Understanding Crypto is an international sensation! People around the world are tuning in to learn about the new and exciting world of crypto and web3. In this episode, James Burtt and Paul Abercrombie explain proof of work and proof of stake, the differences between them, and what they mean for your business.

Consensus Mechanisms

“Proof of work and proof of stake are both consensus mechanisms,” Paul tells listeners, “so effectively various parts of the network agreeing to something and then validating or verifying that something has actually happened and then compensating the person that's done all of that work for doing the work.” Proof of work, what Bitcoin and most cryptocurrencies run on, is the original consensus mechanism and arguably the more secure. Distributed nodes around the world make up the network, so to hack Bitcoin, you’d need to control 51% of the computing power of the network. This is effectively impossible. [Listen from 3:13]

Proof of Work

Proof of work is mining. Nodes compete against each other to complete calculations on the blockchain to mint that block in exchange for block rewards, which is given in the blockchain native currency. Consensus comes in when nodes submit their calculations to the rest of the network and the network agrees. Every node stores a copy of the distributed ledger (blockchain), so once the transaction is verified by the network, it is recorded on the blockchain. This is immutable proof that the transaction happened. “When a transaction happens on the blockchain it's been encrypted, …and there's calculations going on to make sure that that is actually taking place or that that transaction is secure and it's being encrypted in the way that it should do, which is the crypto part of cryptocurrency,” Paul says. It has to be encrypted to keep the digital trust; and the other nodes need to witness and verify that it actually happened. [Listen from 4:21]

Lottery and Limitations

“Mining Bitcoin is a bit like a lottery ticket,” Paul remarks. A new block is minted on the blockchain every 10 minutes, so the more mining power you have, the better your chances of winning the opportunity to mint blocks and earn block rewards. It used to be fairly easy to mine Bitcoin using only your PC and Bitcoin software. Nowadays, the barrier to entry is higher. “Now you have these wholesale aircraft hangars that are full of GPU mining machines mainly mining Bitcoin,” Paul says. The main arguments against mining and proof of work are security and that it’s not friendly to the environment. The need for speed means there is some tradeoff with security, but overall proof of work is secure because it is decentralised. However, the argument that mining is environmentally unfriendly has merit, since it uses lots of electricity which contributes to carbon emissions. In the Far East, electricity is cheap but is generated using coal; many mining operations have moved away from these areas to places like Texas where electricity is still cheap but generated in a cleaner fashion. “It still requires an immense amount of power for a large-scale mining operation,” Paul points out. [Listen from 11:02]

Proof of Stake

Proof of stake is an alternative consensus mechanism that combats the limitations of proof of work. It requires distributed nodes and software similar to proof of work, but it uses a validator instead of a mining machine. A validator is like a referee, Paul says; he or she checks to verify that a transaction happened. There’s a higher barrier to entry in proof of stake, as the network needs less nodes so they want people who are trustworthy. In order to get your validator licence, you need to stake a significant amount of the blockchain’s native currency. Not many people can afford to do this. You can use any device as a data validator: all you need to do is download the software and link it to your wallet with the required amount of crypto. You’ll be paid interest or yield on your part of the staking pool. If you contravene the terms - for example, if you don’t provide the computer power you said you would - your stake can be slashed or taken away from you. [Listen from 16:39]

Final Thoughts

Bitcoin became successful because it was the first digital currency to use a consensus mechanism and reward people for providing their computing power. Some people became millionaires by mining Bitcoin. The environmental concerns however, led to newer cryptos adopting a proof of stake consensus mechanism. This is not without its own limitations: you can lose your stake if you don’t act as agreed. Also, the argument can be made that proof of stake is less secure even though it is more environmentally friendly. James and Paul’s mining farm will be doing both proof of work and proof of stake. [Listen from 23:50]

Key Takeaways

• Proof of work and proof of stake are both consensus mechanisms; you are rewarded for providing your computing power.
• Proof of work is costly to enter now and consumes a lot of electricity, but it’s what made Bitcoin successful.
• Proof of stake is friendlier to the environment, but requires a significant investment. You can lose your stake if you contravene terms.

Resources

James Burtt on Twitter | LinkedIn | Instagram | Clubhouse

Paul Abercrombie on Website | Twitter | LinkedIn | Instagram