Proof of Stake (PoS)

What Is Proof of Stake (PoS)?

The Proof of Stake (PoS) concept states that a person can mine or validate block transactions according to how many coins they hold. This means that the more coins owned by a miner, the more mining power they have.

Key Takeaways

  • With Proof of Stake (POS), cryptocurrency miners can mine or validate block transactions based on the amount of coins a miner holds.
  • Proof of Stake (POS) was created as an alternative to Proof of Work (POW), which is the original consensus algorithm in Blockchain technology, used to confirm transactions and add new blocks to the chain.
  • Proof of Work (POW) mining requires huge amounts of energy consumption to fuel computational power; Proof of Stake (PoS) gives mining power based on the percentage of coins held by a miner.
  • Proof of Stake (POS) is seen as less risky in terms of the potential for miners to attack the network, as it structures compensation in a way that makes an attack less advantageous for the miner.
  • Bitcoin, the largest cryptocurrency, runs on proof of work rather than proof of stake.

Understanding Proof of Stake (PoS)

The proof of work (PoW) consensus algorithm requires each node in the Bitcoin network to solve a problem. The first node that solves the problem is granted permission to add a new block and the miners are awarded bitcoin for their work. The nodes are the administrative body of the blockchainand verify the legitimacy of the transactions in each block. Once a block of transactions has been verified, the data is written into the blockchain.

The proof of stake (PoS) consensus protocol was created as an alternative algorithm seeking to address the scalability and environmental sustainability concerns surrounding the proof of work (PoW) protocol.

How Proof of Stake Addresses Mining Power

Mining requires a great deal of computing power to run different cryptographic calculations to unlock the computational challenges. The computing power translates into a high amount of electricity and power needed for the proof of work.

In 2015, it was estimated that one Bitcoin transaction required the amount of electricity needed to power up 1.57 American households per day. That number has only since gone up. According to the University of Cambridge's Bitcoin Electricity Consumption Index, Bitcoin consumers about 119.87 terawatt-hours per year, which is more than countries like the United Arab Emirates and the Netherlands consume annually. To foot the electricity bill, miners would usually sell their awarded coins for fiat money, which would lead to a downward movement in the price of the cryptocurrency.

The PoW algorithm is widely considered unsustainable, as the energy consumption required to mine Bitcoin leaves a significant carbon footprint in its wake. Additionally, Bitcoin miners generate large amounts of electrical waste because the ASIC machines used to mine Bitcoin only serve one function.

The Bitcoin Energy Consumption Index estimates that the Bitcoin network consumes 132.5 terawatt-hours per year as of June 29, 2021. Similarly, the Bitcoin Energry Consumption Index suggests that a single bitcoin transaction is 2021 is equivalent to the power consumption of an average U.S. household over 57.25 days, a stark contrast to the 2015 power consumption estimate of 1.57 days. Bitcoin miners generally earn their revenue in bitcoin, but often pay their operating expenses like electricity and rent with fiat currency. As a result, the currency exchange activity of miners has a profound effect on the market dynamics of cryptocurrency pricing and profitability.

According to a June 2021 study, the Bitcoin network's power requirements have surged because the rising prices of a single bitcoin have made mining a far more valuable proposition than ever before. The prices have enticed the participation of Bitcoin miners, incentivizing them to spend more on hardware and electricity to compete in the block creation process.

The PoS algorithm, however, seeks to solve this problem by effectively substituting staking for computational power, whereby an individual's mining power is limited to the percentage of ownership staked. This means a drastic reduction in energy consumption and the manufacture of single-purpose hardware, like the ASIC machines because they are no longer needed for their computing power.

The proof of stake (PoS) seeks to address this issue by attributing mining power to the proportion of coins held by a miner. This way, instead of utilizing energy to answer PoW puzzles, a PoS miner is limited to mining a percentage of transactions that is reflective of their ownership stake. For instance, a miner who owns 3% of the coins available can theoretically mine only 3% of the blocks.

The first cryptocurrency to adopt the PoS method was Peercoin. Nxt, Blackcoin, and ShadowCoin soon followed suit.

Risk of Network Attack

Bitcoin uses a PoW system and as such is susceptible to a potential Tragedy of Commons. The Tragedy of Commons refers to a future point in time when there will be fewer bitcoin miners available due to little to no block reward from mining. The only fees that will be earned will come from transaction fees which will also diminish over time as users opt to pay lower fees for their transactions.

With fewer miners than required mining for coins, the network becomes more vulnerable to a 51% attack. A 51% attack is when a miner or mining pool controls 51% of the computational power of the network and creates fraudulent blocks of transactions for themselves while invalidating the transactions of others in the network.

With a PoS, the attacker would need to obtain 51% of the cryptocurrency to carry out a 51% attack. The proof of stake avoids this ‘tragedy’ by making it disadvantageous for a miner with a 51% stake in a cryptocurrency to attack the network. Although it would be difficult and expensive to accumulate 51% of a reputable digital coin, a miner with a 51% stake in the coin would not have it in their best interest to attack a network that they hold a majority share.

If the value of the cryptocurrency falls, this means that the value of their holdings would also fall, and so the majority stake owner would be more incentivized to maintain a secure network.

In addition to Bitcoin, Litecoin (LTC) also uses the PoW method. Nxt (NXT) is an example of a cryptocoin that uses the PoS method. Some coins like Peercoin (PPC) use a mixed system where both methods are incorporated. Currently, Ethereum (ETH) is in the process of switching to a PoS system.

Bitcoin, the largest cryptocurrency, runs on proof of work rather than proof of stake.


What is Proof of staking?

The Proof of Stake (PoS) concept states that a person can mine or validate block transactions according to how many coins they hold.

What Is the Difference Between Proof of Work and Proof of Stake?

Proof of Stake (POS) was created as an alternative to Proof of Work (POW), which is the original consensus algorithm in Blockchain technology, used to confirm transactions and add new blocks to the chain.

Which Coins Use Proof of Stake?

Peercoin, Nxt, Blackcoin, and ShadowCoin all use proof of stake.

Is Proof of Stake Secure?

Proof of Stake (POS) is seen as less risky in terms of the potential for miners to attack the network, as it structures compensation in a way that makes an attack less advantageous for the miner.

Could Bitcoin Change to Proof of Stake?

Logistically, there's a debate that it is near-impossible Bitcoin will change to proof of stake because of some technical challenges involved in the transition, which would really disadvantage those that have put the most effort into bitcoin right now. However, in theory, many including the founder of Swiss cryptocurrency broker Bitcoin Suisse, predict that eventually, Bitcoin will move to a proof of stake model. 

Article Sources

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