What is Proof of Stake? How does it work?

Emerging as an alternative to Bitcoin's Proof of Work protocol, Proof of Stake (PoS) is a protocol that considers digital asset ownership rather than a system based on computational power. The PoS protocol, presented in an article published by blockchain developers Sunny King and Scott Nadal in 2012, focuses on eliminating the high energy consumption and some other problems required for Bitcoin mining. Peercoin was the first cryptocurrency to use the PoS protocol.

The Proof of Work protocol used in the Bitcoin network is a system where miners, who hold most of the processing power, have more say in the network and therefore earn more returns. Bitcoin mining requires high energy consumption, but the Proof of Stake protocol does not allocate network power based on processor power. In PoS, the generation of the next block can be handled by operators who execute several combinations simultaneously. There are multiple types of Proof of Stake protocol.

In the Proof of Stake protocol, users who want to be able to verify transactions and get a share of the revenue must lock their cryptocurrency holdings to be used for verification. In this locking process, called "Staking" (taking a share of the revenue), in the wallet, the amount desired to be used for this transaction cannot be withdrawn from the wallet until it is unlocked, and is marked on the network as the user's stake.

In blockchains using proof-of-stake protocol, users share block verification rewards and transfer fees (miner fee) paid by other users in proportion to their shares. We can liken this process to owning the shares of a publicly traded company. Users who allocate more cryptocurrencies for "staking" get a higher share of revenue, just as people who own more shares get a higher share of the profits the company distributes.

Features of Proof of Stake Protocol

The most prominent feature of Proof of Stake is that it emphasizes capital power over computational power. So instead of starting a trade by running a piece of equipment, it is necessary to have an asset to stack. In the PoS protocol, a user holding more cryptocurrencies can also increase his power in the network. The verification process is based on some rules. Users with more assets in their wallet are more likely to be authenticators. This is where the concept of "staking" comes from. The PoS protocol is based on wallet holders earning by confirming transactions. The user with more assets gets a bigger share of the revenue. However, it should be noted that this does not work the same in all PoS types.

To prevent the wealthiest stakeholder from monopolizing the network, the Proof of Stake protocol uses multiple options for block definitions. The most common PoS selection types are random and cryptocurrency age selection.

In random selection, those who approve transactions are selected among the weakest nodes in terms of computation (hash) value but the richest in terms of share (share) value. In cryptocurrency age selection, users who hold the asset the longest are selected as validators, and after verification, these users are rewarded.

Types of Proof of Stake

The Proof of Stake protocol, which emphasizes the asset ownership of the users, has evolved over time and started to be offered with different options. Delegated Proof of Stake (dPoS) and Leased Proof of Stake (LPoS) are the prominent types of PoS.

Delegated Proof of Stake (DPoS)

In the Proof of Stake protocol based on cryptocurrency ownership, a user has the right to verify transactions and generate blocks by keeping their crypto assets in their wallet connected to the relevant blockchain. dPoS, on the other hand, comes with some additional features and leverages the power of stakeholders to resolve consensus by voting fairly.

It uses a social reputation system to drive consensus across its Delegated Proof-of-Stake (dPoS) blockchain network. Referred to as the least decentralized protocol compared to others, dPoS aims to give cryptocurrency holders a say in the management of the network.

Unlike the Proof-of-Stake system, users delegate their crypto assets in their wallets to another user. Cryptocurrency asset is not transferred from the wallet, but is considered as the asset of the delegated user, increasing the delegated user's voice in the network. The person who receives the right to delegate from other users receives a larger share of the revenues in the network and shares the revenue with the delegates in proportion to their shares.

Leased Proof of Stake (LPoS)

In the Proof of Stake protocol, users are selected according to certain criteria and validate blocks. In other words, they cannot generate income from every block produced. However, in the Proof of Leased Stake (LPoS) protocol, users are allowed to lease a certain percentage of an entire node. This system works exactly like PoS, but it also uses a lease method to provide an incentive to participate to users who hold small amounts of assets. Among the cryptocurrencies using the LPoS protocol, the most well-known is Waves.

Users lease the cryptocurrency in their wallets to other users who approve transactions on the network. In the leasing process, the leased amount does not come out of the user's wallet, but is closed for withdrawal and buying and selling transactions. The leased user receives a larger share of the income while performing mining activities and shares his earnings with his stakeholders in proportion to their shares. The user can terminate the lease or lease more cryptocurrencies at any time.