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WHAT IS 'PROOF OF STAKE' IN BITCOIN?

PROOF OF STAKE IN BITCOIN

April 29, 2021 | 

730 Views | 

JOHN K MWANIKI | 

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Bitcoin is enjoying immense popularity and celebrating its record run. The investment sector has recognized bitcoin as a genuine asset traded widely by many retail consumers and institutional investors. However, many of the challenges of cryptocurrencies remain.

One of the biggest challenges of cryptocurrencies is scalability and proof of work algorithms. Some cryptocurrencies, notably Ethereum, have recognized these problems and are looking to adopt an alternative in proof of stake.

Currently, users anticipate the significant migration of Ethereum to proof of stake mechanism of adding new blocks to the blockchain that uses less electricity and way less work. Bitcoin's migration to proof of work is not yet planned, but many analysts predict that once Ethereum proves the technology, bitcoin will adapt to it as well. It might prove to be a superior system to the proof of work bitcoin relies on.

Consensus is key

Basically, when a regular database processes a transaction, it relies on a centralized system that helps to secure the system and mitigate fraudulent transactions, for instance, a bank.

However, bitcoins are decentralized, which means they have to find another way to validate transactions. So they use blockchain technology to group transactions into blocks and then have a way to prevent users from spamming the system with fake transactions or spending coins they don't hold in their wallets. Bitcoin uses proof of work that involves using computers to solve complex math to confirm the validity of a block.

How the proof of stake works

Proof of stake came as an alternative to proof of work (PoW), the original consensus algorithm in blockchain technology used to validate transactions and add new blocks to the blockchain. In PoW, the right to create new blocks is given to miners with the computational power to solve complex cryptographic puzzles. The downside is that it requires huge amounts of electricity to support the network's security.

Some miners have to sell their coins to meet the high energy costs and computational power for mining bitcoins which is a significant drawback. Due to that, alternative protocols like proof of stake have been developed to address that problem. PoS gives miners mining power depending on the number of cryptocurrencies they hold.

Unlike PoW, whereby miners compete to solve a puzzle, earn a block and get bitcoins as a reward, in PoS, a validator to add a new block in the blockchain is selected from a pool of miners based on a predetermined algorithm or randomly depending on the cryptocurrency. In some PoS systems, a miner may have higher chances of being selected if they have a high amount of staked coins in the network.

How the proof of stake addresses the problem of mining power

Bitcoin mining requires high computing power for a miner to run various cryptographic calculations and solve computational challenges. The computing power needs a high amount of electricity and mining power for proof of work.

Proof of stake aims to solve mining power by attributing the mining power to the proportion of coins a miner holds. Rather than using high energy to solve PoW puzzles, a miner on the PoS blockchain is limited to only a percentage of transactions that reflect their ownership stake. For example, a miner who owns 5% of the available coins can only mine 5% of the blocks.

Risks of network attack

Bitcoin uses a PoW mechanism and may be prone to the tragedy of commons. This means a future point when there will be a small number of bitcoin miners because of little or no block reward from mining. The only fees miners earn will come from transaction fees that will also reduce overtime because users prefer to pay lower transaction fees.

When the network has fewer miners than required to mine coins, it becomes susceptible to a 51% attack- a miner or mining pools control 51% of the computational power in the network and fraudulently creates blocks for themselves while invalidating the transactions of other miners on the network.

On the other hand, in PoS, an attacker would have to obtain 51% of the coins to carry out the 51% attack. But PoS solves this problem by making it less advantageous for a miner with 51% to attack the network. First of all, it isn't easy to accumulate 51% of a reputable digital coin. Secondly, it is not in the best interest for a miner with a 51% stake to attack a network in which they hold the most significant share. If the value of the coin drops, that means they lose the majority of their holdings so, they are more incentivized to maintain a secure network.

Scalability 

For a low number of transactions, PoW works well, but the problem comes in when the transaction volume increases. With a large number of blocks and miners competing, transaction times and costs increase.

The easiest method to solve the problem of slow transactions, which hinders scalability is to change the process of confirming transactions which proof of stake does. PoS uses cryptocurrency to mitigate numerous transactions. Stakers put their cryptocurrency in nodes that provide the collateral to compete in adding a new block to the chain in exchange for a transaction fee as a reward.

That prevents many unverified transactions from entering the blockchain at the same time and caters to the same network security as PoS at a less computational cost.

CONCLUSION

Many users wonder why bitcoin is still using proof of work. Unlike Ethereum that has a pressing need to process a large number of transactions, the bitcoin community doesn't have any urgent need to implement a significant change to its network, not without seeing it in action first. 

Apart from scalability, what will happen when all bitcoin is mined? That will reduce the miner's payout and increase transaction fees, undermining bitcoin's viability. Miners might finally see that a PoS protocol provides a more sustainable means for ensuring transactions can still be processed.

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