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What is Proof-of-Stake and How does it work?

By Romeo F.
8 Sept 2023
7 min read

Proof-of-Stake (PoS) is a consensus mechanism used in blockchain networks to validate transactions and create new blocks. In PoS, participants, known as validators, are chosen to create blocks and secure the network based on the amount of cryptocurrency they hold and are willing to "stake" as collateral.






Proof-of-Stake represents a seismic shift in the way blockchain transactions are validated and new blocks are added to the chain. It's a departure from the energy-intensive PoW, which famously powers the Bitcoin network.

POS touches upon core issues like scalability, security, and accessibility. In this article, we’ll understand why PoS is not just a trend; it's a pivotal step toward the future of blockchain technology.

At its core, Proof-of-Stake is a consensus mechanism that determines how transactions are validated and new blocks are added to the blockchain. Unlike Proof-of-Work, where miners compete to solve complex mathematical puzzles, PoS relies on a more resource-efficient process.

Comparing PoS and PoW

To appreciate the significance of PoS, let's briefly compare it to the traditional PoW mechanism. In PoW, miners invest substantial computational power and energy to solve cryptographic puzzles, a process known as "mining." The first miner to solve the puzzle gets to add the next block and is rewarded with cryptocurrency (like Bitcoin).

In contrast, PoS eliminates the resource-intensive mining process. Instead of competing to solve puzzles, validators are chosen to create blocks based on their "stake" in the network.

This shift dramatically reduces energy consumption and makes PoS networks more scalable, addressing one of the major criticisms of PoW.




Key Components of PoS


To navigate the world of PoS, it's crucial to familiarize yourself with its key components:




Validators


These are participants who lock up a certain amount of cryptocurrency as collateral to be eligible to propose and validate blocks. Validators play a pivotal role in the PoS ecosystem by ensuring the integrity of the network.




Staking


Staking involves the act of locking up a specific amount of cryptocurrency to participate in the network. This collateral is used to vouch for a validator's honesty and commitment to the network's security.




Consensus


PoS networks achieve consensus through the collective agreement of validators. Transactions are validated and blocks are added based on this consensus, which is achieved without the need for resource-intensive computations.

PoS in Different Blockchain Ecosystems

Not all Proof-of-Stake (PoS) systems are equal. Each blockchain ecosystem has its own unique take on PoS, offering a diverse range of features and benefits. In this section, we'll take a look at four notable blockchain ecosystems: Ethereum 2.0, BNBChain, Solana, and Cardano (ADA).




Ethereum 2.0


The Ethereum community has made a monumental shift from the energy-intensive Proof-of-Work (PoW) to the more scalable Proof-of-Stake (PoS) consensus mechanism.

Ethereum 2.0, often called Eth2, represents a groundbreaking upgrade that aims to address some of the pressing issues faced by its predecessor.

The journey of Ethereum’s transition to POS is still underway. The first step was taken in Sep 2022 when the Beacon chain finally merged with the Ethereum mainnet, allowing validators to stake ETH tokens.

Ethereum's upgrade path
Credit: FX Street

Role of validators and staking in Ethereum 2.0


Validators are the heart and soul of Ethereum 2.0. To become a validator, one has to lock up 32 ETH as collateral. These validators are then randomly selected to propose and validate new blocks, with their likelihood of selection directly proportional to the amount of ETH staked.

This system incentivizes validators to act honestly and maintain network security.




Rewards and penalties


The validators in Ethereum get paid for their contribution in two primary ways:

Block rewards: Validators who are randomly selected to propose new blocks are rewarded with a block reward. The block reward is currently 2 ETH, but it is expected to decrease over time.

Transaction fees: Validators also receive a share of the transaction fees that are included in the blocks they validate. The amount of transaction fees that a validator receives depends on the amount of ETH they have staked.

The total amount of rewards that a validator receives depends on a number of factors, including the number of validators in the network, the amount of ETH staked, and the amount of transaction activity on the network.

In addition to the rewards, validators may also earn additional income by charging a commission on the rewards they generate.

