Explained: In crypto mining, what is Proof of Work and Proof of Stake mechanism?

The recent debate in the EU parliament on Proof of Work cryptocurrencies has got the crypto community talking about different consensus mechanisms used in cryptocurrencies. On Monday, the Economic and Monetary Affairs Committee of the European Parliament voted against a version of ‘Markets in Crypto Assets’, or MiCA bill that would have banned Proof of Work-based cryptocurrencies like Bitcoin in the EU.

But what exactly is Proof of Work, and how different is it from Proof of Stake, its nearest counterpart? If you feel left out from these two very fundamental concepts in cryptocurrency, we've got you covered.

To put it simply, Proof of Work (PoW) and Proof of Stake (PoS) are two algorithms used by blockchain protocols to confirm transactions and are linked to mining rewards in cryptocurrencies. Let us individually take a look at each of these consensus mechanisms.

Proof of Work

In layman's terms, proof of work is a piece of data that is tough to create because the process of creating that piece of data is expensive and time-consuming, but is easy to verify by others if that piece meets particular criteria. 

When it comes to cryptocurrencies, Bitcoin uses proof-of-work to verify the data on the blockchain. Bitcoin miners must execute a proof of work that covers all of the data included in a new block for network members to accept it. This process consumes a lot of computational power. In simpler words, they have to solve complex mathematical puzzles to show that they have ‘done the work’ and as a reward they get Bitcoins.

The more processing power and time they put into mining, the more Bitcoin they will get. 

Bitcoin is not the only cryptocurrency that uses this consensus mechanism. Litecoin and a number of other cryptocurrencies follow the Proof of Work protocol. One of the biggest issues with this process is the fact that it consumes a significant amount of energy, which is bad for the environment.

Proof of Stake

To counter this issue, subsequent cryptocurrencies started using the Proof of Stake consensus mechanism. Proof of stake picks validators based on their cryptocurrency holdings, which creates interest and compensates validators/nodes. It's a unique approach to transaction validation. PoS systems, unlike PoW protocols, do not require a lot of energy. It also avoids the centralisation of computational resources.

In the PoS consensus mechanism, rather than miners breaking cryptographic riddles to verify transactions like in PoW, the blockchain decides who has the authority to validate the next block depending on the number of coins the user or miner holds. By calculating the share of tokens and the period of their ownership, the system determines the right to validate. Hence the PoS method uses a more efficient algorithm that reduces energy consumption.

Bottom Line

PoW requires users to do “work” that is to solve complex mathematical problems to add a block and mine cryptocurrencies, whereas PoS lets the users with the biggest amount of tokens (ie their stake on the blockchain) add the subsequent block and mine cryptocurrencies.

Despite being an efficient process, PoW has a lot of drawbacks, the biggest one is the fact that it uses a lot of energy in the process of validation. This was the biggest argument of EU legislators when they favoured the bill banning PoW cryptocurrencies. Many industry experts have been pursuing projects to switch Bitcoin from the PoW consensus mechanism to the PoS protocol. But only time can tell how this pans out.