ELI5: What is proof of work vs. proof of stake?

The short version:

• Proof of work and proof of stake are both methods of validating and storing crypto transactions without the need for a central authority.
• In proof of work, computers race to solve complex puzzles first and “earn” the right to validate the next block of data, generating crypto as a reward. It works well, but it’s immensely power-intensive.
• Proof of stake is more like a lottery system, where a computer is randomly selected to validate the next block of data – so there’s no need to compete on processing power.

Meet Your Retirement Goals Effortlessly

The road to retirement may seem long, but with WiserAdvisor, you can find a trusted partner to guide you every step of the way

WiserAdvisor matches you with vetted financial advisors that offer personalized advice to help you to make the right choices, invest wisely, and secure the retirement you've always dreamed of. Start planning early, and get your retirement mapped out today.

Get Started

ELI5: What is a consensus mechanism?

Proof of work and proof of stake are both consensus mechanisms that keep things organized on the blockchain.

So let’s start with what that means, and why a consensus mechanism is so important.

Say you live in an ancient society with no computers, but you still want to track who has how much money at a given time. Carrying around 1,000 gold coins with you isn’t safe or practical, so you all agree to put your money in the bank and let the bank track everyone’s money.

Joe is in charge of the bank. Soon, he gets greedy. He gives himself money, deletes records of his own spending, and more. In short, he abuses his power as the central authority in charge of the money.

Eventually, you and your neighbors discover what Joe is doing and the whole system falls apart. Clearly, you can’t trust a single person to handle all of the logs.

What you need is a public record

So you get together and decide that what's needed is a public record of everyone’s wealth. All the information is out in the open and can’t be so easily manipulated by one person or entity**.** After feeding Joe to the lions, you erect a giant stone tablet in the town square.

Any time someone spends money, they etch a record of it onto the stone tablet for everyone else to see. And since every transaction record is literally set in stone, it can’t be edited or manipulated by one person without everyone else noticing and raising a stink.

The giant stone ledger works. People trust it because everyone sees the same records in real-time and they can’t be manipulated. Since it’s helped to achieve consensus among everyone in the monetary system, the stone tablet is a great consensus mechanism.

Now, a stone tablet works great if everyone is in the same physical location. But what if there are hundreds of millions of users worldwide?

How do you:

• Validate new transactions,
• Share the new, updated ledger to everyone in the world, and
• Do both in real time?

That brings us to the two main consensus mechanisms for cryptocurrency: Proof of Work and Proof of Stake.

Stop overpaying for home insurance

Home insurance is an essential expense – one that can often be pricey. You can lower your monthly recurring expenses by finding a more economical alternative for home insurance.

SmartFinancial can help you do just that. SmartFinancial’s online marketplace of vetted home insurance providers allows you to quickly shop around for rates from the country’s top insurance companies, and ensure you’re paying the lowest price possible for your home insurance.

Explore better rates

ELI5: What is proof of work (PoW)?

Here’s another scenario: Let’s say you send your friend Carly $100 worth of Bitcoin.

In a POW system, powerful computers around the world race to be the first to add your transaction data to the blockchain.

But even with a giant underground bunker full of computers (this is commonly referred to as a “mine”), validating and adding data to the blockchain can still take a while because it’s such a complex process. Miners do it because they’re rewarded in Bitcoin by the blockchain for being the first to validate a transaction.

In this scenario, once your data is added, the winning computer turns around to all the other computers on the blockchain and says “Y’all good with this? Chris sent Carly $100 worth of Bitcoin?”

All the other computers nod. “Looks good,” they say. “Send us the new block and we’ll add it to our master record.”

“Hold up,” says Carly’s computer. “Actually, he sent her $150 worth of Bitcoin.”

But since Carly’s computer is the only one in the world who disagrees, the rest of the computers say “Nah, fam. Not a chance.”

The only way Carly could “hack” the proof of work blockchain is to win the vote. In theory, she could do this by amassing 51% of the computer power (aka voting power) of the entire blockchain.

For Bitcoin, this would require tens of billions of dollars worth of computers and electricity. But on smaller blockchains, “51% attacks” are still a real threat.

Here’s proof of work in a nutshell:

1. Computers race to validate and add transactions to the blockchain
2. They then turn around to secure the “vote” with all the other computers
3. The new, updated ledger is shared with everyone

However, the big issue facing proof of work right now is that the blockchain has become so long — and the competition to validate new transactions so fierce — that the whole system requires way, way too much power and electricity to maintain.

Seeing the writing on the wall, crypto innovators came up with proof of stake just two years later in 2011.

ELI5: What is proof of stake (PoS)?

The biggest issue with proof of work is that it’s objectively wasteful. By rewarding the biggest, baddest computers in town, it created a need for everyone to keep buying and building faster computers. This led to a global shortage of computer parts and rolling blackouts.

But in a proof of stake system, the “miners” don’t have to compete and out-compute each other to validate transactions.

