What Is Proof of Stake?

Proof-of-stake, or POS, is one method blockchains use to process transactions and verify information. POS works by requiring validators (crypto owners) to stake (hold) their cryptocurrency on the blockchain to earn the right to process transactions.

Understanding proof-of-stake

Blockchains require global users to contribute computing power (nodes) to collectively validate incoming data and add new “blocks” to the chain.

Proof-of-stake is one such consensus mechanism, or method of verifying information entered into a blockchain database. Consensus mechanisms are essential for ensuring the validity and security of blockchains.

How does proof-of-stake work?

In proof-of-stake, cryptocurrency owners earn a chance to be randomly selected to validate transactions.

Each block is validated by more than one node (computer), with validators who stake larger sums or for longer periods of time having higher selection odds. Once several nodes verify a block’s accuracy, it’s added to the blockchain, and the validators earn a reward.

Validators’ willingness to lock up their crypto to participate in the system strengthens the blockchain and incentivizes good behavior. If validators submit fraudulent or inaccurate data, their stake may be “burned.” (Burning occurs when coins are sent to an unusable wallet address, rendering them permanently useless.)

Proof-of-stake vs. proof-of-work

Proof-of-stake was designed as an alternative to the proof-of-work (POW) consensus mechanism employed by Bitcoin. Both mechanisms validate data, process transactions and provide security. However, their methods vary.

Proof-of-work (POW) requires miners, or nodes, to race to solve complex cryptographic puzzles to verify transactions. In return, miners have a chance (but not a guarantee, depending on the number of participants) of receiving tokens.

Becoming a miner involves buying expensive equipment, limiting access. The mining process’ competitive design also burns as much energy as a small country annually.

By contrast, POS validators lock their tokens on the blockchain to earn a chance to validate blocks and earn fees. Validators are randomly selected, and a set number secures each block.

This streamlined design reduces processing power needs by 99%, lowers network congestion and eliminates POW’s rewards-based incentives.

What proof-of-stake means for investors: security concerns

POS reduces the computational, operational and environmental costs of verifying and securing blockchains. While some investors have expressed security concerns, the mechanism’s compensation and governance structure make network attacks highly disadvantageous.

Simply put, commandeering a POS network requires a single validator or group to control 51% of all staked currency. While that’s theoretically possible, POS also outlines a route for validators to disregard fraudulent data and burn a fraudster’s staked tokens.

This design encourages validators to act in ways that benefit not just their own holdings, but the entire blockchain.

What this means for you

Proof-of-stake stands to reduce energy consumption, lower validation barriers and improve security. These benefits have encouraged more blockchains to switch to POS – including, famously, Ethereum’s “Merge” in 2022.

However, as the newer validation mechanism, some kinks remain to be worked out.

And as an investor, that means a blockchain’s validation mechanism may become a consideration in your future cryptocurrency selections.

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