What Is Proof of Stake (PoS)?
The Proof of Stake consensus algorithm was introduced back in 2011 on the Bitcointalk forum to solve the problems of the current most popular algorithm in use – Proof of Work. While they both share the same goal of reaching consensus in the blockchain, the process to reach the goal is quite different.
The proof of stake was created as an alternative to the proof of work (PoW), to tackle inherent issues in the latter. When a transaction is initiated, the transaction data is fitted into a block with a maximum capacity of 1 megabyte, and then duplicated across multiple computers or nodes on the network. The nodes are the administrative body of the blockchain and verify the legitimacy of the transactions in each block. To carry out the verification step, the nodes or miners would need to solve a computational puzzle, known as the proof of work problem. The first miner to decrypt each block transaction problem gets rewarded with coin. Once a block of transactions has been verified, it is added to the blockchain, a public transparent ledger. Mining requires a great deal of computing power to run different cryptographic calculations to unlock the computational challenges. The computing power translates into a high amount of electricity and power needed for the proof of work. In 2015, it was estimated that one Bitcoin transaction required the amount of electricity needed to power up 1.57 American households per day. To foot the electricity bill, miners would usually sell their awarded coins for fiat money, which would lead to a downward movement in the price of the cryptocurrency.
The proof of stake (PoS) seeks to address this issue by attributing mining power to the proportion of coins held by a miner. This way, instead of utilizing energy to answer PoW puzzles, a PoS miner is limited to mining a percentage of transactions that is reflective of his or her ownership stake. For instance, a miner who owns 3% of the Bitcoin available can theoretically mine only 3% of the blocks.
The Proof Of Stake algorithm uses a pseudo-random selection process to select a node to be the validator of the next block, based on a combination of factors that could include the staking age, randomization, and the node’s wealth.
It’s good to note that in Proof of Stake systems, blocks are said to be ‘forged’ rather than mined. Cryptocurrencies using Proof of Stake often start by selling pre-mined coins or they launch with the Proof of Work algorithm and later switch over to Proof of Stake.
Where in Proof of Work-based systems more and more cryptocurrency is created as rewards for miners, the Proof-of-Stake system usually uses transaction fees as a reward.
Users who want to participate in the forging process, are required to lock a certain amount of coins into the network as their stake. The size of the stake determines the chances for a node to be selected as the next validator to forge the next block – the bigger the stake, the bigger the chances. In order for the process not to favor only the wealthiest nodes in the network, more unique methods are added into the selection process. The two most commonly used methods are ‘Randomized Block Selection’ and ‘Coin Age Selection’.
In the Randomized Block Selection method the validators are selected by looking for nodes with a combination of the lowest hash value and the highest stake and since the size of stakes are public, the next forger can usually be predicted by other nodes.
The Coin Age Selection method chooses nodes based on how long their tokens have been staked for. Coin age is calculated by multiplying the number of days the coins have been held as stake by the number of coins that are staked. Once a node has forged a block, their coin age is reset to zero and they must wait a certain period of time to be able to forge another block – this prevents large stake nodes from dominating the blockchain.
Each cryptocurrency using Proof of Stake algorithm has their own set of rules and methods combined for what they think is the best possible combination for them and their users.
When a node gets chosen to forge the next block, it will check if the transactions in the block are valid, signs the block and adds it to the blockchain. As a reward, the node receives the transaction fees that are associated with the transactions in the block.
If a node wants to stop being a forger, its stake along with the earned rewards will be released after a certain period of time, giving the network time to verify that there are no fraudulent blocks added to the blockchain by the node.
The stake works as a financial motivator for the forger node not to validate or create fraudulent transactions. If the network detects a fraudulent transaction, the forger node will lose a part of its stake and its right to participate as a forger in the future. So as long as the stake is higher than the reward, the validator would lose more coins than it would gain in case of attempting fraud.
In order to effectively control the network and approve fraudulent transactions, a node would have to own a majority stake in the network, also known as the 51% attack. Depending on the value of a cryptocurrency, this would be very impractical as in order to gain control of the network you would need to acquire 51% of the circulating supply.
The main advantages of the Proof of Stake algorithm are energy efficiency and security.
A greater number of users are encouraged to run nodes since it’s easy and affordable. This along with the randomization process also makes the network more decentralized, since mining pools are no longer needed to mine the blocks. And since there is less of a need to release many new coins for a reward, this helps the price of a particular coin stay more stable.
