With a recent upgrade, Ethereum—the blockchain on which coin Ether is based—is moving to the Proof-of-Stake (PoS) mining from Proof-of-Work (PoW) mining. While PoW is the original consensus mechanism, first used by Bitcoin, PoS is a newer concept that was developed to overcome limitations in the scalability of the network.

Cryptocurrencies work on decentralised blockchains. This means there is no central authority overseeing the transaction process. However, they require all computers on the network to agree on the legitimacy of a transaction to ensure that nobody spends the same money twice. The mechanism that helps support this decentralised process on crypto blockchains is called a ‘consensus mechanism’.

Blockchain networks currently use two consensus mechanisms:

Proof-of-Work (PoW)

Proof-of-Stake (PoS)

But to understand why Ethereum is now switching to PoS, let's first understand the benefits and disadvantages of both mechanisms.

Proof-of-Work

The older of the two mechanisms, Proof-of-Work is used by traditional blockchains like that of Bitcoin and Ethereum 1.0. This consensus mechanism requires all computers on the blockchain network to execute complex mathematical calculations to decrypt the secured transaction. It, therefore, requires a large amount of computing power to sustain operations.

Every time a certain number of transactions is processed, they are added to a ‘block’ on the blockchain. For each block processed, miners are rewarded a fixed amount of crypto for contributing to the blockchain through their computing power.

Advantages of Proof-of-Work:

A robust method of ensuring security on a decentralised blockchain

Miners are incentivised to join the network as the value of the cryptocurrency being mined grows.

The intense power requirements mean nobody can interfere with the network. Both the above factors contribute to the enhanced security on the blockchain.

Disadvantages of Proof-of-Work:

Heavy power requirements mean that:

A PoW blockchain cannot be upscaled to handle the large number of transactions processed by smart-contract friendly blockchains like Ethereum (explained in proof-of-stake).

Transaction processing is costly.

Proof-of-Stake

Proof-of-Stake is an effective alternative developed to overcome the extreme energy consumption of the Proof-of-Work consensus mechanism. It delegates the network's control to the owners of the token, giving mining power based on the percentage of coins held by a miner.

In the PoS mechanism, a crypto user can become a transaction validator by pledging a part (or all) of their crypto holdings towards the development of the blockchain. In return, the user is rewarded a fixed percentage of the pledged assets as rewards when a new block is added to the blockchain. This process is called the ‘staking’ of crypto assets.

The likelihood of becoming a transaction authenticator on the blockchain is directly proportional to the amount of crypto the user has pledged. Every validator has a stake in the blockchain, which is why it is christened ‘Proof-of-Stake.’ It, therefore, does not require heavy processing power.

The bitcoin blockchain (PoW) only processes incoming and outgoing transactions as opposed to the smart contracts on PoS blockchains. Smart contracts autonomously trigger forward actions when specific criteria in the contract are met. The triggered actions are executed by apps on the blockchain called ‘dApps’ or Decentralised Apps.

Advantages of proof-of-stake:

Low energy consumption and faster transaction speed

Less expensive to sustain operations

Smart contracts have diverse applications in the finance space

Why Ethereum is moving from PoW to PoS

The Ethereum blockchain currently uses the PoW mechanism, adopted from bitcoin's. This results in hefty gas fees of $100 or more. The solution to this problem is to introduce a ‘layer 2’ mechanism like that of newer blockchains such as Polygon.

A layer 2 solution creates a platform wherein various sub-blockchains are built on the main Ethereum blockchain. All the sub-blockchains continuously communicate with each other, thus significantly improving the transaction speed.

The transaction data is still added to the main Ethereum blockchain, so the enhanced security protocols are retained whilst maintaining high transaction speed.

In Ethereum’s case, the best solution is to shift away from the PoW mechanism to the much faster and energy-efficient PoS mechanism.

Migrating to a new consensus mechanism will require the creation of a new native currency as blockchain validators will be required to pledge assets and be rewarded on the latest Ethereum 2.0 blockchain. This is why the cryptocurrency will eventually change from Ether (ETH) to ETH2.

Since current Ethereum users already possess the native cryptocurrency – ETH, their assets will be moved to the new blockchain and converted to ETH2 once it becomes fully operational over the next few years.

(Edited by : Yashi Gupta)