An Introduction to Proof of Stake Blockchain Systems

Discover how proof-of-stake blockchains validate transactions, reduce energy use, and enhance decentralization

Blockchain continues to generate interest from enterprises, individuals, and policymakers. As awareness grows, it becomes increasingly crucial to understand how blockchain networks function. This knowledge contributes to informed policies and can help determine the most valuable ways to apply this innovative technology. From commerce and healthcare to supply chains and intellectual property, blockchain use cases span diverse sectors worldwide.

While existing networks often rely on centralized decision-making, blockchains adopt a more decentralized approach by employing consensus protocols. Such protocols enhance network resilience and reduce the risks associated with single points of failure. Specifically, these systems govern how information is validated and recorded on the blockchain, shaping how cryptocurrency holders and users engage with the network.

Making decisions on blockchain networks

Blockchain technology can facilitate traceability, authenticity, and transparency in the movement of physical and digital assets without centralized authority. This functionality results from implementing a decentralized, distributed network, where all nodes must transparently agree on the validity of each transaction before adding it to the blockchain. Nodes serve as individual computers or devices that maintain a copy of the blockchain and participate in the consensus process.

To illustrate, when transferring a digital asset, all nodes in the blockchain network must agree on the asset's origin, the transaction's validity, and the node's authority to record it. While generally considered permanent and publicly accessible, new transactions are subject to network agreement. This agreement, or consensus protocol, is an essential requirement for all blockchains.

For most blockchains, the protocol determines which transactions are added without the involvement of an individual or organization. In addition, blockchain networks employ different consensus protocols, each with unique features and functionalities. For instance, Cardano utilizes a proof-of-stake (PoS) system called Ouroboros, Bitcoin uses proof-of-work (PoW), and Ethereum employs a proof-of-stake protocol called Gasper.

The evolution of blockchain consensus

The Bitcoin network, conceived by the pseudonymous Satoshi Nakamoto, implemented proof-of-work to solve the double-spending problem, a vulnerability where a single unit of digital currency could be spent multiple times, thereby securing the network's integrity. In proof of work, the first miner to solve a complex mathematical problem gains the ability to add verified transactions into a new block on the chain. In the case of Bitcoin, miners receive tokens in exchange for their efforts.

Despite its benefits, this model could lead to the consolidation of mining power, where a few large entities control the majority. Moreover, given the expense of specialized mining equipment, larger operations have cost advantages, further undermining decentralization. Mining power consolidation poses several risks, including:

• •Higher fees: Large miners could collude to increase transaction costs.
• •Censorship: One participant could block certain transactions.
• •51% attacks: A single entity with majority control could manipulate the blockchain.

Additionally, given the need for extensive computational power, proof of work leads to high energy consumption, representing a notable percentage of global electrical demand. This high energy use, coupled with mining power consolidation, spurred the introduction of proof of stake in 2012.

What is proof of stake?

As an alternative consensus mechanism, proof of stake aims to mitigate proof of work’s intrinsic issues by reducing energy consumption while promoting a more decentralized and accessible network for validators. Proof of stake intends to accomplish this objective by minimizing the resources required for participation, allowing individuals with less powerful hardware to contribute to network security and governance. This fosters inclusivity and reduces the risk of network control becoming concentrated in the hands of a select few with extensive resources. Such a system also promotes a more equitable distribution of influence and rewards within the blockchain ecosystem.

In proof-of-stake blockchain networks, the consensus algorithm randomly selects nodes to validate transactions. This algorithm considers the amount of cryptocurrency held by each validator, or staker, as a measure of their commitment to or stake in the network. The more cryptocurrency a user holds, the greater the probability the protocol will select them to validate transactions and create new blocks.

Validators on proof-of-stake networks are incentivized to act in good faith during transaction validation. Typically, actions that attempt to manipulate the system risk penalties, including the loss of staked funds or other adverse consequences, such as the potential devaluation of the network's native token. By implementing these disincentives for actions like double-signing or failing to maintain network connectivity, proof-of-stake mechanisms discourage any single entity from gaining excessive control over the network's staked cryptocurrency.

In proof of work, the more computational power a miner has, the greater their chances of mining the next block first or before the others. In proof of stake, the more tokens an individual controls and stakes, the more likely they will participate in minting the next block. Given its reliance on processing power, proof of work incentivizes miners to spend money outside the protocol on hardware and energy. Conversely, proof of stake incentivizes validators to keep their funds in the protocol, helping sustain the blockchain ecosystem.

The different proof of stake systems

Because blockchains differ in their unique needs and goals, different networks have developed proof-of-stake variations. This illustrates the fundamental challenge of consensus mechanism design: balancing competing priorities. For instance, networks may choose a longest-chain rule for its simplicity or a Byzantine Fault-tolerant (BFT) rule for its robust handling of faulty nodes.