Instead, the blockchain chooses a “miner” at random to validate the next transaction. So in essence, proof of stake is more like a lottery system than a competition. Technically speaking, the computers (aka “nodes”) chosen are called “validators,” not “miners” in proof of stake.

Your chances of being chosen to validate a transaction — and win some crypto as a reward — aren’t entirely random. For starters, in order to qualify as a validator in the first place, you have to make a minimum deposit of crypto into the blockchain, where it’s held as sort of a “security deposit.”

For example, they say the minimum deposit amount to qualify as a validator in the upcoming Ethereum 2.0 blockchain will be 32 ETH. Not to worry if you don’t have 32 ETH lying around — the staking minimums for other blockchains are much lower, like $1 worth of SOL or ADA.

But even if you have $1 worth of SOL, your chances of being chosen to validate a transaction are going to be super low. That’s why most people stake their crypto via giant pools through their chosen exchange.

If you stake through a huge exchange like Crypto.com, the pool will win random contracts pretty often and Coinbase will regularly distribute payouts to everyone who staked inside the pool. This payout comes in the form of regular interest payments, which is why staking is often likened to the crypto world’s high-yield savings account.

Read more: Crypto staking and lending: everything you should know

What are the key differences?

Now we know:

• Proof of work is using brute force to validate and add transactions to the blockchain, and
• Proof of stake is using a lottery system that’s way less energy-intensive.

But the differences between proof of work and proof of stake don't end there. Here are a few more.

Energy efficiency

The biggest and subjectively most crucial difference between proof of work and proof of stake is the amount of electricity they consume.

Bitcoin alone now consumes more energy than the whole of Argentina. It releases 65 megatons of C02 annually, more air pollution than all of Greece.

Meanwhile, when Ethereum migrates from proof of work to proof of stake, the new Ethereum 2.0 network will consume 99% less energy.

Equipment

The next key difference between the two crypto consensus mechanisms is the hardware required to maintain the blockchain.

Proof of work requires giant “crypto mines” or “farms” full of computers all competing with similar mines around the world to validate transactions first and earn more rewards.

But since proof of stake chooses validators based on the amount of crypto they deposit — not their computer processing muscles — the world’s biggest staking pool can be run from a work laptop in an internet cafe.

Processing speed

Proof of work presents a complex puzzle to a world of miners and rewards whomever figures it out first. That process can be slow and intensive.

Proof of stake, on the other hand, simply picks a winner and gives them homework, rapidly accelerating transaction speeds.

All told, when Ethereum migrates to PoS, its transaction speed is expected to jump from 15 transactions per second to as high as 100,000.

Related>>Ethereum 101: Everything you need to know about investing in ETH

Traceability

One of the core tenets of crypto is decentralization. This goes all the way back to Satoshi Nakamoto’s original Bitcoin whitepaper/manifesto. No one — whether it’s an individual or an entire government — should be able to control, manipulate, or suppress this new form of currency.

Predictably, China wasn’t a fan. The Middle Kingdom banned mining and trading in 2021. And within just a few months, China’s share of global mining went from around 70% to 0%.

A big reason why Chinese authorities were able to snuff out mining so quickly is because crypto mines are easily detectable on the power grid. But again, since PoS cryptos use less power than a toaster, they’re significantly harder to detect — and may contribute to a revival of China’s crypto industry.

Scalability

There’s an ongoing debate as to whether proof of work or proof of stake is more scalable in the long term.

At first glance, proof of work isn’t scalable at all. Bitcoin alone is already consuming 0.5% of the world’s electricity, and that’s with “just” 114 million users worldwide.

But proof of work aficionados will say that experimental upgrades like the Lightning Network will address power consumption issues — and that proof of stake is still too untested to scale up too quickly.

All things considered, the jury’s still out on scalability.

Resources required to “hack” it

Both PoW and PoS blockchains are vulnerable to 51% attacks; the only difference is what you need to hack it.

To hack a proof of work blockchain,

you need to control 51% of the total computing aka mining power supporting that blockchain. So not just a ton of computer power, but also a ton of electricity. But this also makes Bitcoin very secure.

To hack a proof of stake blockchain,

you’d need to control 51% of the total deposited aka staked crypto in that blockchain.

Some say that PoS blockchains are psychologically more secure since the hacker would have to own most of the crypto in that blockchain before stealing from it. In other words, if you gain a 51% stake of a PoS blockchain, you're the person who be most hurt by stealing from effectively destroying its value.

The bottom line

If the granular details and difference between proof of work and proof of stake still fly over your head, you’re not alone. The key takeaway is this: crypto is inefficient but it doesn’t have to be.

Proof of stake just might be the Tesla to proof of work’s Hummer. It’s a quantum leap forward, ensuring a future for the technology as a whole.

Learn more:

• What Is Web3 And why should investors care?
• The ABCs of cryptocurrency: A glossary of common crypto terms
• NFT funds are coming: What investors need to know
• Biden’s crypto executive order: What’s in It?