As the inefficiency of proof of work (PoW) system is gradually becoming an issue in the cryptocurrency space nowadays, the proof of stake system is gradually attracting lots of attention. A major reason for this is that Proof of Stake holds more benefits in the cryptocurrency mining community than the PoW system. In fact, the PoS system was developed as a better alternative to the PoW system and to tackle inherent problems in PoW.
Several cryptocurrencies are currently ditching the PoW system to adopt PoS. Peercoin was the first cryptocurrency to adopt the PoS system, followed by Nxt, Blackcoin, and ShadowCoin. A recent report has it that Ethereum is making plans to switch over from the PoW system to PoS system soon. But what exactly is the PoS system?
What is Proof of Stake?
Proof of stake is an alternative method of verifying transactions on a Blockchain. To better understand the PoS system, it is important to briefly explain the PoW system.
Proof of Work – this is a crypto mining method where the miner uses sophisticated mining rigs or powerful computers to solve complex mathematical calculations. When several mathematical calculations are successfully completed for several transactions, the mining process verifies the legitimacy of the transactions and creates new cryptocurrency units. Several miners attempt to solve the complex puzzle but the first miner to solve the puzzle is rewarded with the newly created cryptocurrency unit.
But as the number of miners increase, more computing power is added to the mining network. This increase the average number of mathematical calculations needed to create a new block. As a result, it becomes more difficult for a miner to win a reward. Mining consumes lots of electrical power and miners need to generate money to pay the electricity costs and recover the hardware cost. This forces miners to sell their rewarded crypto unit for fiat money, which would create a downward movement on the price of the cryptocurrency. This is what the PoS system seeks to address by assigning mining power to miners in accordance with the proportion of coins they held.
So just like the PoW concept, the PoS system is also a crypto mining method but requires the miner to show ownership of a certain number of crypto coins. According to the PoS method, a miner can only mine according to the number of cryptocurrency units he or she holds. Therefore, the more Blackcoin or another PoS cryptocurrency a miner owns the more mining power the miner has.
How Proof of Stake Works
The Proof of Stake concept limits the power of a miner to mining only a percentage of block transactions that is equivalent to his or her ownership stake. For instance, if a miner owns 5% of the available PoS coins, he or she would be able to mine only 5% of the transaction blocks. This way, the miner won’t be using large electrical power to solve the proof of work problem but less electrical power to solve the proof of stake puzzle.
Actually, in the PoS system, decrypting the block transaction problem is referred to as “forging” or “minting,” and not mining. Anyone who validates block transactions and creates new blocks in the PoS system is known as “forger.” A forger is selected in a pseudo-random way based on his or her stake – the number of cryptocurrency units he or she holds.
In order to create new blocks or validate block transactions in the PoS system, a forger is required to first put his or her own crypto coins at stake – in an escrow account. This is done to prevent any fraudulent transaction. If a forger validates a fraudulent transaction, he or she does not only lose his or her stake but also loses his or her right to participate in further forging. As a result, forgers are induced to validate only the right transactions.
In most PoS currencies, the currencies units are created at the launch of the currencies and their total number is fixed. Therefore, forgers are rewarded with transaction fees rather than the currencies units. But in few PoS cases, new currencies units are created by inflating the supply of the coins. This makes it possible to reward forgers with newly created currencies units along with the transaction fees.