How Proof-of-Stake Is Playing A Critical Role In The Blockchain Ecosystem

The Proof-of-Stake (PoS) consensus mechanism has emerged as the most viable solution to Bitcoin and Ethereum’s energy problem. The world’s two most popular blockchains have long been criticized for their enormous power consumption, with one recent study from U.K. financial site MoneySuperMarket estimating that each Bitcoin transaction costs in excess of $100 in terms of energy costs.

Understanding that Bitcoin’s Proof-of-Work (PoW) consensus would one day be a problem, the PoS consensus was first described by Sunny King and Scott Nadal in a 2012 paper. The pair set out to solve Bitcoin’s energy problem using an alternative method known as “staking”, in which a deterministic algorithm chooses nodes to process blocks, based on the number of coins a staker holds. That’s opposed to PoW, where miners race to solve complex mathematical problems to become chosen as the next block producer.

Under the PoS system, stakers have a greater chance of being chosen to add the next block – and earn rewards for doing so – the more coins they stake. PoS therefore avoids the ever-increasing energy costs associated with Bitcoin mining.

Proof-of-Stake Is Born

The first ever cryptocurrency to implement a PoS consensus was Peercoin, which was created by Sunny King in 2013 as an alternative to Bitcoin. Peercoin wasn’t a true PoS coin though, as it adopted a hybrid approach that saw most new Peercoins initially created by miners using the older PoW consensus. King implemented this method in order to preserve decentralization of the network. These days, the majority of Peercoins are now minted through PoS, though Peercoin miners continue to this day.

The first true PoS cryptocurrency was Pavel Vasin’s Blackcoin, which made its debut in 2014. Blackcoin made a number of improvements, most notably removing PoW mining completely. Decentralization was instead ensured via a fairer distribution of Blackcoin’s tokens. Blackcoin also removed the coin age mechanism of Peercoin, which was designed to prevent rich coin stakers from accruing the majority of the staking rewards. Vasin did this to reduce the chance of a so-called 51% stake attack, as older coin holders in Peercoin need less than 51% of staking coins to create a fork.

While Blackcoin was a big improvement, the project never really caught the imagination. Though it exists today, its value has fallen to just 3 cents per coin, down from its all-time high of $1.05 in 2018.

While Blackcoin ultimately failed as a cryptocurrency, it did at least succeed in laying foundations for the rise of a new generation of PoS projects. The same year Blackcoin launched, Jae Kwon published the Tendermint whitepaper that eventually grew to become the Cosmos Network, while Ethereum co-founder Vitalik Buterin proposed Slasher, a punitive PoS algorithm on which the forthcoming launch of Ethereum 2.0 will be based.

Also in 2014 we saw the debut of BitShares, the first blockchain network to use what is known as a Delegated Proof-of-Stake consensus, which has since been adopted by EOS, Lisk, Tron and other notable blockchains.

PoS Hits The Big Time

It was those early ideas that led to the blossoming of PoS with the launch of a third generation of projects including Algorand, Cardano, and most notably, Tezos.

Tezos is a smart contract-capable blockchain similar to Ethereum that launched in 2018. Unlike its peers, Tezos was the first to implement what is known as a Liquid Proof-of-Stake consensus mechanism that lowers the barrier for entry to network validators, leading to greater decentralization, more democratic governance and stronger network security.

The main difference between Tezos’ LPoS and DPoS mechanisms is that delegation in Tezos is optional, whereas in DPoS there is a fixed set of block producers, or delegates. With LPoS, the aim is to maintain a dynamic validator set in order to facilitate token holder coordination and more accountable governance.

Tezos’ LPoS consensus allows regular users of the network to participate in block generation by lending their tokens to one of the nodes in exchange for a reward. In Tezos, the process of validating is called “baking”, and the algorithm chooses a baker to create each block from the pool of eligible nodes. Bakers with the highest stakes and reputation are the most likely to be picked. When chosen, they create a new block that’s then sent to 32 other nodes from the pool to be attested. Once that’s done, the block is entered onto the Tezos blockchain and the baker receives a reward.

The advantage of LPoS is that it has a practically unlimited pool of bakers, with anyone able to become a validator with a stake of 8,000 $XTZ or higher. DPoS networks in contrast have a far more limited group of validators to choose from due to the significant computing infrastructure requirements and the need to stake a substantial amount of tokens. Tezos also allows delegation of staking rights, meaning that $XTZ holders can delegate tokens to a baker to earn a share of the staking rewards. There’s a big incentive for token holders to do this, as there’s no requirement for users to share ownership rights or lock their tokens.

Aside from the decentralization, governance and security benefits, Tezos provides protection against double-spending. Should a node identify a baker that’s double-spending, they can report this with proof in coming cycles. That prevents malicious behavior by bakers.

The Future Of Blockchain?

Tezos ultimately emerged as the first PoS chain to scale successfully, and today it supports a growing ecosystem of DeFi applications with over $91 million in total value locked. Its success has spawned a cluster of rival projects that also operate a PoS consensus, including big names such as Cardano, which launched the same year, and Cosmos and Algorand, which launched in 2019.

The following year, 2020, proved to be a milestone for the PoS ecosystem as we saw the mainnet launch of dozens of chains including Polkadot, Celo, Elrond Network, Harmony, NEAR, Matic and Oasis. Many of those chains are now fostering rapid growth in their own ecosystems, especially Polkadot, which boasts $336 million in TVL in DeFi.

The next big development in PoS is due to take place this year, as Ethereum finally rolls out its long-awaited Ethereum 2.0 Phase 2 upgrade, transfering from its PoW consensus mechanism to PoS in an effort to make the network more scalable, secure, and sustainable than it is now. Ethereum’s shift to PoS was motivated by the need for a more climate-friendly and decentralized network that has already been proven with the success of earlier PoS projects. Ethereum has no alternative but PoS, because its annual energy usage is rising fast. Data from Statista published in Dec. 2021 showed that one Ethereum transaction uses energy equivalent to a stunning 100,000 transactions on Visa.

Thanks to its dominant position in the blockchain industry, especially in terms of DeFi, Ethereum’s coming transition to PoS could well become the most important event in the history of the consensus mechanism so far. PoS has come a long way since the days of Peercoin and Blackcoin, and although there’s a lot of debate on whether Ethereum’s upgrade will succeed, it is now a permanent fixture in the blockchain landscape and one that will continue to be so for a long time to come.

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