What is Proof of Stake? An Overview of PoS Blockchains

Proof of Stake (PoS) is one variety of blockchain consensus algorithm in which users who hold a specific blockchain’s coin— and only users who hold that blockchain’s coin— are allowed to participate in validation. These individuals, known as “stakers,” help the network to validate transactions and create new blocks.

In recent years, Proof of Stake has become one of the most popular blockchain consensus protocols. As of the time of writing, the top 10 Proof of Stake projects by market capitalization contain over $6.7 billion dollars in digital assets. This figure is even higher if modified Proof of Stake consensus mechanisms, such as Delegated Proof of Stake (DPoS), are included.

With the eventual release of Serenity (also known as Ethereum 2.0), roughly 50 more cryptocurrencies in the top 100 market cap rankings will likely be using Proof of Stake. Thus, the importance of this specific consensus mechanism is expected to increase significantly in the coming years.

In this article, we’ll explain exactly how Proof of Stake works and explore some of the projects that use it. We will also overview a few of the known limitations to Proof of Stake and explain how hybrid consensus rules might be the most ideal consensus method.

What Is Proof of Stake?

Proof of Stake is one specific variety of consensus mechanism that blockchain networks use to come to agreement on which transactions should be approved and which should be rejected.

While Proof of Work is perhaps the most famous blockchain consensus protocol, as it’s used on the Bitcoin network, there are a number of other prominent examples, including Proof of Stake (PoS). Other examples include Delegated Proof of Stake (DPoS), Proof of Authority (PoA), and Proof of Capacity (PoC).

Here’s why the Proof of Stake consensus mechanism is important and how it works at a basic level.

Consensus Basics

It’s essential to understand the fundamentals of consensus before answering the question, “What is Proof of Stake?”

Every blockchain's peer to peer network needs a way to make sure every transaction is valid and that nobody is spending money they don't have or spending the same money twice. Blockchain networks are decentralized, which basically means that each node (computer) in the network will individually verify all transactions.

Since each node validates independently, the network needs a way for all the nodes to come to agreement on which transactions are valid and which are not. The set of rules that a network uses to come to agreement is called a “blockchain consensus protocol.” Different blockchains use different consensus protocols. Proof of Stake is simply one popular variety of a consensus protocol.

Proof of Stake Definition

In the most basic terms, Proof of Stake is a method of securing a decentralized blockchain network by allowing people who hold that blockchain’s coins to validate transactions and blocks.

Through this process, known as staking, validators are able to earn additional coins (known as block rewards) proportional to the amount staked. Those with more coins at stake typically validate more blocks and thus earn more block rewards.

Since these stakers hold the coin, they have a financial interest in keeping the network honest and making sure no fraudulent transactions are validated. In most Proof of Stake systems, bad actors who verify fraudulent transactions don’t receive block rewards and can lose staked funds.

It’s important to note that the process of staking is not the same as cryptocurrency mining. While both stakers and miners serve the same purpose— helping to keep a blockchain secure and in return for coins— they are entirely distinct.

Mining is specific to Proof of Work blockchains. It does not require holding any of a blockchain’s currency but it often requires using specialized mining equipment to solve complex math problems to mine blocks. Staking, on the other hand, does require holding a certain amount of a blockchain’s currency but can be done on an ordinary home computer.

Origins of Proof of Stake

Proof of Stake was developed as an alternative to the Proof of Work consensus mechanism. Proof of Work arguably still plays a larger role in blockchain consensus as Bitcoin, Ethereum, and other major blockchains use it. However, this is beginning to change, as many networks are considering or are already working towards migrating to Proof of Stake in the near future.

Proof of Work Limitations

Proof of Work has a number of limitations that prevent it from being considered a perfect solution for consensus. Here are a few examples why Proof of Work has become less popular and why Proof of Stake is gaining more traction.

With the rise of ASIC mining rigs, network centralization and coin supply centralization have both become major problems. This means that fewer people control the security of the network, which works counter to the intent of decentralized blockchains. It could also potentially cause security vulnerabilities, as it would theoretically be much easier for major mining pool operators to collude and launch a 51% attack.

In addition, Proof of Work blockchains are not energy efficient. In fact, mining equipment for Proof of Work networks accounts for around 0.2 percent of global energy consumption or around the equivalent carbon dioxide production as the entire city of Kansas City, Missouri. If more people run mining rigs, this could lead to even more energy consumption.

The First Proof of Stake Blockchain Proposed and Implemented

In August 2012, Sunny King and Scott Nadal released a whitepaper titled, “PPCoin: Peer-to-Peer Crypto-Currency with Proof-of-Stake.” This document introduced the concept of Proof of Stake by proposing a block generation structure for Proof of Stake transactions involving kernel input, two stake inputs, and stake output.

