Proof-of-stake (PoS) is not necessarily a new concept in the crypto space, but it has garnered much greater levels of attention recently due to Ethereum’s switch to this alternative consensus mechanism from proof-of-work (PoW). The earliest days of the Bitcoin network’s existence did focus with critics who saw PoW as a limitation of the original design in terms of scalability and security. Additionally, many worry about the potential negative impact PoW mining. The one it could have on the environment due to the large amount of energy that is in use in the process.
PoS intends to take care of these and other concerns. However, the jury is still out on whether or not PoS actually achieves its intended goals. There are concerns regarding the potential increased centralization that comes with a move from PoW to PoS. And at least part of the Ethereum community has become concerned with the potential regulatory capture of the platform since The Merge took place in September 2022. So, what is PoS and what does it mean for the future of crypto?
Proof-of-Work vs Proof-of-Stake in Crypto
In a blockchain system, there needs to be a way to maintain consensus on the order of transactions. If this consensus did not exist, there would be no way to prevent users from spending the same coins twice, as there would be no way to know which transaction came first. In Bitcoin, consensus regarding the ownership of coins maintains by the PoW miners.
These miners point their computer hardware at the crypto network in a lottery-esque system. Those with more computing power effectively have a higher chance of mining the next block of transaction, or to keep with the analogy, they have more lottery tickets. The idea is that these entities are trust to properly handle the task of ordering transactions on the Bitcoin network because they get an award for this activity via the block reward, which is made up of newly-created bitcoin and transaction fees. Miners are more than happy with this setup, as their goal is to earn more revenue via block rewards than they spend on their hardware, electricity, and other costs of mining.
In a PoS-based system, mining hardware replaces with crypto holdings. Instead of pointing hardware at the blockchain network, stakers agree to lock up their coins and earn rewards for participating in the process of maintaining consensus around the order of transactions and current account balances. Stakers are effectively able to earn a yield on their coins when they lock up their coins in this manner.
One should note that PoS systems can exist at multiple levels of the blockchain application stack. However, staking has also been in adoption by tokens that are made on top of those base blockchain layers. Specifically, staking is popular amongst so-called decentralized autonomous organizations (DAOs).
These DAOs usually associate with a particular app or community that exists on top of a layer-one blockchain. Those who hold tokens related to the DAO are somewhat similar to holders of stock in traditional companies. These DAO token holders are able to do things like vote on proposals for the future direction of the DAO. Also, earn dividends base on revenue that is generate by the DAO. However, DAO tokens and traditional stocks currently exist under two extremely different legal and regulatory environments. This is as this is still an experimental aspect of crypto finance.
The similarities between PoS on layer-one blockchains and DAO token staking is most clearly seen when you look at decentralized applications that pay dividends to DAO token holders who are willing to lock up their coins in order to participate in DAO governance and earn dividends.
There is one main questions people have had ever since Ethereum made its switch to PoS. This is whether Bitcoin may make a similar move in the near future. In short, this is extremely unlikely to happen for a variety of reasons. First of all, Ethereum and Bitcoin are quite different in terms of their intended use cases. While Ethereum is mostly in use for the development of decentralized applications, the point of Bitcoin is to be money.
And the security models for these two different use cases are not at all similar. Bitcoin must remain as decentralized and trustless as possible. This is so it remains credible as an apolitical, permission-less medium of exchange and store of value.
Additionally, it’s extremely difficult to make changes to Bitcoin/crypto. Some view this as a negative aspect of the system. However, it also further proves its key value proposition as a truly decentralized and unchangeable system. A move from PoW to PoS would be extremely controversial, so it is unlikely to gain much traction at all.
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