A Proof of Stake Explanation

Several altcoins are choosing to use Proof of Stake (PoS) as their consensus mechanism, most notably Ethereum.  The PoS consensus mechanism is a significant shift from Bitcoin’s legacy Proof of Work system of consensus mechanism.  We will introduce you to consensus mechanisms, what PoS is, why it is superior to Proof of Work, and what issues it may have in its development. 

Consensus Mechanisms

To understand PoS, we first need to understand consensus mechanisms, also known as consensus protocols or algorithms.  A consensus mechanism is a way a distributed system (a network of computers) agrees on a source of truth to stay secure.  In centralized systems, this source is decided by a controlling entity, but with a distributed system, many authorities, called nodes, must cooperate to maintain the network.  The system requires a computational mechanism by which nodes come to an agreement or consensus of both the most recent and accurate record of data across the system.  Consensus mechanisms have established consensus among database nodes, application servers, and other enterprise infrastructure for decades.  More recently, new consensus mechanisms have been developed, allowing crypto-economic systems (Bitcoin/Ethereum) to agree on the state of the network while also preventing hacks where the consensus is compromised by a hacker that controls “51%” of the network. 

Courtesy of researchgate.net

Courtesy of Allerin.com

Proof of Stake

The Proof of Stake consensus mechanism consists of a group of validators that organize transactions and create new blocks on a blockchain network so that there is a consensus between nodes on the network. 

Courtesy of researchgate.net

The Proof of Stake mechanism will activate a validator upon receipt of a sufficient stake.  In Ethereum’s system, this is 32ETH.  With Proof of Stake, validators don’t need significant computational power to mine blocks; they are randomly selected to create (propose) blocks depending on their percentage stake and, when not chosen, will validate the proposed blocks, called attesting.  A user’s stake is there to ensure good behavior and punish bad behavior.  Validators will receive incentives for both proposing new blocks and for attesting other validators’ blocks, while they can lose a portion of the stake if they go offline and fail to validate or lose their entire stake if they attest to a malicious block or for deliberate collusion. 

5 Parts Of PoS

1. Validating- When a transaction is submitted on the network, the randomly chosen validator will add it to the proposed block.
2. Attesting- Unchosen validators will attest to another validator’s proposal, confirming that the transaction looks as it should. With Ethereum, the attestation is recorded on an overseeing ledger called the “beacon chain” rather than the separate networks called “shards.” At least 128 users must attest each shard block. 
3. Slots/Epocs- The set 12 second timeframe to validate a block is called a slot, and only one block is created in a slot.  32 slots make up an “Epoc” and at the end of an Epoc a new group of 128 users is formed for the next validation Epoc.  This regular and random selection process increases security preventing collusion and other bad acts.
4. Crosslinking- With sufficient attestations of a proposed block, a crosslink confirming block inclusion (and the transaction on that block) is created between separate chains, in Etheeum’s case on the beacon chain. The validator is then rewarded for their proposal.  
5. Finality- The point where a block on a distributed network can no longer change. For Ethereum, a finality protocol called Casper will confirm validators agree on the block’s state at checkpoints, and when 2/3rds of the validators agree, the block is finalized.  This process further increases the network’s security

PoS makes several improvements over Proof of Work.

• Energy Efficiency– Blocks are no longer mined, which takes significant computing and electrical power. The estimated power savings is 99%
• Reduced Barrier to Entry- PoW requires an ever faster and more expensive hardware arms race for block creation. The PoS validators have an equal chance of creating a new block. 
• Reduced Centralization- PoS should create more nodes on the network, reducing the centralization power.
• Separate Chains(shards) support- with the creation of 64 tied chains, focus can be on ones that need support, and the entire network’s speed and throughput can be increased.

Ethereum 2.0’s Beacon Chain

Ethereum is the most prominent crypto to incorporate PoS as its consensus mechanism.  It must be noted that its beacon chain is an integral part of the Ethereum PoS process.  Ethereum plans is to have 64 shard chains, each with validators and attestors for new blocks.  The beacon chain has the following tasks under its control:

• Confirming stakes
• Choosing shard members
• Choosing validators
• Crosslinking
• Reward payment
• Penalty enforcement (stake slashing and ejections)
• Finality
• Making information available to other shards for syncing

PoS Security

The risk of a 51% attack is not eliminated with PoS, but the attackers put themselves at significant risk.  They must control a minimum 51% of the ETH staked, which is 64 shards *128 users*32 Eth *51%*approximately 2,200USD/ETH = $294,125,568.  With an attack, the price of ETH would drop, significantly reducing this staked value, which reduces the incentive of attack while increasing the incentive to keep the network healthy and secure.  The validators are responsible for identifying and flagging nefarious incidents. 

Proof of Stake Pros and Cons

Pros

Ease of staking- Running a node requires neither significant hardware nor energy investment.  Staking pools are available if investors don’t have enough stake for a full node. (Staking Pool –  a group of investors that combine their partial investments to stake a full node.)

Decentralized– PoS has increased participation.  With PoW, mining means with more nodes, there is an increased percent of returns.  There is an equal percent reward and representation across the network with PoS. 

Secure Separation- With PoS, separation into shard chains allows increased transaction throughput by simultaneously creating multiple blocks.  If a PoW system were separated, it would only lower the power needed to hack and compromise that part of the network.   

Cons

Relatively untested- Proof-of-Stake is still a young consensus mechanism and when compared to PoW, much less tested.

Summary

While there are several possible consensus methods, Proof of Stake evolves older blockchains’ classic Proof of Work method.  In theory, it will reduce energy consumption and hardware costs while providing a more democratic distribution of rewards and representation to the participants while simultaneously increasing security and throughput.  Though these claims have still yet to be proven on a comprehensive level, the potential appears to be there, and the second-largest crypto is betting on it.  Once the Ethereum 2.0 upgrade has been completed (shard chains to begin in 2022), we will get the answers to many of these questions, but until then, it is uncertain if PoS is the future of cryptos or not. 

Disclaimer:  The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment.  Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.

The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business.  Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.

The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.