Proof Of Stake is a blockchain verification method that is much more energy-efficient and less risky than the more common Proof of Work method. Only one miner is chosen as a time to validate the blockchain, but the miner must lock up some of their coins as collateral to be chosen.
Note: If you don’t want to read through this article, we have created an animated video that you can watch below instead.
Think of it like this...
In Proof of Work, let’s say you have runners lining up for a race. All 8 racers are racing to the finish line, but some racers have an advantage given the amount of resources they have, they have stronger legs or weigh less. Even though all racers get to the finish line eventually… only 1 person wins and gets the reward (a shiny bitcoin) while the others still run down the track. Those who didn’t win essentially wasted their energy for no reward.
With Proof of Stake, all the runners would line up at the starting line and the user would be selected on a few factors (which we will talk about soon) and then only a single racer would be selected. This way, we don’t waste electricity or energy! And nobody runs without a reward.
When it comes to coins that use proof-of-work (like bitcoin), many large mining companies compete to solve a block’s reward the fastest.
Proof of Work also isn’t fair to DIY miners who don’t have access to powerful machines that can win the “puzzle-solving” task the quickest. We want there to be lots of miners so that the coin is truly “decentralized” and the blockchain is safe. If those large companies join together… they could start making fake transactions, because the blockchain is “majority vote”. If they get even 51%... you can kiss your bitcoins goodbye.
Proof of Stake attempts to fix this, by only selecting one “validator” (which is what Proof-Of-Stake coins call miners). The validator (or miner) then gets to solve the “puzzle” and earn the reward, while other validators double check them. It’s much more fair this way.
One key thing when it comes to proof-of-stake, is that since only one validator is selected, it is very important that they solve it correctly, otherwise we will have to select someone else, wait for them to solve it correctly and in the crypto space, time is money. To solve this, we make sure they “lock up” some of their coins. Other validators can double check their work, and if they are wrong, we penalize them and take some of their coins. This process of “locking their coins up as collateral” is called Staking.
So in short, to participate in a proof-of-work coin, you have to own some of that coin. Then you lock it up so you can’t use it and wait to get picked to mine. When you get picked, if you mine correctly, you get a staking reward… and if you mine incorrectly, you get penalized and lose some of the coin you initially locked up.
The way we select who gets to be the validator is important too! In many cases, Proof of Stake coins will bias those who are staking the most coins- they have the most to lose. Sometimes we also calculate in how long they have been locking those coins up, because if they have them and haven’t lost them, they probably are making lots of good calculations. If we only selected based on the age of their stake, or who has the most stake, we would probably be selecting the big and rich mining facilities again… To solve this, we also add in a bit of a random number picker. I’m not going to go into it in that video, honestly I don’t know much about it either.
Now there is a good incentive for them to correctly verify the blockchain, and a good selection process to reduce energy waste.
I hope this clears things up, and if it did please leave a like below because it helps our channel grow… it takes us a ton of time to research, narrate, animate and promote videos like this. If it doesn’t clear things up, leave a comment below and let us know it’s confusing so we can break it down further! Now that you kinda know how it works, let’s go over the risks and rewards.
What are the Risks involved in Staking?
Risk 1: Locking Period
When you go to stake your coin, it’ll be moved into what is called a “locked” state. During this time you won't be able to move your coins - you can’t send or cash them out. Sometimes you have to lock them up for a certain amount of time, like a month minimum.
Risk 2: Technical Knowledge
In almost every case, it’s not as easy as downloading a software then pushing a button. You usually have to know how to code, how to set up your computer to validate, and how to accept rewards into a wallet. If there’s an issue, you are liable to fix it.
Risk 3: Validator Commission
You don’t have to set up the validating process yourself, you can give your coins to someone who has the knowledge and equipment to do it all. These platforms usually require a validator commission for the use of their computers. This could cut your profit and they could change it at any point.
Risk 4: Rewards Duration
Depending on the network you choose, it could take minutes, days, and even weeks to see the payout of your staking position. This is why it’s crucial to see the networks rewards payout time.
Risk 5: Bad Behavior
PoS is built on validators and if the validation turns out to be bad, you’ll lose some of your stake. There is a very very small chance you have a true validation, but the network says you’re wrong. Nobody mentions this, but it is a risk.
Ethereum 2.0 up to 15%, but probably around 4-7%.
Tezos - 6%, but Coinbase does it for you at 4.6%
Cardano - 4-5%
Algo - 8-10%
Many other coins offer rewards, but those are the big ones at the moment.
Proof of stake has quite a few benefits over proof of work, but it has downsides too, like it can invalidate DIY gpu miners who want to participate without owning a bunch of the coin. I hope this video helped you understand what proof of stake it, and if you liked it, be sure to subscribe because we are planning to release many similar videos.