Chain Research — Decrypting PoW and PoS

When Bitcoin mined its first Genesis Block in 2009, it was accomplished using the “Proof-of-Work” consensus mechanism. Proof-of-Work, often referred to as “PoW”, is a secure computing system implemented by several blockchains including Bitcoin and Ethereum. When running a blockchain network, each block needs validation by a set of nodes. Nodes are paramount in a blockchain network because they ensure the data integrity of each transaction. Using secure hashing algorithms, there is no way to reverse a transaction once it is broadcast to the network for verification. This is what gives blockchain technology the reputation for being an immutable ledger. Using computational power, each block on the blockchain is validated by using an intense mathematical process to verify the block, and add it to the chain of existing blocks. This process is known as mining. Miners who participate in validating new transactions on the blockchain’s distributed ledger are rewarded in freshly minted cryptocurrencies for contributing their resources to the peer-to-peer (P2P) network.

Hal Finney built the modern Proof-of-Work system, and was also the first recipient of Bitcoin. He originally intended to use ‘Reusable PoW’ for tackling spam emails. Nick Szabo, a researcher who worked closely with Finney, discovered that the Reusable PoW model could be used as a trustless payment system, and coined the term ‘bit gold’. Szabo suggested that digital currency “could even serve as the foundation for a sort of payment system, playing the role in the informational world of gold in the physical world.”

First tweet about Bitcoin by Hal Finney, Software Developer and Early Crypto Pioneer

Environmental Concerns with PoW

There is no limit on how many mining set-ups an individual can own. In recent years, the rewards for GPU mining have dropped considerably. This could be due to a number of factors: an influx of miners on the network, the price of equipment and electricity, and the price of the cryptocurrency itself. Miners receive constant backlash from regulators and environmentalists because mining requires high-levels of energy consumption. Although carbon footprints vary throughout regions, miners require intense energy requirements (which can be supplemented through renewable resources), and competitive mining computers (rigs). Bitcoin originally was mined on CPUs, but as technology advanced into tinier and more powerful computer graphics cards, the difficulty of equations on the network increased as well. This leads to greater competition among miners, which in turn, increases the scarcity of the cryptocurrency.

There are other alternatives that exist beyond the PoW mechanism that are used to verify network transactions. Another method to ensure the decentralized and immutable record of the blockchain is staking.

How does PoS differ from PoW?

Proof-of-Stake works like this: a set of nodes, known as ‘stakers’, choose to stake their own digital assets as collateral for validating transactions on the blockchain. Since the coins are already created, there is no need for ‘mining’ them. This eliminates a need for advanced machines solving complex cryptographic puzzles. It also solves the issue of surging energy costs.

Validators are rewarded by their stake in network fees, instead of newly minted tokens. The collateral a staker puts down tends to be locked/frozen for a certain amount of time, and cannot be transferred. The greater amount of staked assets, and the longer its duration, the higher chance the staker has of participating as a network validator.

Stakers are also warned about the risks of getting penalized in a form of ‘slashing’, for misbehaving on the network. If a validator is charged for inactivity, dishonest validations, or any type of malicious behavior they are at risk of a slashing penalty. “The penalty may vary from being charged a fixed amount of tokens, a fixed percentage, complete slashing of the stake and banning the validator from the network and destroying his stake entirely”, says Novum Insights. The end-goal of slashing, is to encourage honesty, availability, and security between network participants.

PoS and PoW may operate under different protocols, but they both share the same functionality as a fully decentralized, immutable system of record. PoS still has its fair share of concerns, similar to the environmental unpleasantries of PoW. Many feel that PoS hasn’t been around long enough to be tested and proven to be as secure as PoW. Others worry about getting slashed for being inactive on the network or by errors in the network’s algorithm. And finally, some are concerned that PoS will favor validators who have contributed the most to the network, and will continue to be chosen and paid by the algorithm again in the future.

Vitalik’s Vision for Ethereum 2.0

Vitalik Buterin is the co-founder of the Ethereum Network. In terms of market capitalization, Ethereum is the second-largest cryptocurrency in volume, behind Bitcoin. Unlike its founding father, Ethereum is equipped with a variety of application uses instead of a sole cashless payment system. The Ethereum Virtual Machine (EVM) is the preferred choice for developers looking to build dApps (decentralized applications) on a network. DApps are nearly identical to traditional web applications in relation to front-end user experience, but in terms of back-end, dApps operate in a completely different framework. Ethereum is notorious for accommodating developer experience for new programmers entering the space. Developers can launch a dApp on the EVM despite which underlying programming language they use. This network architecture eliminates the need to build an entirely new blockchain for each dApp.

Most dApps exist exclusively on the Ethereum blockchain. Albeit, one would require extensive knowledge of blockchain development and be familiar with building on EVM frameworks. Thankfully, services such as Chain, assist organizations with little understanding of blockchain technology to scale their decentralized products. Those with development experience can still resort to Chain’s Cloud Service, which gives development teams access to 18 EVM-compatible blockchains, for free.

Ethereum was also the first to introduce smart contracts. Smart Contracts are a key component to the network, and terminate the need for intermediaries and centralized third-parties. In short, smart contracts are self-executing contracts, with the terms of the agreement between both parties written directly into lines of code. Once the contract is deployed on the blockchain, it is irreversible, and will execute the terms of the contract once the conditions are met. Smart contracts are widely used in DeFi and are integrated into dApps as well.

With all the advancements Ethereum has contributed to the industry, it’s understandable why Buterin is pushing for the migration from PoW to PoS consensus. Since the network is one of the most mature and established in the industry, it needs to find more eco-friendly ways to scale. On top of that, one of the major weaknesses in Ethereum’s network is slow processing times and higher transaction costs compared to alternative networks. Many believe that PoS will address this concern and Ethereum will become more efficient after its Merge.

The Merge

The Merge is coined as a multi-year event that is designed to upgrade Ethereum’s PoW consensus mechanism to PoS. Due to the design and technological differences in consensus protocols, Ethereum has been slow and cautious to release Ethereum 2.0. According to BlockWorks, “The Ethereum development team has been working on the transition since 2016 and has called off the switch multiple times. An enormous Web3 ecosystem of business decentralized apps, decentralized exchanges and NFT (non-fungible token) marketplaces depend on an error-free transition”.

In December 2020, Ethereum’s development team launched the Beacon Chain, which is Phase 0 of the Merge. The Beacon Chain exists as a parallel PoS side-chain to Ethereum’s existing PoW blockchain (i.e the Ethereum Mainnet). Beacon Chain does not impact users, applications or smart contracts on the main chain, and serves as a record keeper for all transactions. Buterin has announced the full integration of PoS and Ethereum 2.0 later this summer.

The Ethereum Foundation claims that once the Merge is fully implemented, the new consensus mechanism is estimated to reduce energy use by 99.95%.