FINTECH FRIDAYS

13th August 2021

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What is the difference between Proof of Work Vs Proof of Stake?

If you’ve heard of cryptocurrencies such as Bitcoin, Ethereum, Dogecoin, etc. Most of them would likely be operating under a Proof of Work (PoW) or a Proof of Stake (PoS) algorithm. These algorithms help maintain a decentralized ledger for secure transactions to occur.

 

The traditional algorithm and more widely adopted one is Proof or Work. The first and most obvious example is Bitcoin. Bitcoin miners employ hundreds and thousands of specialised computers also known as ‘mining rigs’ in a race to solve a complex mathematical puzzle, the ‘winner’ of each puzzle would record a certain number of transactions into the next block in the blockchain and be rewarded with newly mined Bitcoins.

 

As the price of Bitcoin has skyrocketed, so have the number of mining farms blooming all around the world. And with the Bitcoin gold rush on full throttle, so have the size of the electricity bills racked up by Bitcoin miners globally. According to the Cambridge Center for Alternative Finance (CCAF)’s findings, Bitcoin is estimated to consume around 82.18 terawatt-hours/TWh in a year, and with some quick math, that is enough energy to power 11.85 million average Australian households for a year.

Hence, this is a burgeoning problem, as the large amounts of energy consumed are perceived as a wasteful use of energy with environmental concerns stemming from the source of energy generation. In May 2021, Elon Musk said Tesla would no longer accept bitcoin as a payment method because of environmental concerns, and Bitcoin’s value promptly tanked. 

 

Proof of Stake (POS) was created as an alternative to proof of work. With Proof of Stake (POS), instead of using expensive equipment and burning through a ton of energy, miners would simply be staking their cryptocurrencies in a node, and the algorithm would choose nodes at random to be the next validator whom will record a certain number of transactions into the next block in the blockchain and be rewarded with newly minted cryptos, eg: Ethereum.

 

According to the Ethereum blog post, the staff working on transitioning Ethereum to Proof of Work to Proof of Stake can reduce the amount of energy consumed during the validation process by 99.95%. This is due to the hardware requirements to run a Proof of Stake validator node, which consists of only needing a regular everyday computer or laptop, whilst mining through proof of work would require advanced and expensive and electricity draining computer hardware. This is one of the most significant reasons why people pro-Ethereum litigate as the most significant advantage Ethereum has over Bitcoin.  


Staking rewards are also currently significantly decreasing with the total amount of Ethereum being staked proportional to the rewards, with currently a reward of 6% APR (Annual Percentage Rate), however this number would continue to decrease with the number of Ethereum staked. 

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However, to participate and obtain these rewards is not cheap with the minimum Eth needed to be staked set at 32. This currently equates to $140,533.71 AUD, therefore unfortunately for any university student that is looking to stake and become a validator is very rare. However, there is an alternative where you can participate in Staking Services, that allows anyone to stake in a pool.

 

As suggested on the Ethereum official website, there are over 30 different staking services that pool tokens together with minimum stakes that allow an individual to deposit any amount to stake, however, the rewards that will be designated to the staker would be lower and some occur monthly fees. If you were looking for a riskier and rewarding investment, there also lies different currencies that can give you reward rates of up to 50%, with examples such as Polkadot and the Binance Smart Coin offering 13.47% and 15.67% respectively.

References:

https://www.investopedia.com/terms/p/proof-stake-pos.asp

https://www.coindesk.com/how-does-ethereum-staking-work

https://www.investopedia.com/terms/p/proof-work.asp

The views expressed within this article are those of the authors and do not represent the views of the Finance Student's Association. All images and references in this article are for fair and educational purposes only. The content in this article is not intended as legal, financial or investment advice and should not be construed or relied on as such.