Intro to Proof-of-Stake
  • Proof of stake is a type of consensus mechanism used to validate cryptocurrency transactions. With this system, owners of the cryptocurrency can stake their coins, which gives them the right to check new blocks of transactions and add them to the blockchain.
  • This method is an alternative to proof of work, the first consensus mechanism developed for cryptocurrencies. Since proof of stake is much more energy-efficient, it has gotten more popular as attention has turned to how crypto mining affects the planet.
  • Understanding proof of stake is important for those investing in cryptocurrency. Here's a guide to how it works, its pros and cons, and examples of cryptocurrencies that use it.

How does Proof-of-Stake work?
  • The proof-of-stake model allows owners of a cryptocurrency to stake coins and create their own validator nodes. 
  • Staking is when you pledge your coins to be used for verifying transactions. Your coins are locked up while you stake them, but you can unstake them if you want to trade them.
  • When a block of transactions is ready to be processed, the cryptocurrency's proof-of-stake protocol will choose a validator node to review the block.
  • The validator checks if the transactions in the block are accurate.
  • If the transactions are accurate, they add the block to the blockchain and receive crypto rewards for their contribution. However, if a validator proposes adding a block with inaccurate information, they lose some of their staked holdings as a penalty.
Proof-of-Stake example
Let's look at how this works with Cardano (CRYPTO:ADA), a major cryptocurrency that uses proof of stake.
  • Anyone who owns Cardano can stake it and set up their own validator node.
  • When Cardano needs to verify blocks of transactions, its Ouroboros protocol selects a validator.
  • The validator checks the block, adds it, and receives more Cardano for their trouble.
Mining Power in Proof-of-Stake
  • Mining power in proof of stake depends on the amount of coins a validator is staking. Participants who stake more coins are more likely to be chosen to add new blocks.
  • Each proof-of-stake protocol works differently in how it chooses validators.
    • There's usually an element of randomization involved, and the selection process can also depend on other factors such as how long validators have been staking their coins.
  • Although anyone staking crypto could be chosen as a validator, the odds are very low if you're staking a comparatively small amount.
    • If your coins make up 0.001% of the total amount that has been staked, then your likelihood of being chosen as a validator would be about 0.001%.
  • That's why most participants join staking pools.
    • The staking pool's owner sets up the validator node, and a group of people pool their coins together for a better chance of winning new blocks.
    • Rewards are split among the pool's participants. The pool owner may also take a small fee.
Proof-of-Stake vs Proof-of-Work
  • The biggest difference between proof of stake and proof of work is their energy usage.
  • Proof of work requires miners to compete to solve complex mathematical problems.
  • The first miner to solve the problem gets to add a block of transactions and earn rewards.
    • This results in mining devices around the world computing the same problems and using substantial energy.
  • Since proof of stake doesn't require validators to all solve complex equations, it's a much more eco-friendly way to verify transactions.


Pros and Cons of Proof-of-Stake

Here are the pros and cons of the proof-of-stake model:


Nothing at stake
  • A successful PoS system must address the problem of "nothing at stake". That is, randomly-selected validators must face a disincentive for bad behavior as well as a high probability that bad behavior will be detected.
  • The burden of detection usually falls on the rest of the network, which can either accept or reject the validator's opinion. A solution to mitigate the "nothing at stake" problem is to extract a penalty for emitting opinions that are ultimately rejected by the network: validators face economic penalties when they generate blocks that are rejected by sizable numbers of other nodes.
  • A validator is thus incentivized to generate blocks that are likely to be accepted by the network and faces economic punishment when it fails to do so. Validators place funds (i.e. the stake) at risk.
  • For any given block, a validator is selected in a pseudo-random fashion. The validator with a larger stake has a higher probability of being selected to generate a block. While PoS systems generally reward validators with new coins for honest behavior, so-called block rewards, validators also receive transaction fees in return for generating blocks that the rest of the network accepts.