Proof of work vs Proof of stake

With the influx of scrypt ASICs, an ever increasing number of cryptocurrencies are choosing to launch with, or switch to a proof of stake (POS) mechanism for securing the network. Where as the scrypt hashing algorithm, developed by Litecoin had been the mechanism of choice, the high temperatures, electricity costs and an ongoing hardware arms race have encouraged coin developers to reassess their options and most new cryptocurrencies are released with a short term proof of work (POW) stage which is quickly followed by a switch to POS.

There is ongoing discussion and research in the Bitcoin community about POS and Litecoin developer, Charlie Lee recently ruled out a switch from the current scrypt algorithm. Other cryptocurrecies such as Reddcoin have forked to enable a switch from POW to a form of POS.

What is proof of work?

 

In the context of cryptocurrency, proof of work usually implies a coin will be mined using electronic hardware. Common hardware used to mine cryptocurrencies can be CPUs, GPUs, ASICs or FPGAs. By performing proof of work, miners generate blocks (a record of recent transactions) which are then confirmed by others in the network and added to the block chain (ledger of transactions). Rewards are given to miners who have found blocks. The miner benefits from being rewarded in the form of coins and the cryptocurrency network benefits from the miner’s computing power.

What is proof of stake?

 
Proof of stake is an alternative method to proof of work in the way that the network is secured and new coins are produced and distributed. Rather than mining, the network is maintained by users leaving their wallets open to ‘stake’ and they are rewarded proportionally to the amount of coins they stake. POS blocks are minted in similar way to POW and transactions added to the blockchain. As proof of stake does not require ‘work’ a wallet can be left open on any regular computer, regardless of specification.
 

Proof of work vs proof of stake

When looking around the web, there are a variety of opinions about which mechanism is the best to use for cryptocurrencies. Bitcoin and Litecoin are the biggest cryptocurrencies in terms of market capitalisation and up until this point have both chosen to stick with proof of work, as have Darkcoin and Dogecoin. However some of the newer and upcoming coins such as Vericoin and Blackcoin have chosen to use proof of stake.

One reason newer and smaller coins are choosing to go with POS over POW is the threat of 51% attacks. If a malicious pool, farm or miner can acquire over 51% of the network hashrate then there is a double spend vulnerability. An attacker can create a private fork as he is generating blocks faster than the rest of the network which would allow them to spend money twice. An example is the successful double spend attack on Rubycoin which uses the scrypt algorithm. The attacker was able gain over 51% of the network hashrate which was around 500mh/s which sounds like a lot until you realise that for the cost of a bitcoin or two you are easily able to rent enough mining power to perform an attack on a coin that has a marketcap of $125,000. The influx of large, expensive ASICs means that a lot of hash power is available to a small group of people. Scrypt coins with a small network hashrate will become increasingly vulnerable, something that Charlie Lee of Litecoin recently pointed out to the Dogecoin community.

Scrypt, however is not the only POW hashing algorithm. A number of alternatives have been used including x11, x13, x15 and x17 which use a number of hashing functions (the clue is in the name). They require less power and generate less heat that scrypt and so have become popular amongst miners. There are rumors that FPGAs can be programmed to mine these coins which would present much the same problem that ASICs do for Scrypt. It would be correct to assume that if any coin becomes profitable enough to mine that dedicated hardware for mining would soon follow, something Vertcoin seems to have realised as they have announced a switch from their ‘ASIC resistant’ Scrypt-N algorithm to a new Lyra2 algorithm.

A notable method of POW is the Myriad system which allows mining using five different algorithms of which each have the chance of finding the next block. This means that for a 51% attack to occur, the attacker would have to have 51% of five different algorithms which is possible but much more unlikely given the effort required. It also allows ASICs to encompassed by the network rather than deterring them which is the strategy used by many cryptocurrencies.

For a successful attack on a POS coin, the attacker would need 51% of the total coins being staked. Recently Navajo (a POS coin) was hit by a successful double spend attack. After Mintpal was recently compromised and a large amount of coins stolen, many feared that the successful attack could lead to a double spend attack as the attacker has acquired so many Vericoins. In the end they hard-forked to restore the network back to a previous state, an action which has proved controversial. For a POS cryptocurrency that is widely distributed, the threat of a 51% is much smaller than for coins which use POW. If a person were to own 51% of the total coins then by attacking the network he would likely devalue his own investment which is a great deterrent. In terms of security, both POW and POS are not, nor ever will be 100% secure, however a POS system has the edge on most forms of POW in regards to a 51% attack. (this is disputed here). A weakness of POS that many have highlighted is that people can vote for both sides of a fork when staking as there is no incentive (such as that provided by POW) to pick one fork. However much like a 51% attack the gains from staking on both forks would be trivial and could harm the value of the coin giving stakers a big incentive to preserve the integrity of the blockchain.

The security of the network isn’t the only thing to be taken into consideration though. What about the economics of distribution? For stability and a healthy economic scenario, the more evenly distributed a coin is, the better. POW allows anyone with the correct hardware to help maintain the blockchain and thus acquire minted coins. POS on the other hand only rewards those who already own coins with new coins.

Hardware that can be used for POW is in no way evenly distributed but it is far more evenly distributed than the owners of one particular cryptocurrency. Think about the number of people in the world who own a PC vs the number of people who own blackcoin. The opportunity for newcomers to acquire new coins with the resources at their disposal (hardware and electricity) vs money is much higher for cryptocurrencies that utilise POW.

Then there is the issue of hoarding. The value of any cryptocurrency is driven by supply and demand. POS by its very nature encourages users not to spend but save and stake to generate more coins. From a short term perspective many will see this a good attribute as a lower amount of coins will be sold on exchanges which will in turn bring the value up. However from a longer term perspective a coin is effectively worthless if no one spends it. Vendors and merchants will receive less buys and therefore have less incentive to accept it as a payment method. Without anywhere to spend a coin then there is no value in it apart from speculation.

Most POS coins start with a short period of POW to distribute the initial coins and then switch to POS. This essentially means that anyone that was around for the short period of mining is greatly rewarded, not only from the coins they were able to mine but also from the potential to then stake these coins when it switches to POS. Anyone who wants to get involved after the initial POW stage is at a massive disadvantage as a large amount of coins are distributed to a small amount of people during the inception of the coin.

In the end, the reality of the situation is that if you invest more you get more return. Whether it be mining hardware or coins to stake. The big difference I see is that POW gives a slightly fairer chance for anyone to acquire coins than POS does. It obviously depends on the method of POW and coins that use an algorithm that can be mined by ASICs such as Bitcoin and Litecoin are expensive to get into where as others such as Vertcoin and Myriadcoin offer the best chance of fair distribution.