What is the difference between Proof of Work and Proof of Stake?
There are two types of cryptocurrencies: those that must be mined (bitcoin, ether, lightcoin, Monero), and pre-mined during the genesis event (Ripple, Stellar, Cardano, EOS, NEO). In this article, we will talk what is the difference between the two types of coins and what advantages and disadvantages each group has.
What is the basis of the both types of coins?
Although the two kinds of cryptocurrencies differ in the generation method, the basis of both types of coins is the same — verification process. Ultimately, every transaction processed by the network must be verified by someone to ensure that coins has not been spent twice. In fact, we are talking about the difference in the verification process. Groups of transaction are combined into a block; after verification, the block joins other previously confirmed blocks, creating a chain of true transactions, or blockchain.
Mining is a process whereby individuals, groups or companies, using powerful computers, solve complex math equations for transaction blocks verifying. These math tasks are part of the encryption process that protects transactions from cybercriminals and third-party access. The first one who successfully solves a math problem and signs a block of transactions receives a reward. As is known, in the Proof-of-Work model (PoW), the block reward is paid in the same currency as the verified transaction. Miner, who confirmed the block of transactions in the Ethereum network, will receive a reward in ETR. Miners earn by investing this cryptocurrency and selling it later, or immediately converting into fiat money.
Disadvantages of mining:
There are certain drawbacks of mining. It can be very expensive due to the large amounts of electricity consumed. In crypto currencies with a lower capitalization, the competition is usually lower than in Bitcoin (Bitcoin) or Ethereum (ETH / USD). Bitcoin mining requires specialized ASIC chips, combined into huge farms.
Electricity is one of the main expenditure items of these projects, which is why China, with its relatively cheap electricity, has become home to four of the world's five largest Bitcoin farms. In addition to spending on electricity, mining farms have to spend considerable funds on new equipment that is becoming obsolete in a few months. Moreover, large projects need additional cooling, because during operation, servers and graphics cards are heated to high temperatures.
The Proof-of-Work model is potentially vulnerable to an attack of 51% (a group of people with 51% of the processing power that have a control of the network and its participants). For popular crypto currencies such as Bitcoin, Ethereum, Lightcoin (LTC / USD) and Monero (XMR / USD), this is not a problem due to their large size. However, smaller cryptocurrencies with long time of block processing and low daily volumes are at risk of this attack.
At the other end of the spectrum are pre-mined cryptocurrencies such as Ripple (XRP / USD), Stellar, Cardano, EOS (EOS / USD) and NEO (NEO / USD). They use the Proof-of-Stake model (PoS). There is no need in super-powerful computers for the work of such cryptocurrencies, and the network participants do not compete among themselves for the right to sign another block.
Thus, the costs for this approach are much lower. Transaction verification is provided by the owners of crypto currency. It looks like this: the more coins you have, the longer you own it, the higher the probability that you will be selected or transaction block verification. Special mechanisms built in the system prevent the dominance of large holders of crypto currency in the verification process. There are many random ways to select owners for signing a transaction block. This ensures that small holders have a chance to participate in the process. In addition, the Proof-of-Stake method implies a different way of rewarding -- instead of the generated coins, the signatory receives the aggregate transaction fees of the block. They may be less that mining reward, but the costs of this verification method are much lower.
Disadvantages of pre-mined cryptocurrencies:
Given the much lower costs of the Proof-of-Stake method, it may appear that this is a more progressive way of transaction verification. However, this method has some drawbacks. For example, such cryptocurrencies are insured against the risk of 51% attack, but on the other hand, a person who has 51% of all tokens can gain control over the network and its participants.
Of course, in the case of high-capitalized cryptocurrencies, the probability of this scenario is low, but small analogs may suffer from this vulnerability. It is also worth noting that the Proof-of-Stake model gives large owners additional votes in determining the further development of the network. For example, most NEO tokens belong to several founders. This helps to increase the transactions speed and saves the consensus time, but also makes the crypto currency too centralized. In other words, in the Proof-of-Stake model, large players gain considerable power, that is theoretically impossible in the Proof-of-Work model.
What’s the best method?
Both methods have their pros and cons. But there is one important factor that has not been touched yet. Eventually, some of the largest mined currencies (for example, Bitcoin) will reach their token limit. At this point they will have to switch to Proof-of-Stake. Since it significantly reduces the power consumption and does not require such high computing power, gradually all the cryptocurrency will be transferred to the PoS model.