If you have ever delved deeper into the world of cryptocurrency than the surface, you’ve no doubt noticed that there are several different concepts underpinning how the various cryptocoins out there function. Two of the most common consensus algorithms are proof of work (PoW) and proof of stake (PoS), sometimes called dedicated proof of state (DPos). What do these terms mean and how do they differ? What do they mean for you, as someone interested in building your wealth through cryptocurrency?
What Is a Consensus Algorithm?
A consensus algorithm is nothing more than a tool used within the world of cryptocurrency (and data science as a whole) to ensure that agreement has been reached on a single data value as applied to a distributed network, such as the distributed ledger that is blockchain technology. In short, it’s a means of verifying that all parties in the network are in agreement about the value of the data in question, and that the value is accurate.
Proof of Work
The proof of work consensus algorithm is the oldest in existence, and it is what supports bitcoin hosting, as well as numerous other altcoins that rely on the same model. Proof of work is what enables mining to occur in the first place – without the proof of work algorithm, there would be no way for mining to occur, and no way to build profit from the process. In proof of work, the algorithm validates that the work occurred, and that the result of the work was accurate.
In the case of bitcoin and many other cryptocoins, that work is solving an expansive mathematical problem. The validation is ensuring that the answer is correct. The result is the discovery of a new block, and the reward of bitcoins (or other altcoins) given to the miner or pool responsible for finding the block.
With that being said, proof of work has some drawbacks. For instance, the mining process requires significant energy to be expended, which comes at a financial cost, as well as a cost to the environment. There is also the fact that building a mining rig can be very expensive, and that the share of coins will eventually drop as more and more miners get into the act.
Proof of Stake
Proof of stake is another consensus algorithm growing in popularity. It works very differently from proof of work, though. In this situation, the validator (who would be the miner in a proof of work setup) is chosen based on the size of the stake he or she has in the cryptocurrency. The more stake they have, the greater the chance that you will be named the validator of the next block. Proof of stake is also based on the age of your stake. The older the stake, and the larger the stake, the greater the chance of being named the validator.
The drawback to this system is the possibility for a few entities to ultimately control the future of the cryptocurrency mining industry and dominate block validation. Another drawback here is that mining is not possible, which means that the only ways to build wealth from these altcoins is through buying and selling, or trading through cryptocurrency exchanges.
Of course, there are some benefits to the proof of stake method. For instance, there is no need to build expensive mining rigs, and no excess draw on the power grid. Validations are faster with PoS setups, and validators are more loyal to individual coins.
Ultimately, both PoW and PoS have a role to play in cryptocurrencies, and both offer pros and cons. The ultimate winner remains to be seen.