What is Proof-of-Stake?
Staker is dedicated to Proof-of-Stake (PoS) cryptocurrencies and to the variations of this network consensus algorithm, and it is important for Staker visitors to understand how it works and its main advantages which increase its importance in the long term.
The consensus algorithm essentially makes cryptocurrency financial operations valid. After the cryptocurrency transaction is approved, its validity is not disputed by any member of its financial community. All transactions are stored in the form of blocks referring to each other and forming a chain. Every new transaction needs a new block in the blockchain, and the consensus algorithm defines the rules on how the new block is created and who exactly gets a reward for making it.
Stake is a central measuring point in PoS. The system automatically finds a combination of the amount of cryptocurrency units owned by a cryptocurrency holder together with the lowest hash value necessary to identify the block. In Proof-of-Stake cryptocurrency communities, coin holders are often called stakers.
Proof-of-Stake cryptocurrencies usually have an additional element of random selection so that even the holders of a small stake get a chance to create a new block. Major Proof-of-Stake principles can be customized by the development teams. For example, in some systems, stakers of chronologically older coin supply are more likely to receive a block reward.
The modern cryptocurrency market is, however, dominated by an older algorithm - Proof-of-Work (PoW). Bitcoin, the most capitalized cryptocurrency as of today, is using it and there are no signs that the community would change it to PoS.
Proof-of-Work has a notable barrier for those who want to form a new block and receive a reward: computing power. Solving a difficult mathematical problem before any other miner requires a fast computer, and the network difficulty is growing overtime proportionally to the number of the network participants. In the long term, it can become complicated for cryptocurrency holders to get a new block reward via Proof-of-Work mining. Despite this, it is still attractive for many people due to the fact that they can easily comprehend what backs PoW cryptocurrencies - computing power and electricity spent in the process. The competition of miners has even formed a separate market of mining rigs and created new jobs.
PoW seemed like a good solution during the early days of cryptocurrency as a working concept, but in the following years, it has become apparent that those who would like to periodically receive a Bitcoin block reward must invest a lot of money to form mining rigs. The rise of mining energy consumption has led to unexpected consequences - now some regional governments even ban PoW facilities and lift it only under certain conditions. These bans are imposed due to the increasing electricity prices for regular residents of the area.
Proof-of-Stake does not require to quickly solve a mathematical puzzle before all other network participants to get a block reward. This, in turn, erases the need for electricity. Moreover, stakers do not risk to fall behind due to the constantly increasing difficulty.
Block Reward Availability
The growing network difficulty in PoW cryptocurrencies eventually leaves no room for newcomers who are no longer able to form new blocks via regular PCs and need to have expensive mining rigs. On the contrary, PoS cryptocurrencies difficulty barrier requires a certain minimum amount of stake. The aforementioned random element makes it possible to get new units as a block reward even after several years of the cryptocurrency existence. One staker cannot always be the one who gets it all - there is a cooldown period of several blocks after which the network participant can receive a reward. The latter principle is called maturity.
The Proof-of-Work algorithm has security problems: miners can overtake more than 50% of the new coin community and create anomalously big amounts of cryptocurrency. Proof-of-Stake is once again drives out the undesirable scenario due to its core principles based on other factors than mining.
The economic atmosphere is better in Proof-of-Stake cryptocurrencies: stakers, each being a block validator, have a genuine interest in the network prosperity. The long-term stake investment ensures that the new member has intentions beneficial for all other members. Meanwhile, miners can form pools manipulating the cryptocurrency price and want it to be higher so that the block rewards quickly pays off the initial hardware investments. The high price hinders the initial goal of every cryptocurrency - to be a liquid payment tool - and undermines the trust of the traditional financial community. Instead, new investors view it as a commodity with hopes for the constant growth. In other occasions, miners can decrease the price to reach short-term gains. Both pumping and dumping can lead to unnecessary price spikes.
All these factors combined, Proof-of-Work clearly has some long-term problems which hamper the development of the cryptocurrency market and create unfair economic situations, while Proof-of-Stake prevents most of them and allows to use cryptocurrencies as a digital means of payment without any central issuer.