If you don't know about proof-of-work (PoW) and proof-of-stake (PoS) and are too afraid or embarrassed to ask at this stage, this article is for you. And by the way, we don't believe there's any question lame enough not to be answered. So keep those questions coming!
For the benefit of our readers, this article will be structured into the following parts:
What is a consensus mechanism, and who are validators?
What are PoW and PoS?
Differences between the two
Their limitations and why the two are not compatible?
What is a Consensus Mechanism, and Who are Validators?
Before we jump in, here's some sociological context for why consensus mechanisms are needed:
Trust is the currency of modern-day highly complex human systems. Let me tell you how – our financial system is premised on trust in a few financial institutions to do the right thing. Likewise, our internet experiences are governed by the big tech to make our lives easier.
But, centralized authorities may not always act in your best interests to fulfill their needs. Be it the 2008 Financial Crisis or the Cambridge Analytica Scandal; many historical instances have exposed this vulnerability. "If centralization of trust is such a bad thing, why do we continue with the same old faulty systems?" Well, the issue emerges from something called the Byzantine generals problem. It states that a distributed network cannot reach a consensus or agreement on something.
But this theory has been proved wrong by consensus mechanisms. Think of the consensus mechanism as the engine that drives the blockchain. A set of validators maintains blockchains. These validators solve super complicated mathematical problems to verify transactions. In return for their work, validators get rewarded in the native cryptocurrency. It puts the responsibility of verification on unbiased mathematics and software instead of potentially biased human systems.
What are PoW & PoS?
There are two kinds of consensus mechanisms:
Proof-of-work is the original consensus mechanism that is used in Bitcoin. It is built upon the expending of energy to achieve consensus. Let's understand this with the help of an example:
Ryan sends 1 $BTC to Cynthia. This transaction request gets broadcast to all the validators of the network. At a very simplistic level, the validators check if Ryan has 1 $BTC at all. They also check if that 1 $BTC has already been used before (double spending). If it has been, the transaction gets rejected. Then, based on what most validators vote, the transaction is added or rejected. Whoever correctly verifies it first gets rewarded.
Note: In the real world, the task of doing all the verifications is abstracted in the form of a mathematical problem. The mathematical problem fundamentally revolves around finding the nonce of the transaction. This is a very computation-intensive process.
Unsustainable for the environment: Proof-of-work blockchains derive their security from the sheer computational intensity of the mining process. This, however, has raised red flags for many because of its disregard for sustainability.
Heavy Investment in Infrastructure Required: Running a validator node on a typical computer is impossible in a PoW blockchain. Therefore, costly hardware equipment can only conduct the verification process.
Proof-of-stake consensus mechanism emerged as a greener alternative to the proof-of-work consensus mechanism. At its core, PoS validators have to stake the network's required amount of native cryptocurrency to participate. Let's extend our previous example to understand this:
Ryan sends 1 $DOT to Cynthia. A validator is chosen at random from among the network. The selected validator then verifies the transaction. After this, the selected validator informs the rest of the validators about its review of the transaction. If they agree, the transaction is verified, and all the validators are rewarded according to their proportion of staked native tokens. However, the rest of the validators disagree with the selected validator, and the selected validator is punished by having his native tokens slashed.
Note: Typically, the probability of getting chosen to verify the transaction increases with an increase in the amount of staked native token. That is why staking platforms provide lucrative APYs over staked deposits, as it raises the probability of them being chosen as a validator, which would lead to rewards from the system.
Vulnerable to Abuse by the Richer: The greater the amount of token staked, the greater the validator's influence over the network. The Richer participants might usurp the control of the network.
Less secure: If the token's market capitalization is not high enough, an attacker can swoop in and buy out a major chunk of the token supply, stake it, and exercise heavy influence over the network.
Differences Between PoW & PoS
The computational power determines the probability of validating a transaction.
The staked amount of tokens determines the probability of validating a transaction.
The validators are required to solve complex mathematical problems. Hence expensive hardware is needed.
The validators are NOT required to solve complex mathematical problems. Hence, no expense is required.
They are less energy efficient.
They are more energy-efficient.
Validators earn via block rewards.
Validators earn via network fees.
Why are 2 Different Chains Incompatible?
You must have wondered why you cannot directly use $BTC on the Ethereum mainnet without having to wrap your $BTC into $WBTC. Well, the answer lies in the standards established by blockchain. Every chain happens to have a different set of standards. This makes their tokens incompatible with some other token of any other token standard. In our context, Ethereum only supports two token standards ERC-20 (fungible) and ERC-721(non-fungible). And since $BTC fits into none of them, it has to be exchanged for $WBTC, which is an ERC-20 token.
It's early days to declare who is the clear winner in this battle of consensus mechanism. However, both of them have a basis for themselves. On top of that, many other consensus mechanisms are cropping up. Some are a combination of several consensus mechanisms, while some are entirely new and results of experiments in game theory and distributed networks. However, one thing we can say for certain is that the consensus mechanisms will only improve.