may delegate to a validator who has a zero percent commission but may feel more comfortable delegating to a pool with a small fee and better history of payouts.
Throughput/Network Speed
Part of the issue with Bitcoin and Ethereum is high transaction costs due to network congestion, which is tied to the throughput or network speed. Both of those networks have very low transactions per second, which means it does not take a lot for the network to become congested and create a situation where you have to pay a high fee in order to push your transaction through in a reasonable amount of time.
With proof of stake, each validator or pool becomes a node through which transactions can be processed, effectively increasing the throughput and network speed the more validators are on the network and creating blockchains that can process thousands of transactions per second with a much lower cost.
Environment
One of the biggest benefits to a proof of stake blockchain is the lowered environmental impact they generate compared to proof of work. It takes much less processing power to validate transactions, meaning that for something that has many transactions like NFT sales, a proof of stake blockchain is much more efficient for cost and speed.
The Downsides of Proof of Stake
It should be noted that proof of stake is not without criticism and many Bitcoin maximalists believe it simply isn’t as secure as the tried-and-tested proof of work consensus method. Here are some of the potential downsides to proof of stake:
Minimum Thresholds
While staking and validating on a proof of stake network can be extremely beneficial, it is important to keep in mind that many networks require a minimum stake for delegators and/or validators. In some cases, it is fairly negligible (such as needing 8 ADA to stake on Cardano), but in some cases it can mean a high barrier to entry for most (such as needing to stake 32 ETH to be a validator on Ethereum 2.0). There are criticisms that this could lead to a more centralized crypto environment with large companies earning most of the rewards from staking.
Lock Ups
While not necessarily a bad thing for network security, many proof of stake blockchains have a lock up period after you stake. This means that once you stake your assets there is a minimum amount of time you have to wait before you can have access to them if you choose to unstake. For example, staking on Polkadot (DOT) has a 28-day lock up once you end your delegation, while Terra (LUNA) has a 21-day period after you choose your delegation.
Bad Actors/Loss of Rewards
As mentioned earlier, if you choose an untrustworthy validator (bad actor), it can mean negatives for you as a delegator. Depending on the protocol you can lose rewards or even your staked assets if the validator performs bad actions such as not being online, failing to properly validate, or some sort of collusion.
Less Secure than Proof of Work
While not meant to discourage anybody from buying into a proof of stake cryptocurrency, it is undoubtedly less secure than a proof of work cryptocurrency. This is because it takes much less power to affect the network, however, it is still extremely financially expensive to attempt an attack on a proof of stake network and while less secure than proof of work, it is still extremely safe.
Current Proof of Stake Cryptocurrencies
While not an exhaustive list, here are a few examples of top crypto assets that use proof of stake and their current rewards:
Minimum delegation requirement is 8 ADA, 0 for pool operation (though less likely to attract delegators if you have nothing at stake). Pool operators can charge varying fees. Current payout is around 5% a year depending on pool and there is no lock up of your ADA.
Solana is one of the newer cryptocurrencies but it has snagged a surprisingly large amount of market share thanks to its insanely fast transactions (50,000 tps) and low fees. It’s relatively easy to stake SOL and you can do it directly from wallets like Exodus or exchanges such as Kraken. You only need .01 SOL to get started. On the other hand staking SOL as a validator is one of the most difficult propositions in staking as you need expensive equipment and a large amount of SOL to get started. Current payout for stakers is around 5-6%.
No minimum delegation, but you have to be in the top 16 of your pool in order to receive a payout, meaning there is a small barrier for entry as a delegator (called nominators for DOT). In order to be a validator you need to stake 350 DOT. 28 day lock up once you end your stake. Current payout is around 13% a year but you are not guaranteed payouts as with some other networks.
No minimum delegation amount and payouts occur regardless of your stake compared to others delegating to the same pool. Fairly large barrier for entry as a validator (called Bakers), as it requires 8,000 XTZ to be a baker. There is no lock up for delegating, but baking has a 14 day lock up period. Current payout is around 5% a year.
No minimum delegation amount or minimum amount to be a validator, but being a validator requires a lot of work and time that most people do not have. Validators can charge a commission of anywhere of 0-100%, and bad activity can result in loss of rewards or assets for delegators and the validator. There is a 21-day lock up period for both delegation and validation, with current payouts being around 5% a year.
No minimum delegation amount and only need 1 ATOM to be a validator though it is extremely technically complex. Validators can charge a variable fee as with Cardano and Terra, and there is a 21-day lock up period for both delegators and validators. Current payout is around 9% a year.