Validators who misbehave or propose invalid blocks may face penalties, including the slashing of their staked ETH. This mechanism ensures that participants have a strong incentive to act in the best interests of the network.

BNBChain

BNBChain is another prominent blockchain ecosystem that has embraced the PoS consensus mechanism. BNB, developed by Binance, offers an efficient and scalable platform for decentralized applications and smart contracts.




BNB Validators Reward


BNBChain staking page
Credit: BNBChain

BNB Chain uses a Proof-of-Staked Authority (PoSA) consensus mechanism, which is a hybrid of Proof-of-Authority (PoA) and Delegated Proof-of-Stake (DPoS).

In PoSA, validators are randomly selected to propose blocks and verify transactions. The probability of being selected as a validator is proportional to the amount of BNB staked.

Validators who behave dishonestly, such as by proposing an invalid block, are penalized by having their staked BNB slashed.

The validator system in BNB Chain is designed to be more secure, efficient, and scalable than the PoW consensus mechanism used by Bitcoin and Ethereum.




Key features of the validator system in BNB Chain


Staking: To become a validator, a user must stake a certain amount of BNB, which is locked up as collateral. The amount of BNB required to stake varies depending on the network's requirements.

Random selection: Validators are randomly selected to propose blocks and verify transactions. This ensures that no single validator has too much control over the network.

Slashing: Validators who behave dishonestly, such as by proposing an invalid block, are penalized by having their staked BNB slashed. This helps deter malicious behavior and ensure the security of the network.

Delegating: Users who do not want to become validators themselves can delegate their BNB to other validators. This allows them to participate in the consensus mechanism without having to stake their own BNB.

Solana

Solana uses a Proof-of-History (PoH) consensus mechanism, which is a type of Proof-of-Stake (PoS) consensus mechanism that they developed.

In PoH, validators are randomly selected to propose blocks and verify transactions. The probability of being selected as a validator is proportional to the amount of SOL staked.

In addition to staking SOL, validators must also maintain a high-performance node that is always online. This ensures that the network is always available and that transactions are processed quickly.

Validators who behave dishonestly, such as by proposing an invalid block, are penalized by having their staked SOL slashed.

Cardano

Cardano uses a very similar Proof-of-Stake structure with some unique features.

In Cardano, there are two types of validators:

Stake pools: Stake pools are groups of users who pool their ADA together to increase their chances of being selected as a validator.

Delegators: Delegators are users who stake their ADA to a stake pool. This allows them to participate in the consensus mechanism without having to run their own validator node.

Liquid Staking: Enhancing PoS Liquidity

Liquid staking is a revolutionary concept within the PoS ecosystem. It allows participants to stake their tokens in a network while still maintaining liquidity and fungibility.

In other words, you can have your cake and eat it too. Traditionally, when you stake your assets in a PoS network, they become locked and non-transferable for a certain period.

Liquid staking changes that game by making staked assets liquid and tradable.

It addresses a significant challenge for stakers, who often face a dilemma: they want to contribute to network security and earn rewards through staking, but they also want the flexibility to use their assets for other purposes or trade them on the open market.

Liquid staking bridges this gap, providing stakers with the best of both worlds.

Liquid staking definition
Credit: OKX

How Liquid Staking Works


The magic of liquid staking lies in its ability to represent your staked tokens as fungible assets. When you stake your tokens in a PoS network, you receive a tokenized representation of your staked assets, often referred to as "staked tokens" or "staking derivatives."

These staked tokens are tradable and can be used just like the original tokens.

Here's how it works: Let's say you have 100 tokens that you want to stake. Instead of locking up the entire 100 tokens, you can convert them into 100 staked tokens, which are liquid and tradable.

These staked tokens still represent your stake in the network, and they often accrue rewards in real-time, just like traditional staking. This means you can participate in staking and enjoy the benefits while keeping your assets fungible.

Examples of ETH Staking Tokens: Lido ETH (stETH), Rocket Pool ETH (rETH), etc.

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