Proof of stake types that utilize the longest-chain rule allow for any number of nodes, enhancing decentralization and better protecting against attacks. With this type of blockchain, the longest chain of valid blocks becomes the perceived valid chain, with a stake-weighted voting process determining consensus. This proof of stake type generally better accommodates the needs of permissionless blockchains that prioritize decentralization. In fact, Cardano uses the longest-chain-rule type of consensus mechanism.

The design of BFT-style consensus mechanisms makes them fast and more robust against malicious or Byzantine attacks. A Byzantine attack involves harmful network actors colluding to disrupt its operations, often by spreading false information or acting against the network's best interests. With this proof of stake type, a committee of validators guides consensus by verifying transactions and creating new blocks. These blockchains achieve faster settlement times because each validator directly communicates with every other validator to reach consensus.

However, this intensive communication process creates computational overhead. The processing power required for each validator to manage those connections becomes a bottleneck, limiting the practical number of participants. As a result, this model often serves in permissioned networks like Ripple or protocols designed to host multiple smaller blockchains like the Cosmos ecosystem.

Delving deeper into proof-of-stake protocols

A closer look at the technical distinctions between various proof-of-stake consensus mechanisms offers valuable insights into the differing approaches to validator selection.

• •Threshold PoS: Validators possess a minimum token amount to participate.
• •Pure PoS: Randomly selects validators.
• •Nominated PoS: Token holders nominate validators for block creation.
• •Hybrid PoS: Combines proof of work and proof of stake, securing blockchain through token ownership and computational work.
• •Delegated PoS: Holders delegate tokens to validators for block creation.
• •Cardano PoS (Ouroboros): Resembles Delegated PoS, but ada holders delegate to stake pools.
• •Ethereum PoS (Gasper): Validators directly stake ether, lacking explicit token delegation.
• •Masternode PoS: Extends Nominated PoS with masternodes performing additional functions (e.g., instant transactions).

By offering various methods to select validators and participate in the consensus process, these proof of stake variations allow flexibility in designing and implementing blockchain solutions. Each has unique advantages and disadvantages that should be considered when evaluating network suitability.

Exploring Cardano’s consensus protocol

Cardano uses the Ouroboros family of protocols as its specific proof-of-stake consensus mechanism. These mechanisms employ the verifiable random function (VRF) to select a validator while ensuring randomness and easy participant verification.

The number of tokens a block producer possesses, like Cardano’s ada, refers to their pledged stake. The more ada a validator controls, either their own or delegated from others, the higher the probability of being chosen to create a block and receive rewards. While delegators don't directly validate blocks, they influence the network by selecting reliable stake pools run by stake pool operators (SPOs). Rewards depend on the amount of ada delegated and the pool's performance in creating blocks and maintaining network stability. Notably, delegation rewards can vary, and no guarantees exist.

This delegation grants SPOs voting rights within the Cardano network, enhancing overall platform reliability and security. Importantly, ada holders retain complete control of their assets throughout the delegation process and can access or withdraw funds anytime. Moreover, since the protocol assigns block validation, delegators have no control over the block production process and cannot exploit or manipulate it.

On other blockchains, slashing acts as a penalty mechanism, partially or fully confiscating a validator’s staked funds for malicious or negligent behavior, such as double signing or prolonged inactivity. Cardano relies on other mechanisms to ensure the network's security and integrity, such as SPO pledges (the amount of ada an operator commits to their own pool), robust operational resilience, and a high degree of decentralization.

The diversity of decentralized consensus

Unlike centralized networks, most blockchains leverage consensus protocols to validate transactions in a decentralized manner, determining which become part of the ledger. Proof of stake provides a more energy-conscious alternative to proof of work and aims to promote optimal decentralization through accessible validation criteria.

While proof of stake offers a general framework for decentralized validation, specific implementations of such consensus mechanisms can vary significantly. These variations, particularly in validator selection, directly influence network characteristics. Indeed, differences in how validators are chosen, such as through thresholds, nominations, random selection, delegation, masternodes, or hybrid models, can yield unique features and functionalities.

For example, Cardano's proof-of-stake protocol provides a unique benefit: it allows users to vote for block producers without transferring control of their tokens or risking the loss of their funds due to lock-up periods. Compared to alternative proof-of-stake blockchains, this fosters a more inclusive system. Understanding the similarities, differences, and variations between the multiple proof-of-stake systems is crucial for developing effective and adaptable blockchain architectures. It also makes it easier to decide which consensus protocols to use in various sectors, from manufacturing and agriculture to luxury goods and beyond.

To learn more about blockchain technology, visit Cardano Academy to access the Cardano Blockchain Certified Associate (CBCA) course, which prepares participants for formal certification.