Ethereum: Proof of Work vs Proof of Stake

What is Ethereum?

Proposed in 2013 by Vitalik Buterin and launched in 2015, Ethereum is a decentralized open source blockchain platform that allows developers to build decentralized applications, also known as DApps, that run on its network.While Bitcoin was designed primarily to allow secure and anonymous decentralized transactions, Ethereum offers additional functionality in the sense where it is programmable: It enables the development of smart contracts—self executing agreements that can automate the transfer of crypto assets and other actions based on predefined conditions. 

Transactions and payments are conducted on the Ethereum blockchain using its native cryptocurrency, Ether, which serves as a store of value and is traded on various cryptocurrency exchanges. Ether has gained significant traction in recent years, with the second biggest market capitalization behind Bitcoin.

Initially, the blockchain relied on a Proof of Work system (PoW), similar to what Bitcoin still uses today, which compensated miners for solving complex mathematical puzzles. The process incentivised users to invest in powerful computers, which consumed significant amounts of energy, negatively impacting the environment. This raised concerns over the sustainability of cryptocurrency mining, denouncing its negative externalities and long term impacts.

Proof of Work (PoW) 

Proof of Work is a blockchain census protocol in which minors receive compensation, generally in the form of transaction fees, for validating transactions on the blockchain. Bitcoin is the most popular cryptocurrency to utilize a proof of work model. When a token is sent from one wallet to another, the underlying software creates a transaction that gets broadcasted to the network. Miners then have the responsibility to validate these transactions by solving complex mathematical problems on the blockchain, which often require powerful computational hardware to be executed. Once validated, a block of assembled transactions is accepted and verified by other miners. 

The biggest drawbacks to a proof of work census protocol are transaction speed and energy inefficiency. The PoW system is slow to accommodate the sheer volume of transactions on the network, resulting in congestion and slow processing. In addition to high electricity bills, a miner is incentivised to invest in expensive computers to keep up with the ever rising demand for computing power. The average individual most certainly cannot be a miner and therefore cannot participate in securing the network.

Proof of Stake (PoS) 

Proof-of-Stake (PoS) is an alternative consensus mechanism to Proof of Work, used to verify transactions, add blocks, and ensure the security of transactions. While PoW utilizes entities called “miners” to solve for a hash number, PoS utilizes entities called “validators” to own the said tokens for the right to own transaction fees. In the PoS system, validators are randomly selected to confirm a transaction based on the weight of their stake. The held token is placed in collateral, and the validator is then awarded a transaction fee off the validated block.

One complementary function enabled by the PoS system is sharding, a technique that enhances the performance of the blockchain and its capacity to process transactions at a larger scale. The practice consists of dividing the blockchain into smaller partitions to handle a greater number of transactions on the overall network. Sharding is facilitated by the implementation of PoS which, by reducing energy consumption, allows for more nodes to function simultaneously on the blockchain. This division also enables the blockchain to process several transactions in parallel, reducing congestion and significantly increasing the output of the network. 

However, the PoW system is more proven in terms of security. Validators in a PoS system with extremely large holdings could gain excessive influence over the verification process. Another con of the PoS system is that some currencies relying on the PoS system require collateral to be locked for a specific amount of time, creating liquidity a concern for investors. 

While PoS has its pros and cons, it is generally regarded as the better choice as the more eco friendly and cheaper alternative, sparing users from the heavy expenses related to energy consumption and investments in computing hardware. 

The Merge

To address the issue, drastic changes had to be executed on the Ethereum blockchain. On September 15, 2022, PoW was replaced with a newly established Proof of Stake (PoS) system, which does not require significant computational power. Instead, users are chosen randomly based on the amount of their stake to validate new blocks on the Ethereum network. They are then compensated for their work with newly minted ETH for validating the transactions.

This process came to be known as “The Merge”, which consisted of joining the previously existing Ethereum mainnet with its new PoS consensus layer, Beacon Chain. The adoption of the Beacon Chain is a crucial upgrade in the development of the Ethereum blockchain, improving its potential for scalability, security and functionality. This execution by the Ethereum team virtually eliminated the need for mass computing power, reducing its energy consumption by a remarkable 99.95%.

Conclusion 

Overall, Ethereum’s shift from a Proof of Work to a Proof of Stake system in September 2022 is a major deal in the realm of Blockchain and a big step forward for the internet of transactions. And while issues of influence and liquidity are yet to be addressed, the new system enhances scalability, efficiency and security on the Blockchain, while simultaneously eliminating the negative externalities associated with cryptocurrency mining. This breakthrough is therefore paving the way for a greener and more sustainable adoption of blockchain and decentralized technologies, reshaping the world of business and transactions. 

Authors: Ghassan Jisr, Omer Kervanci, Joe Henry