DEFINITION of 'Proof of Stake (PoS)'

Proof of Stake (PoS) concept states that a person can mine or validate block transactions according to how many coins he or she holds. This means that the more Bitcoin or altcoin owned by a miner, the more mining power he or she has.

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

BREAKING DOWN 'Proof of Stake (PoS)'

The proof of stake was created as an alternative to the proof of work (PoW), to tackle inherent issues in the latter. When a transaction is initiated, the transaction data is fitted into a block with a maximum capacity of 1 megabyte, and then duplicated across multiple computers or nodes on the network. The nodes are the administrative body of the blockchain and verify the legitimacy of the transactions in each block. To carry out the verification step, the nodes or miners would need to solve a computational puzzle, known as the proof of work problem. The first miner to decrypt each block transaction problem gets rewarded with coin. Once a block of transactions has been verified, it is added to the blockchain, a public transparent ledger.

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. 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 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 his or her ownership stake. For instance, a miner who owns 3% of the Bitcoin available can theoretically mine only 3% of the blocks.

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 himself, 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 51% stake in the coin would not have it in his best interest to attack a network which he holds a majority share. If the value of the cryptocurrency falls, this means that the value of his 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. As of May 2017, Ethereum (ETH) is in the process of completely switching from a PoW to a PoS system.

RELATED TERMS
  1. Proof of Activity (Cryptocurrency)

    Proof of activity is the blockchain consensus algorithm based ...
  2. Slimcoin (Cryptocurrency)

    Slimcoin is a unique peer-to-peer cryptocurrency that allows ...
  3. Block (Bitcoin Block)

    Blocks are files where data pertaining to the Bitcoin network ...
  4. Decred (DCR)

    Decred is a completely autonomous blockchain-based cryptocurrency ...
  5. Mining Pool

    A mining pool is a joint group of cryptocurrency miners who combine ...
  6. Block Explorer

    A block explorer is a website that allows users a real-time, ...
Related Articles
  1. Tech

    What is Bitcoin Mining?

    Bitcoin mining is how Bitcoin gets released into circulation.
  2. Tech

    Bitcoin Miners No Longer Turning a Profit Creating Cryptocurrency

    Falling bitcoin prices, a surge in competition among miners and lower transaction fees have cut into miners' revenues.
  3. Trading

    Bitcoin Cash: The New King of Cryptocurrency?

    Investors are wondering if the popularity of Bitcoin Cash poses a serious threat to the Bitcoin throne.
  4. Tech

    How Do You Mine Ethereum?

    Mining for ethereum is a profitable, essential, and oftentimes confusing process. Here's the basics of how to do it.
  5. Tech

    Only 20 Percent Of Total Bitcoins Remain To Be Mined

    As of this past weekend, 80 percent of all bitcoins have been mined. What happens to bitcoin's price?
  6. Tech

    How Does Bitcoin Mining Work?

    Bitcoin mining, explained like you're five.
  7. Tech

    What Happens to Bitcoin After All 21 Million are Mined?

    The popular cryptocurrency has a finite supply. What will happen when we reach that point?
  8. Tech

    What Happens If China Bans Bitcoin Mining: 3 Scenarios

    China has already banned ICOs and is shutting down Bitcoin exchanges. What would happen if they also banned crypto mining?
  9. Tech

    Bitcoin vs. Bitcoin Cash: What's the Difference?

    We break down the difference between Bitcoin and Bitcoin Cash, and what it might mean for the future of cryptocurrencies
  10. Tech

    Which Countries Benefit From China's Crackdown On Bitcoin Mining?

    Three countries are poised to benefit from China's efforts to drive bitcoin miners from its shores.
RELATED FAQS
  1. What is the metals and mining sector?

    Learn about the mining sector and the many ways that mining companies profit from the location and extraction of minerals ... Read Answer >>
  2. What criteria classify a company as a junior gold miner?

    Learn about junior gold miners, companies that exclusively mine for gold. These firms typically rely on venture capital and ... Read Answer >>
  3. What main factors affect share prices in the metals and mining sector?

    Discover the primary factors that influence share prices of companies in the metals and mining sector and how companies can ... Read Answer >>
  4. Why do Bitcoins have value?

    Performing with transactional anonymity, Bitcoin has value as a private digital currency, investment tool and social networking ... Read Answer >>
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center