Blockchain networks transmit enormous volumes of tokens over their networks on a continuous basis. For this reason, they need to be extremely secure in much the same way as banks, credit cards, and financial technology (fintech) apps.

Without robust security, both centralized and decentralized networks can fall victim to hackers and thieves processing fraudulent transactions.

Unlike the centralized networks found in traditional finance (TradFi), blockchain networks—with some exceptions—are decentralized. These decentralized networks differ from TradFi networks by making network redundancy a security feature—not a bug. On these networks, full nodes store the transaction history of the network and approve pending transactions. Even if some of the nodes try to approve faulty transactions, the transactions will be rejected as long as the majority of nodes are honest actors.

In order to ensure network security, nearly all of the most secure blockchain protocols provide rewards to incentivize people and companies to run these full nodes and support blockchain consensus—meaning they have reached agreement on what crypto transactions are legitimate and need to be approved.

Proof of work and proof of stake

Blockchains employ a variety of consensus methods to secure their networks; for example, Bitcoin uses proof of work (PoW). With PoW, crypto miners run full nodes and use computing power and electricity to solve a cryptographic puzzle for every new block—approximately every ten minutes. While this was first done on standard home computers, the incentives to mine soon led to crypto miners deploying more advanced GPU miners.

These days, PoW mining is most efficiently done at an industrial scale in warehouses that deploy application specific integrated circuit (ASIC) crypto miners that are purpose built to do only one thing: mine Bitcoin (BTC) and other cryptocurrencies that utilize the same SHA-256 mining algorithm (such as BCH).

In return for doing this, Bitcoin miners are rewarded with BTC transaction fees and block rewards that are paid in BTC. Whoever solves the cryptographic puzzle for a specific block earns the transaction fees within the block and the associated block reward. The BTC block reward is 6.125 BTC (at time of writing) and is halved every four years (the next halving is scheduled to occur in April 2024).

Bitcoin has faced criticism over the vast amounts of capital and electricity that are deployed solely to secure its proof of work blockchain. In addition, the crypto mining “arms race” has made the activity unprofitable unless conducted at scale via a significant initial capital investment. For these reasons and more, other blockchain protocols began experimenting with alternative ways to secure their networks. One of the most popular alternatives, proof of stake, doesn’t require mining hardware—or much electricity.

Proof of stake blockchains

While early blockchains including Bitcoin, Dogecoin and Litecoin generally use PoW, later blockchain protocols began experimenting with proof of stake (PoS). With PoS, holders of crypto on a specific blockchain can stake this crypto in order to earn staking rewards—the PoS equivalent to crypto mining rewards. These crypto rewards are the incentive that encourages both crypto miners and stakers to participate.

One primary benefit is that PoS networks tend to be far more energy-efficient. In addition, staking can often be accomplished without specialized hardware and may only require a crypto wallet that can be run on a computer or smartphone. While users stake crypto, they are also supporting the blockchain security of the protocol (although this may depend on the network and your staking method). In much the same way that an increase in miners (or their combined computing power) increases the security of Bitcoin and other PoW protocols, an increase in crypto stakers should increase the blockchain security of PoS networks. PoS blockchains include Ethereum, Cardano, Polkadot, Polygon, Avalanche, and many others.

Staking and PoS variations

In general, most of these PoS networks function by rewarding holders of the associated cryptocurrency. However, they are not identical in terms of how they operate and how they have designed their proof of stake networks to function.

For those who want to stake crypto to earn staking rewards, this is an important factor to consider. For example, some blockchains have substantial staking minimums that must be met in order to stake crypto (Ethereum requires 32 ETH) while others do not. Other processes for staking can also vary. For example, some protocols allow you to stake for as long or as short of a time frame as you want. Other protocols may specify a lock-up period that must be reached prior to receiving—or initiating—staking rewards.

As PoS networks have developed, variations on PoS consensus continue to be released that may offer benefits to the blockchain, the stakers, or both parties. Variations of PoS include Delegated PoS (DPoS), Liquid PoS (LPoS), Pure PoS (PPoS), and many others. Some “Hybrid PoS” blockchains even utilize both PoW and PoS simultaneously (such as Decred and Dash).

In subsequent articles in this series, we’re going to cover how to get started staking, the various staking options to choose from, how staking compares with other yield-generating strategies in crypto, how staking rates change, the staking process, and more advanced staking topics like liquid staking derivatives (LSDs).

Cheat Sheet

• Blockchain networks utilized consensus mechanisms to secure their protocols.
  Popular consensus methods include proof of work (PoW), proof of stake (PoS), and hybrid consensus methods that combine PoS and PoW.
• Bitcoin uses PoW and is praised for its network security. Some question the electricity usage and hardware requirements of Bitcoin and other PoW networks.
• PoS networks tend to be far more energy efficient and don’t require large amounts of specialized hardware.
• PoS networks include Cardano, Ethereum, Polkadot, Polygon, Avalanche, and many others.
• PoS networks can vary in the requirements needed to stake on their network (including staking time periods and staking minimums).