It’s good to remember that the cryptocurrency industry is rapidly changing and evolving and there are also several other algorithms and methods being developed and experimented with.
Why would I want to stake my ETH?
For staking your ETH and attesting to correct blocks, you will be rewarded with additional ETH through a network wide interest rate as well as receive a portion of network transaction fees.
What are the minimum requirements to stake?
- A minimum of 32 ETH per validator
- Computer with sufficient hardware specs
- Internet connection
What software do I need to run to stake?
There are two main types of software to be aware of when considering staking on Ethereum:
- Beacon nodes: This is the hub for your validators.
- Stores canonical state, handles peers and incoming sync, propagates blocks and attestations.
- Has a gRPC server that clients can connect to and provides a public API.
- Validator clients: Talks to your beacon node and signs blocks. You can have multiple of these at 32 ETH each.
- Stores important secrets such as RANDAO reveal, proof of custody for shared data, and BLS private key.
- Can swap underlying beacon nodes efficiently.
- Tracks shared state execution data and data blobs that the validator has signed.
This means that there are three possible combinations of software to run:
- Beacon node only
- Beacon node + validator client
- Beacon node + multiple validator clients
What happens if I lose my internet connection while staking?
The key to being a validator is to ensure that you are consistently available to vote for blocks which in turn secures the network. Therefore, there is a slight penalty if your validator client goes offline at any point, in order to encourage validator availability. There are two scenarios where this can happen:
- If blocks are finalizing and you’re offline, you can lose x% of your deposit over a year where x=current_interest
- For example, if the current interest rate is 5%, you would lose 0.0137% of your deposit every day, but gain that for every day you’re online.
- If blocks aren’t finalizing (33% of validators are offline) and you’re offline, you can lose 60% in 18 days.
If at any point your deposit drops below 16 ETH you will be removed from the validator set entirely.
How long is my Ether locked up if I stake?
There is a withdraw queue that you are placed into when wanting to withdraw ETH from your validator. If there is no queue, then the minimum withdraw time is 18 hours and adjusts dynamically depending on how many people are withdrawing at that time.
Proof of Stake on Ethereum 2.0
Ethereum 2.0 is a Proof of Stake chain that will go live in phases, starting with Phase 0 in 2020. Phase 0 of Ethereum 2.0 will launch what is called the beacon chain, which will establish and maintain the Proof of Stake consensus mechanism.
In Ethereum 2.0, the PoS consensus mechanism will require validators to stake 32 ETH to run a validator node on the network. Each time a block is set to be proposed, at least 4 and up to 64 random committees of 128 validator nodes will be selected from the entire pool of validators to attest the block.
In order to become a validator on Ethereum 2.0, validators will deposit 32 ETH into the official Ethereum 2.0 deposit contract, which has been developed and released by the Ethereum Foundation. Validators will need to stake 32 ETH for each validator node they wish to run. (This is provably secure, and there is less than a 1 in a trillion chance that an attacker controlling 1/3 of the validators on the network would control ⅔ of the validators in a committee to successfully execute an attack).
In Phase 0 of Ethereum 2.0, rewards for proposing and attesting will not be distributed to validators until the minimum threshold of staked ETH and committed validators is reached to launch the network. The network will require at least 524,288 ETH to be staked, divided among at least 16,384 validator nodes. Once the threshold is live and the genesis block is created, rewards will begin to be distributed to validators.
Proof of work
Proof of work is a form of cryptographic zero-knowledge proof in which one party proves to others that a certain amount of computational effort has been expended for some purpose.
What are the benefits of Proof of Stake over Proof of Work?
- No need to consume large quantities of electricity in order to secure a blockchain. (It’s estimated that both Bitcoin and Ethereum burn over $1 million worth of electricity and hardware costs per day as part of their consensus mechanism.)
- Because of the lack of high electricity consumption requirements, there is not as much need to issue as many new coins in order to motivate participants to keep participating in the network. It may theoretically even be possible to have negative net issuance, where a portion of transaction fees is “burned” thus decreasing the supply over time.
- Proof of Stake opens the door to a wider array of techniques that use game-theoretic mechanism design in order to more effectively discourage centralized cartels from forming and, if they do form, from acting in ways that are harmful to the network (such as selfish mining in Proof of Work).
