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How the Proof-of-Stake algorithm works

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Proof-of-Stake (PoS)

Proof-of-Stake (PoS) is a widely embraced consensus algorithm that serves as the foundation for numerous blockchain platforms, including Ethereum, Cardano, Solana, Tezos, and Algorand. Its popularity and appeal stem from the elimination of the requirement to invest in costly mining equipment, offering a straightforward avenue for passive income through staking.

One of the primary advantages of PoS over Proof-of-Work (PoW) lies in its reduced power consumption when generating blocks on the network, addressing environmental concerns associated with traditional mining processes. Additionally, PoS is recognized for enhancing the security of blockchain networks, contributing to its growing adoption in the cryptocurrency ecosystem. The staking mechanism further simplifies participation, allowing users to actively engage with the network and earn rewards without the need for resource-intensive mining activities.

How did the PoS algorithm come about?

When programmers develop any blockchain (e.g., a decentralized protocol for transactions with an updatable database), two questions arise:

  • What principle will be used to grant the right to generate a block;
  • How transactions will be validated to protect double-spending and similar abuses.

In the process of solving these problems, several ideas have emerged for consensus mechanisms, sets of rules by which participants in the blockchain agree on exactly how transactions can be approved and included in new blocks.

Satoshi Nakamoto proposed the Proof-of-Work (consensus proof-of-work) mechanism in 2008 before the launch of the Bitcoin blockchain. With the PoW algorithm, operators of nodes in the blockchain (miners) in free competition mode solve resource-intensive mathematical calculations – trying to find a beautiful value of the block hash (with zeros at the end) by a matching method. In case of success, the winning miner or pool gets the opportunity to add the found block, and in return receives a reward – new bitcoins, thus organized the issue of cryptocurrency.

After some time it became clear that the PoW algorithm inevitably leads to a constant increase in mining power, followed by the growth of network complexity (so that miners did not find a beautiful hash too quickly, and fit into the interval of block creation, which is set by the program code in the blockchain), as well as the growth of energy consumption and spending on its payment. The need to use more powerful and profitable equipment decreased the availability of mining and earning on it.

In 2011, one of the popular crypto forums proposed an alternative idea for a consensus mechanism – Proof-of-Stake proof of ownership. The right to vote in the blockchain should be given to all its participants according to what share of the total number of coins they own.

In 2012, PoS was put into practice in the cryptocurrency PPCoin. Fresh coins were distributed by mining, and transactions could be processed by any node that stored PPC tokens. A similar hybrid PoW+PoS scheme was used in other early projects. The first PoS blockchain without mining became NXT in 2013. The Proof-of-Stake consensus mechanism turned out to be so successful and flexible that in the following years it was implemented in hundreds of decentralized networks in different variants and modifications.

How PoS works

The original concept of the Proof-of-Stake (PoS) algorithm is that the right to manage a blockchain is granted to all its participants according to the proportion of coins held in their wallets. The canonical PoS mechanism gives each participant the ability to create a new block in the network, provided that they hold a certain minimum number of coins in their official wallets. These coins must be held in a wallet for a certain amount of time, starting with a certain block.

Each wallet in the system is a complete node (node) and stores its own copy of the blockchain – a list of all transactions since the blockchain was launched. It is important to note that such a wallet can function both on powerful servers and on less productive devices such as laptops, Raspberry Pi microcomputers or cloud services. Nowadays, hardware requirements for validators have gotten a bit more complex, and many blockchains require fairly powerful server machines.

As a result, the more coins held in a wallet, the higher the probability of creating a new block, which in turn leads to a reward for the validator for processing transactions on the block.

The process of holding (staking) coins in a wallet to be rewarded for participating in blockchain security is the blocking of coins in a smart contract with the inability to move them for a certain period of time – from a few hours to a few weeks or months, depending on the particular network.

POS

Staking

The reward for generating new blocks in the network serves to compensate nodes for the cost of transaction validation and is paid in native blockchain coins. The amount of reward for each generated block is usually fixed, but can vary depending on the network parameters.

Here is an example on the Tron blockchain platform, where a validator (super-representative) receives 32 TRX for each block generated. Some of these coins are sent to users who have frozen their TRX in steaking and thus support this validator.

The profitability of steaking for validators and coin holders is determined by two key factors:

  1. Rate of issue: This is the fixed value of coins issued when each new block is formed.
  2. Staking Ratio: This is the ratio of staked coins in circulation to the total supply of coins in the system.

To give an example, if the annual issuance through staking is 1 million coins and the total supply of coins in the system is 100 million, then the yield of staking at 50% blocked coins will be 2% per annum. If the proportion of coins in steaking is 25% of the total supply, the yield doubles to 4% per annum. This allows system participants to predict and adapt their steaking strategies depending on network conditions.

Varieties of Proof-of-Stake consensus

Several different types of consensus have been developed based on the basic PoS principle.

  • Leased Proof-of-Stake (LPoS) – used in the Waves blockchain, where users rent their coins to a validator for a fee;
  • Nominated Proof-of-Stake (NPoS) – used in the Polkadot blockchain platform and involves so-called nominators who pledge their coins to validators and are responsible for their integrity;
  • Pure Proof-of-Stake (PPoS, “pure proof-of-stake”) – used in the Algorand network, where validators of the next block are secretly and randomly selected among all wallets with a balance of more than 1 ALGO;
  • Effective Proof-of-Stake(EPoS) – used in the Harmony blockchain platform. Has a special reward distribution mechanism that encourages the launch of many small validators instead of a small number of large validators, which encourages decentralization;
  • Proof-of-Authority (PoA) – a hybrid algorithm that combines proof-of-share and reputation validators, each of which must be approved by the developers. In PoA, a validator must undergo an identity verification process similar to KYC. This algorithm uses BNB Chain.

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