Proof of Stake explained

The Proof of Stake (PoS) consensus mechanism is gathering a lot of attention since Ethereum announced that it is in the process of moving from PoW to PoS. In this article we will explain in layman’s terms what PoS is, how it’s secure, and why businesses are moving more to this framework.

Vitalik Buterin shared this update on Github, proposing a transition to PoS. Justin Drake, a researcher at the Ethereum Foundation, followed up with Buterin’s post on Github and explained the rationale behind the proposal. Targeting 2^25 ETH at stake (~32M ETH) for the long term will enhance security and it will reduce base inflation to ~1% and the base return to ~3.2%. Thus, with an ambitious 32 Million Ether staked, Ethereum’s 1% inflation rate will rival that of Bitcoin’s, which currently sits at 3.94%.

What is Proof of Stake?

Proof of Stake is a mechanism for transaction verification on a blockchain network. A PoS system requires users to show ownership of a certain number of cryptocurrency units for creating a new block. Users are chosen in a pseudo-random way, depending on their stake. Blocks are forged or created and not mined, unlike PoW system which involves mining. Thus, users who forge or create new blocks are termed as forgers.

The number of cryptocurrencies, ie. total supply, is fixed right from its launch in most cases. Coins with no fixed supply can inflate circulation by rewarding forgers with new currency units as rewards.

What makes PoS secure?

Forgers stake their holdings for validating transactions. This is similar to depositing funds in an escrow account. If forgers validate fraudulent transactions, they lose their holding that was kept as “stake”. Additionally, they also lose the right to participate as a forger in the future. Thus, staking their holdings enables forgers to partake in the forging process. Their stake motivates them to validate right transactions.

Coins that adopt PoS either have an ICO or begin with PoW and then move to PoS, as this system does not provide a way to handle initial distribution of tokens.

Popular cryptocurrencies running on PoS are Dash, NEO, Neblio, Qtum, Lisk, Nxt, and Peercoin.

How are forgers selected?

Forgers staking a high percentage of their holdings would have an advantage over others. To overcome this, forgers are not selected by the size of their stake. Instead, several unique methods of selection have been created. The most popular of these methods are the ‘Randomized Block Selection’ and the ‘Coin Age Based Selection’ methods.

• Randomized block selection – A formula looks for the user with the combination of the lowest hash value and the size of their stake for selecting the next forger. Since the size of the stakes are public, and each node can correctly predict which user will forge the next block.
• Coin Age based selection – This method selects a forger based on what is the duration for which the forger has staked his holdings. Coin age is calculated by multiplying the number of days the cryptocurrency coins have been held as stake by the number of coins that are being staked. Coins must have been held for a minimum of 30 days before they can compete for a block. Users who have staked older and larger sets of coins have a greater chance of being assigned to forge the next block. Once a user has forged a block, their coin age is reset to zero and then they must wait at least 30 days again before they can sign another block. The user is assigned to forge the next block within a maximum period of 90 days, this prevents users with very old and large stakes from dominating the blockchain thereby making the network more secure. In this method of selection, forgers can create blocks more frequently.

How are the rewards paid out to forgers?

Coins set a target interest rate, which users can expect to earn from the staking process. This rate is also the maximum rate at which the currency supply is inflated over time.

PoS vs. PoW

PoW systems have an adverse effect on the environment due to their high consumption of electricity. PoS is more environmentally friendly, efficient and has lower associated costs. A greater number of people are encouraged to run nodes and get involved because it is easy and affordable to participate in this system; this results in more decentralization.

While every cryptocurrency using the PoS system has a unique set of rules and provisions, this guide is an overview of general PoS systems. Additionally, in this rapidly evolving industry, several other methods of transaction verification and block creation are being tested every day. Most coins running on the PoW system, like Ethereum, are now moving to PoS owing to environmental concerns and a race to build a larger community and increase demand in the community.