Many have claimed that Proof of Stake will make cryptocurrencies more energy-efficient without compromising security. But what exactly is Proof of Stake? And how is it used to provide consensus in some cryptocurrencies?

Problems with Proof of Work

Bitcoin’s Proof of Work (PoW) protocol, released in 2008-2009, revolutionized digital currencies. For the first time, a form of electronic money did not need a central server. Also, bitcoin had solved the double-spending problem that had plagued electronic money in the past. It had created a chain of blocks that revealed the history of all past bitcoin transactions and could not be reversed unless an attacker had massive computing power. This meant that any bitcoins spent by a user would be irrevocably transferred to the recipient.

However, despite this great achievement, Bitcoin’s Proof of Work system had some significant issues. First, as the difficulty of the PoW puzzle increased as more miners joined the network, the energy-cost of maintaining the network also increased over time. As a result, the Bitcoin network consumed more and more electricity as it grew. Many cryptocurrency enthusiasts became concerned that this was both damaging to the environment and economically irrational.

Second, the cost of mining a block became so prohibitive that only very large organizations were able to afford the capital outlays needed to keep their operations going. To overcome this problem, small miners were forced to join ‘mining pools’. These pools would harness the CPU power of thousands of individual members. When the pool successfully completed a block, it would distribute the rewards to all of the individual miners based on the computing power they contributed. Some cryptocurrency enthusiasts were concerned that this development could lead to a large group having undue influence over the network in the future.

As these problems spread, many cryptocurrency developers started looking for an alternative to PoW. In 2011, the most popular alternative discussed on message boards was a protocol called ‘Proof of Stake’ (PoS). No one was quite sure how PoS would work except that in some way, blocks would be added to the blockchain based on the amount of tokens held by a miner instead of how many CPUs the miner controlled. This was based on the idea that a miner who held a lot of tokens had a ‘stake’ in the system and would want the system to remain legitimate.

Peercoin  The First Proof of Stake Cryptocurrency

Peercoin, the first cryptocurrency to make use of PoS, was created in 2012 by Sunny King and Scott Nadal. In the Peercoin system, users who have held at least one coin in their wallets for the past 30 days or more form a pool from which a new block creator is chosen. This block creator has the right to add the next block to the blockchain. The probability of being chosen as block creator is higher or lower depending on the coin age of the user, which is the number of coins in the user’s wallet multiplied by the number of days these coins have been held. The higher the coin age of the user, the more likely he/she is to be chosen as block creator. However, once a user is chosen as block creator, his/her coin age is reset to zero. This is meant to prevent rich users from dominating block creation. In this system, a new block creator is chosen about once every seven minutes.

The block creators who are also known as forgers are given a reward for writing blocks, and this reward is higher if the coin age of the user is higher. This results in an “interest rate” of about 1% per annum paid to all users that hold their coins and do not spend them. However, this interest rate is paid out in random chunks over the course of the year instead of a fixed schedule.

When Peercoin was first released, it still used PoW to produce some coins. However, this aspect has diminished over time.  As a result, Peercoin has become more energy-efficient and decentralized.

Nxt and Randomized Block Selection

Some developers were unhappy with the coin age concept used in Peercoin, and they decided to create an alternative PoS protocol called ‘randomized block selection’, which was first used by the cryptocurrency known as Nxt. In the Nxt blockchain, blockchain creators are picked every sixty seconds, and the probability of a user becoming the forger is determined by the amount of coins the user has had in his/her wallet in the last 1,440 blocks (equivalent to about 24 hours). Coins held on to longer than this time period do not increase the likelihood of a user being picked as a block creator. All of the Nxt coins in existence were produced in the initial creation event, and no further coins will ever be created. As such, forgers are paid out of transaction fees rather than being awarded newly minted coins.

According to Nxt developers, the top five Nxt accounts contributed just 35% of the total number of blocks to the blockchain, as compared to bitcoin, where 70% of all blocks were contributed by the top five accounts. This statistic further supports the idea that blockchains that use the PoS protocol are more decentralized and possibly energy-efficient.

Ethereum’s Casper Protocol

Another cryptocurrency experimenting with the PoS protocol is the popular Ethereum. Ethereum is a smart contract platform that currently uses PoW as its consensus protocol. However, Ethereum developers intend to move to PoS in the future using a protocol they call Casper. In the Casper system, nodes have to place a certain number of coins in a smart contract. This deposit is called a bond, and the nodes who deposit these coins are called bonded validators. Bonded validators vote on which blocks are to be added to the blockchain, and after multiple voting rounds, a block is added to the blockchain.

Each vote is a ‘bet’ as to how the consensus process will turn out when the final round is finished. If a validator votes with the rest of his peers, he will receive transaction fees and the right to mint new coins and will earn back his original deposit. On the other hand, if a validator votes against most of his peers, he will lose part of his deposit. Furthermore, if a validator does something that is obviously fraudulent, such as betting on a block with invalid transactions, the validator forfeits all of the deposited coins.

Casper is currently being run on test networks but is expected to go live sometime in 2019. Ethereum developers hope that this new PoS protocol will allow Ethereum to be more energy-efficient and decentralized.

Conclusion

The PoW consensus protocol is still used in many cryptocurrencies today. However, PoW requires an ever expanding rate of electricity usage in order to secure the network. As a result, many cryptocurrencies have chosen to experiment with PoS protocols. As it stands, PoS protocols will continue to be important to the cryptocurrency community.