One of the fundamental concepts of blockchain is understanding how new coins are created and distributed. In virtually all cryptocurrencies the cryptographic code requires either the use of proof of work (POW) or proof of stake (POS).
Proof of work and proof of stake are protocols designed to ensure that the transaction history that makes up the block chain are as free from error and forgery as possible.
Proof of work
The proof of work concept is a coding idea used in coins such as Bitcoin and Litecoin. Proof of work aims to ensure that the blockchain remains as an accurate and immutable database of transactions. The blockchain mining process uses a cryptographic hashing algorithm in its code. The result of the hashing algorithm is to identify false transaction histories submitted to the blockchain. This is because fake transaction histories will not produce the required answer to solve the hashing algorithm. As such, false transaction histories are rejected.
Downsides to proof of work
However, there are some downsides to proof of work. The mining process behind proof of work is computationally intensive. To solve the algorithm a mining computer must do a lot of work in order to find the solution.
The result of such a large computational power requirement means that in order to mine you will need to invest in specialist equipment. Proof of work requires specialist mining hardware with efficient computer graphics cards. Furthermore, there are ongoing electricity costs associated with mining.
Tragedy of the Commons risk
Finally, proof of work facilitates the ‘Tragedy of the Commons’. No, this isn’t some out-of-place reference to English Parliament. Instead it refers to the risk of the 51% attack.
The theory is that as payouts for mining Bitcoin reduce over time there is less incentive for smaller miners to mine. As a result, greater control of the mining process goes to bigger mining pools. As such, this increases the risk of a mining pool controlling more than 50% of the mining process. This could allow them to force through false transaction profiles that favour themselves.
Proof of stake
Used in the Ethereum code, proof of stake is an alternative to proof of work that avoids the risk of the Tragedy of the Commons. Additionally, it is a validation process that is less computationally intensive than proof of work.
In proof of stake a node contributing to the network must stake some tokens that you already have. As a reward the stake generates a percentage return much like a dividend from a stock investment.
Attempts at forging transactions histories could mean that you could forfeit your stake. False transaction histories are identified as those transaction histories that do not agree with the consensus. Users of the cryptocurrency know to trust the block with the most stake behind it.
Assessing proof of stake
Compared to proof of work, proof of stake does not require as much computing power. This is because the computer is not trying to solve any cryptographic hashing algorithm. As such there is no initial investment in specialist equipment required and cheaper running costs.
The drawback is that you must already own special tokens in order to stake. In the case of Ethereum, the staking token is called Ether. More importantly, proof of stake is arguably not as secure as trying to solve a hashing algorithm as in the case of proof of work.