Although the paper itself doesn’t include too many details, King and Nadal did successfully launch Peercoin as the first Proof of Stake blockchain network in 2012. Moreover, Peercoin demonstrated that Proof of Work could be replaced by a more efficient consensus mechanism. This inspired future projects to follow in their footsteps.

Popular Proof of Stake Projects

Although Peercoin (PPC) is still operational today, it is no longer the most popular Proof of Stake blockchain. There are several blockchains that have further improved upon its design.

Note that each blockchain network has its own requirements for staking. It’s important to verify whether or not a specific wallet supports staking rewards for a specific blockchain’s coins and/or tokens.

Cosmos Network

Cosmos Hub is the Cosmos Network's Proof of Stake blockchain. Note that many people define Cosmos as a Delegated Proof of Stake (DPoS) blockchain instead of a pure PoS blockchain. Its design is based on the Tendermint BFT consensus engine, which relies on a set of validators to secure the network.

ATOM serves as the network’s staking coin and stakers bond their ATOM coins as collateral. The weight (i.e. voting power) of a validator determines whether or not they are an active validator. Initially, only the top 100 validators with the most voting power serve as active validators on Cosmos. All non-validators are known as delegators and actively participate in network governance by selecting which ATOM holders become network validators. Annual staking rewards are currently around 8 percent for delegators and about 9 percent for validators.

Neo

Neo’s blockchain network utilizes a modified Proof of Stake system called Delegated Byzantine Fault Tolerance (dBFT). All NEO token holders have the ability to vote for delegates. The qualification requirements to potentially become a delegate are minimal. One only needs a reliable internet connection, a valid ID, and 1,000 GAS.

NEO staking rewards are somewhat unique in the fact that block rewards aren’t distributed in NEO, the network’s main cryptocurrency. Instead, they are distributed as another cryptocurrency called GAS. Annual staking rewards are currently 1.19 percent for all stakers.

Qtum

Qtum’s blockchain gives QTUM holders several different options for staking.

Method 1 involves using a command line interface on Linux, OSX, Windows, or Raspberry Pi. Method 2 involves staking with qtum-qt wallet, which includes a GUI.

Although the Qtum website says the Qtum Core wallet is the only wallet that supports Qtum Proof of Stake staking, users actually have another option. Binance added staking support for QTUM in 2019. Annual staking rewards are currently around 4.72 percent for all stakers.

Current Limitations of Proof of Stake

Despite the fact that Proof of Stake was designed to solve the pain points of Proof of Work, it has its own limitations. All blockchain projects should consider the following drawbacks and attack vectors before implementing a Proof of Stake consensus mechanism.

Initial Distribution: Blockchain networks with cryptocurrencies must have an initial distribution phase for the currency. That's true because Proof of Stake consensus mechanism assumes that users already have coins or tokens in their wallet for staking. As a result, there must be a separate system in place for minting and distributing an initial supply.
Monopolization: Proof of Work mining is accessible to only a small percentage of people, which tends to create an oligarchy with a few large mining farms controlling the vast majority of the network. Proof of Stake is generally considered to be more accessible because stakers don’t have to buy additional hardware to participate in staking. Still, this doesn’t necessarily prevent the centralization of the network, since larger token holders receive higher staking rewards. Networks can still become monopolized if rules aren’t added to prevent such scenarios.
Fake Stake Attacks: Proof of Stake vastly minimizes the threat of 51% attacks, which are common on Proof of Work blockchains. However, “Fake Stake” attacks present another potential security challenge that Proof of Stake networks must consider.
Nothing at Stake (NoS) Attacks: This is a common theoretical issue specific to Proof of Stake networks. Because staking doesn’t come with realized costs (e.g. electric costs for running a mining rig to validate transactions on Proof of Work networks), it costs a validator nothing to validate transactions on multiple forks in Proof of Stake blockchains. Validating on both is actually economically beneficial for stakers but creates security dilemmas for the blockchain’s peer to peer network.

Smart Chain Projects Can Choose Between Proof of Work and Proof of Stake

Komodo is a multi-chain blockchain platform that provides technology for launching independent, composable Smart Chains. They're independent in that each Smart Chain has its own networks, currency, and consensus rules. There is no forced dependence on the Komodo blockchain or KMD coin, and transaction fees are always paid in each Smart Chain's native coin.

When you launch a Smart Chain with Komodo's technology, you can customize your chain's consensus rules. You can choose Proof of Work, Proof of Stake, or a combination of the two. In addition, Komodo gives projects the option to level-up to Bitcoin-level security with the delayed Proof of Work (DPoW) security feature and to activate the Dilithium module to enable a quantum-secure blockchain.

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