Proof of Stake and Proof of Work

  • 2023 Sep 10

Proof of Stake and Proof of Work are two different consensus algorithms or mechanisms in blockchain technology. An algorithm or consensus mechanism is a fundamental concept in blockchain or distributed ledger technology (DLT). Blockchain is a distributed ledger that records financial transactions and other data. In accounting and finance, a ledger is a book that contains all financial data, including transactions like buying and selling. It stores information such as account names, creditors, debtors, and other financial and transaction data separately and independently.

Transaction security:

A Distributed Ledger Technology (DLT) is a crucial component in the verification of ownership and proof of work. It plays a significant role because it accomplishes three essential tasks: confirming ownership, identifying identities, and clarifying and determining the status. Blockchain is a public distributed ledger. We mentioned that the blockchain structure is defined as a chain of blocks. On the other hand, we mentioned that blockchain is a decentralized ledger in which buying and selling data is recorded. As a result, blockchain should be understood as a chain of transaction histories that stores all data in units called blocks. Each of these block units is responsible for storing a batch of data or transaction history. In these blocks, information such as date, time, price or the amount of user purchases, as well as seller data, are retained in peer-to-peer transactions. Instead of your data and identity information, a unique and individual digital signature is used in these blocks. This signature or unique code is called a hash.

Your DeFi (Decentralized Finance) saves you: An answer to the question of what proof of ownership and proof of work is?

In this part of our response to the question of what proof of ownership and proof of work is, let’s go back to the algorithm, system, or consensus mechanism! We mentioned that blockchain is a chain of blocks. Each block contains some of the data and information from previous blocks. This storage process means that any change in the arrangement of data and information will result in a chain of changes. In other words, a change in one block will trigger a cascade of changes in the blockchain. The consensus algorithm takes advantage of this fluid and decentralized feature of the blockchain and allows all users to reach consensus on a change. In this financial democracy, when everyone agrees on a change, it becomes universal. In fact, the consensus mechanism in DeFi (Decentralized Finance) systems is a security requirement.

What is Defi?

DeFi stands for Decentralized Finance. In this system, users engage in buying and selling financial assets without the need for traditional intermediaries or barriers found in conventional markets. In the DeFi blockchain system, each user or blockchain node has the right to approve or reject transactions and data related to a financial resource. If the nodes reach a consensus, the transaction and its data are added to the blocks. In blockchain terminology, a node refers to each of the users. Each node has the power to create and generate messages, receive them, and send them. DeFi is essentially about creating a decentralized financial ecosystem where users have more direct control and autonomy over their financial activities, reducing the reliance on centralized financial institutions.

Trustworthy Transactions!

In the previous paragraph and in response to the question of what proof of ownership and proof of work are, we touched on the consensus mechanism. Two of the most important consensus mechanisms are proof of ownership and proof of work. These two mechanisms empower users or blockchain nodes to monitor the network without fraud, deception, risk, or danger. Traditional financial systems rely on centralized mechanisms and processes. Trust in transaction correctness in these centralized systems is established through financial institutions that confirm transaction validity with reference to their private servers and services. This system doesn’t require mechanisms like proof of work or ownership. It’s a different story in decentralized systems.”

Decentralized Structure and the Question of Proof of Ownership and Proof of Work

Decentralized system like blockchain and in response to the question of what proof of ownership and proof of work are, it’s crucial to refer to the secure functioning of proof of ownership and proof of work. In a decentralized blockchain network, all users collectively serve as network owners. In essence, one can think of the blockchain as a bank where all customers are also owners of the bank, and every transaction within it requires the approval of each one of them. However, a problem arises here – the self-regulation issue. The main challenge of this financial democracy is the democracy itself. How can we be sure that all users or members of this blockchain-based financial democracy act ethically and refrain from fraud, deception, and theft? We lack such assurance! That’s why we use validation mechanisms.

One of these validation methods is proof of work. But let’s first delve into one of the most important concepts of blockchain: Byzantine Fault Tolerance!

Byzantine Fault Tolerance (BFT)

Byzantine Fault Tolerance (BFT) has its roots in a logical problem known as the Byzantine Generals’ Problem. This problem can be described as follows: Imagine a group of Byzantine generals who need to reach a consensus on whether to attack or retreat. If the generals all agree on a plan of action, they will succeed without any issues. However, if their communication breaks down and some generals give conflicting orders, they will fail. So, what can be done to ensure consensus in such a situation? The best approach is Byzantine Fault Tolerance (BFT). In this method, the compromised nodes or users are not allowed to participate in the decision-making process, ensuring the integrity of the decision. Two common implementations of BFT are Proof of Work and Proof of Stake.

A more optimized and adapted version of this problem, considering the behavior of machines, is Practical Byzantine Fault Tolerance (PBFT). In this approach, it is assumed that malicious nodes cannot exceed one-third of all nodes. The more nodes there are, the lower the probability that the number of malicious nodes approaches or exceeds one-third of all nodes. Therefore, the number of honest nodes is always greater than the malicious nodes, ensuring linearizability. Linearizability is another form of Nakamoto Consensus or Nakamoto Consensus. This principle states that the entire network reaches consensus on the correctness of a transaction or digital transaction. This consensus is divided into four components: Proof of Work, block selection, scarcity, and incentive structures.

Proof of Work (PoW) Mechanism

Proof of Work (PoW) is used in a scenario where you want to participate in block production. However, you need to pass an important test: you must prove your honesty and authenticity. How do you do that? Do you need to pay a fee? What is the cost? The cost you pay for this work is computational power and electricity consumption. You must demonstrate that you are a legitimate participant and not malicious. Since the network structure is democratic, you have to compete with other validators or miners.

Therefore, if you enter the network from the outside and intend to engage in illegal activities, you must have more processing power than all other miners in this competition. This would discredit you because this action has no economic justification and does not align with the logic of working within the network. But a user who wins this competition, meaning other competing users validate them, can become responsible for creating a new block and receive a reward.

Tokens: Don’t Spend Them Twice!

Proof of Stake (PoS) is a security mechanism and a form of distributed consensus used to prevent double spending of coins. This process is carried out by users who are randomly selected. These selected users are called validators or bakers. Validators who wish to participate in the block production process and receive rewards must perform several tasks. The first task is to purchase network-specific tokens. After depositing or acquiring the tokens, they must stake them. Staking in blockchain means locking up the tokens. By doing this, the user nominates themselves to become a forger or block creator.

A Response to Proof of Ownership and Proof of Work

In response to our fundamental question of what proof of ownership and proof of work are, validators play a crucial role. Validators, randomly selected by the network through a process, are validated by all nodes in a competition, and one of them is chosen to create a block. Each validator has a chance of winning in this process based on their stake or ownership. The reward and the chance to create a block constitute the incentive for this competition. In this method, if someone attempts to engage in malicious activity, they risk losing their locked assets. Hackers trying to attack from outside the network would need to acquire a significant portion of the tokens, which is economically impractical, making the attacker the main loser in such a hack.

If, in the proof of ownership mechanism, nodes select representatives who base their work on the Byzantine Fault Tolerance (BFT) protocol, we encounter a specific form of proof of ownership known as Delegated Proof of Stake (DPoS). In DPoS, this select group, through a rotational leadership system, has the sole authority to create a block. This method is characterized by decentralization and high security. Since the number of representatives is limited, trust among them is high.