- Reduced centralization risks, as economies of scale, are much less of an issue. $10 million of coins will get you exactly 10 times higher returns than $1 million of coins, without any additional disproportionate gains because at the higher level you can afford better mass-production equipment, which is an advantage for Proof of Work.
- Ability to use economic penalties to make various forms of 51% attacks vastly more expensive to carry out than Proof of Work. To paraphrase Vlad Zamfir, “it’s as though your ASIC farm burned down if you participated in a 51% attack”.
Finding Solutions with Proof of Stake
Proof of Stake is a different kind of consensus mechanism blockchains can use to agree upon a single true record of data history. Whereas in PoW miners expend energy (electricity) to mine blocks into existence, in PoS validators commit stake to attest (or ‘validate’) blocks into existence.
Validators are the participants on the network who run nodes (called validator nodes) to propose and attest blocks on a PoS blockchain. They do so by staking crypto (in the case of Ethereum 2.0, ETH) on the network and make themselves available to be randomly selected to propose a block. Other validators then “attest” that they have seen the block. When a sufficient number of attestations for the block has been collected, the block is added to the blockchain. Validators receive rewards both for successfully proposing blocks (just as they do in PoW) and for making attestations about blocks that they have seen.
The crypto-economic incentives for PoS are designed to create more compelling rewards for proper behavior and more severe penalties for malicious behavior. The core crypto-economic incentive boils down to the requirement that validators stake their own crypto––i.e. money––on the network. Instead of considering the secondary cost of electricity to run a PoW node, validators on PoS chains are forced to directly deposit a significant monetary amount onto the network.
Validators accrue rewards for making blocks and attestations when it is their turn to do so. They are penalized for not following through with their responsibilities when it is their turn to do so – i.e. if they are offline. Penalties for being offline are relatively mild and equate to about the same as the expected rewards over time. So, if a validator is participating correctly more than half the time then her rewards will be a net positive.
Should a validator attempt to attack or compromise the blockchain by trying to propose a new set of data history, however, a different penalty mechanism kicks in: a substantial portion of their staked amount will be slashed (possibly up to the whole amount of stake) and they will be ejected from the network. The result is a tremendous financial risk of a failed attack by a validator. To draw an analogy to PoW, it would be as if a miner who failed an attack on a PoW chain was forced to burn down her entire mining rig instead of just eating the cost of the electricity she spent on a failed attack. Furthermore, this architecture places the security of the network directly in the hands of those maintaining the network and holding its native crypto-asset in the protocol itself..
Proof of Stake addresses the three issues of PoW chains discussed earlier – accessibility, centralization, and especially scalability:
Accessibility: Proof of Stake blockchains do not require validators to worry about the initial hardware costs or pay attention to electricity rates in the same way miners on PoW chains must. It is, therefore, a significantly lower barrier to entry for an individual to run a validator node on a PoS chain than run a mining node on a PoW chain. There is, however, a notable barrier to accessible entry for PoS. Validators must stake a minimum amount of crypto to run a full validator node. For Ethereum 2.0, for example, this amount is 32 ETH ($6,500 at the time of writing). For many, that is a significant amount of money and a deterrent to active participation. In the same way, PoW chains have mining pools, however, there will be staking pools that aggregate the funds of participants unable or unwilling to stake 32 ETH. The pool will stake on their behalf, and they will receive rewards as a percentage of their stake.
Centralization: With reduced barriers to entry and the elimination of concerns about minimizing electricity costs, PoS networks are significantly more decentralized at the node level than PoW networks. Participation in a PoS chain requires only a non-zero amount of crypto, an internet connection, and a computer (or phone/tablet). That opens up the doors of participation and revenue generation to a much larger group of people. Additionally, economies of scale are far lower in PoS economics than PoW. In PoW systems, the more hash power a miner controlled, the greater the % of rewards he would be able to receive. In PoS, a validator’s % return stays constant whether she manages 1 node or 1,000.
Scalability: Proof of Stake alone does not improve scalability. However, PoS architectures allow the implementation of a scalability solution known as sharding without reducing security. Sharding is a database scaling mechanism in which a blockchain is partitioned into multiple shard chains, each of which is capable of processing blocks. This relieves the blockchain from having to process each block simultaneously, and instead allows multiple blocks (and, in other words, more sets of data) to be processed all at once. With Ethereum 2.0, for example, sharding will partition the blockchain into 64 separate shard chains, meaning the network will process transactions at a minimum of 64x the transaction speed of the original PoW chain.