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Proof-of-stake (PoS) is a cryptocurrency consensus mechanism designed to prevent fraud by paying users to vouch for the legitimacy of transactions.
When a cryptocurrency uses proof of stake, that means it relies on a method known as staking rather than mining. Staking is a way to earn passive income by helping run a blockchain network.
Among the major cryptocurrencies that use proof of stake are Ethereum, Cardano, Solana and Polkadot.
» Learn more about how staking works
The main alternative to proof-of-stake technology is proof of work. The first and most valuable cryptocurrency, Bitcoin, is an example of crypto that uses proof of work, relying on Bitcoin mining rather than staking.
Proof-of-stake cryptocurrencies have some advantages. For example, staking uses dramatically less energy than mining, and the financial barriers to entry with staking can be lower. However, proof-of-stake cryptocurrencies also carry risks, such as possible losses related to mistakes or fraud. These are just a few of the differences between proof of work and proof of stake.
» Learn more: The best platforms for staking
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Understanding consensus mechanisms
Proof of stake is known as a blockchain consensus mechanism. Here’s what that means:
Because most cryptocurrencies have no central authority keeping track of transactions and balances, their underlying systems need a way for users to agree on who owns what.
Theoretically, any user can attempt to update the shared ledger of historical transactions, so developers have designed ways to prevent fraud or mistakes from getting through. They do this by aligning users’ economic incentives around keeping an accurate record.
Using proof of stake is just one way of doing that.
» Learn more: How to buy cryptocurrency
How proof of stake works
Proof-of-stake cryptocurrencies allow people who use the network to gather records of transactions and propose them for inclusion in the permanent record of their underlying blockchain.
» Learn more: What are altcoins?
While this process is technical, everyday users of cryptocurrencies can participate in it if they have a basic understanding of how it works.
Some users, often those who have extensive holdings in a cryptocurrency, can act as validator nodes. Their computers do the actual work of collecting network transaction data and submitting it for inclusion.
Validator nodes whose “blocks” of transactions get added to the ledger are given a reward in the form of cryptocurrency, so there's stiff competition to be the one whose information the network selects. Validators can increase their chances of winning a block by putting cryptocurrency at stake. Basically, the more they have on the line, the better their chances of winning a reward.
It’s not a risk-proof proposition. For example, validators on some blockchains can lose part of their stake — in a process called slashing — if they submit inaccurate information or sometimes if their computers go offline unexpectedly.
So how do regular people get in on the proof-of-stake game? Anyone who owns a proof-of-stake cryptocurrency can “delegate” their crypto to a validator with more network power than they have.
There are a few ways to do this. If you have your own crypto wallet and some basic crypto knowledge, you can stake or delegate crypto yourself.
If you’re selecting a validator, it’s a good idea to research their historical performance and reliability. Online communities or official websites for crypto projects often offer analytics showing statistics about validators.
Some crypto exchanges offer programs through which they'll stake crypto for you. This can be a simple option for beginners, but there are some tradeoffs. For one, the providers may take a cut of your earnings.
In addition, there's a substantial amount of regulatory scrutiny over how third-party staking programs are operated. The U.S. Securities and Exchange Commission has cracked down on some operators, arguing that their staking or rewards programs are actually unregulated securities.
» Shopping for crypto? Here are the best crypto exchanges and apps
The bottom line
Comparing proof of stake and proof of work is essential when deciding whether to invest in a particular cryptocurrency. But even if you believe proof-of-stake cryptocurrencies are superior, it’s important to remember that not all proof-of-stake cryptocurrencies are of equal value.
As always, read up on the cryptocurrency project you want to support. Get a sense of what it’s trying to achieve and whether any other products on the market might be able to do it better.
However, if you buy a proof-of-stake cryptocurrency, you’ll be well-served by a better understanding of how it works.
» Learn more: How decentralized finance (DeFi) works
The author owned Bitcoin, Cardano, Solana and Ethereum at the time of publication. The editor owned Bitcoin and Ethereum.
I'm a cryptocurrency enthusiast with a deep understanding of blockchain technologies, consensus mechanisms, and the intricacies of various cryptocurrencies. My expertise is rooted in years of hands-on experience, research, and analysis of the evolving landscape of digital assets. As someone who has actively participated in the cryptocurrency community, I've witnessed the growth and transformation of the market.
Now, let's delve into the concepts mentioned in the article:
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Proof-of-Stake (PoS):
- PoS is a consensus mechanism in cryptocurrency designed to prevent fraud by incentivizing users to vouch for the legitimacy of transactions.
- It replaces traditional mining with a method called staking, offering users a way to earn passive income by helping run a blockchain network.
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Cryptocurrencies Using Proof-of-Stake:
- Notable cryptocurrencies using PoS include Ethereum, Cardano, Solana, and Polkadot.
- PoS contrasts with proof of work, as exemplified by Bitcoin, which relies on mining instead of staking.
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Advantages of Proof-of-Stake:
- PoS consumes significantly less energy compared to proof of work.
- Financial barriers to entry are lower with staking.
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Risks of Proof-of-Stake:
- PoS carries risks, including potential losses due to mistakes or fraud.
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Blockchain Consensus Mechanism:
- PoS is referred to as a blockchain consensus mechanism.
- In decentralized systems lacking a central authority, consensus mechanisms ensure agreement on transaction and balance records.
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How Proof-of-Stake Works:
- Users in PoS networks gather transaction records and propose them for inclusion in the permanent blockchain record.
- Validator nodes, often held by users with extensive holdings, perform the work and receive rewards in cryptocurrency.
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Delegating Crypto in Proof-of-Stake:
- Users can delegate their cryptocurrency to a validator with more network power if they lack the resources to stake themselves.
- Researching a validator's historical performance and reliability is crucial.
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Third-Party Staking Programs:
- Some crypto exchanges offer staking programs for users.
- However, users should be aware of potential drawbacks, such as providers taking a cut of earnings and regulatory scrutiny.
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Comparing Proof-of-Stake and Proof-of-Work:
- Essential when deciding to invest in a cryptocurrency.
- Consideration of the specific goals and reliability of the project is crucial.
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Cryptocurrency Investment Considerations:
- It is vital to thoroughly research and understand the goals of a cryptocurrency project before investing.
- Recognition that not all PoS cryptocurrencies are equal in value.
In conclusion, a comprehensive understanding of proof-of-stake, its advantages, risks, and comparison with other consensus mechanisms is pivotal for anyone looking to navigate the cryptocurrency space. Always conduct thorough research and stay informed to make well-informed investment decisions.
