What Is Proof of Stake?

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  1. So how does proof of stake actually work?
  2. So what’s the incentive to participate if I don’t have a large stake?
  3. How does this work as a security mechanism?

Ayn Rand would love proof of stake.

Proof of stake is a consensus mechanism for decentralized ledgers. It lets computers scattered around the world keep the same database in the same confirmed state across many different locations at once, so it’s become a useful tool for a variety of emergent cryptocurrencies to maintain their operations successfully.

This gets niche and technical quickly, so it deserves a step back before we go deeper. We’ll start with where proof of stake came from, then we’ll get into how it works and why it’s an economic egalitarian dream come true.

Proof of stake emerged in 2011 to solve issues related to a different consensus mechanism.

“Proof of work” used to be the only game in town for maintaining blockchain consensus, but it wasn’t without certain issues. Success in a proof of work system is related to having lots and lots of processing power to mine new coins. Cryptocurrencies that depend on it (most notably Bitcoin) require lots of electricity to keep the network running. It only takes one correct guess-and-check calculation to successfully mine new coins, so that means all the electricity used in attempts to solve proof of work’s cryptographic puzzles with incorrect answers is just wasted. The community began calling for a different way to do things.

Proof of stake was first presented on the Bitcointalk forum as an alternative vehicle for preserving blockchain consensus without sucking up so much electricity. This system doesn’t care much about processing power, but instead pays attention to how much cryptocurrency a user holds. Their chances of successfully confirming transactions on the blockchain (and winning the reward for doing so) vary directly with how much cryptocurrency they hold.

Whether you like it or not, this system is one in which the rich fundamentally tend to get richer. It seems to be ripped from the pages of Atlas Shrugged — proof of stake depends on prime movers to come to a cryptocurrency before there’s major incentive to do so. The incentive only comes later down the road.

Proof of stake has its own vocabulary.

New coins aren’t “mined,” they’re “forged.” Cryptocurrencies driven by proof of stake will often start operation by selling pre-mined coins, or they might launch with a conventional proof of work algorithm before later switching over to proof of stake.

“Randomized block selection” and “coin age selection” are methods that work to prevent favoring only the wealthiest nodes on the network. “Election” is the way that nodes on the network are chosen to validate new blocks.

There are only more niche terms to uncover the deeper you go, but the important takeaway is that proof of stake solves exactly the same problem as proof of work. It just does it in a completely different way.

So how does proof of stake actually work?

Just like proof of work systems, cryptocurrency users on a proof of stake system make transactions that are gathered into blocks. Those blocks need to be verified to ensure that money sent is genuinely received, and the people who verify those transactions get to collect a block’s associated transaction fee as a reward.

But those who are “elected” to confirm a block on a proof of stake blockchain are chosen in a pseudo-random manner based on a variety of traits. These might include the staking age, true randomization, and the node’s wealth.

If you want to forge blocks in a proof of stake environment, then you need to have skin in the game! Forgers must lock up a certain amount of coins in the network in order to keep it running. This is their “stake,” and it plays a major role in determining your chances in being selected as the validator to forge the next block.

The more you have at stake, the better your chances are.

When a node gets chosen to forge the next block, it will check if the transactions in the block are valid, sign the block, and add it to the blockchain. As a reward, the node receives the transaction fees that are associated with the transactions in the block.

So what’s the incentive to participate if I don’t have a large stake?

As mentioned above, there are a few different mechanisms in play to ensure that the richest node isn’t selected time and time again. “Randomized block selection” sees validators selected by looking for nodes with a combination of the lowest hash value and the highest stake. “Coin age selection” is a method that chooses nodes based on how long they’ve held their coins in stake. Smaller players get to compete in time since they can’t compete in resources — after they successfully forge a block, their coin age is reset to zero and they’re back to waiting again.

These methods come together in mix-and-match format across different cryptocurrencies. It’s up to the initial architects to determine what rules they think are fairest to them and their users.

How does this work as a security mechanism?

Where proof of work put the burden on hardware and computing power, proof of stake puts the burden on software and economic incentives.

You’ll recall that 51% attacks in a proof of work system would require an unrealistic amount of computing power burning a completely impractical amount of electricity in order to be successful. By the time an attacker controlled the network, he or she would have spent more resources than they would gain.

As proof of stake requires participants to pledge assets, 51% attacks are only possible by owning more than half of the money in an entire economy. Sure, you could start buying like crazy to acquire a meaningful fraction, but this would only make the price to continue acquiring coins much higher. And because so much of this game involves having cards face-up on the table, the humans involved in perpetuating the ecosystem would quickly catch on and choose not to sell their assets.

Proof of work is a technological security measure; proof of stake is an economic security measure. As a transcendentally egalitarian consensus mechanism, it is rippling with libertarian political implications. At the same time, different proof of stake systems have their own flavors of fairness added in. It’s not entirely using money to make more money, but it definitely helps to start with significant assets in a proof of stake paradigm.

That’s why Ayn Rand would love it.

Marco Streng is the CEO and co-founder of Genesis Group and Genesis Mining, one of the largest crypto mining companies in the world. Prior to co-founding Genesis in 2013 and becoming an impassioned advocate for blockchain technology and cryptocurrencies, Marco studied mathematics at the Ludwig-Maximilian University of Munich.

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