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What is Ethereum Proof of Stake (POS)? In-depth Guide

Jon Ganor
Jon Ganor
What is Ethereum Proof of Stake (POS)? In-depth Guide
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  • Ethereum's transition from PoW to PoS through "The Merge" in September 2022 has dramatically impacted the DeFi ecosystem.
  • PoS replaces energy-intensive mining with validators who stake their Ethereum, reducing energy consumption by about 99.95%.
  • The shift to PoS improves scalability, leading to faster transaction confirmations and increased network capacity, which is vital for DeFi applications.
  • PoS introduces new opportunities for validators to earn rewards through staking, fostering participation and growth in the DeFi ecosystem.

Intro to Proof of Stake & Ethereum

The Ethereum network has come a long way since its inception in 2015, revolutionizing the blockchain landscape and giving rise to a vibrant ecosystem of decentralized finance (DeFi) applications. Over the years, Ethereum has faced several challenges, most notably scalability, and high transaction fees due to its initial proof-of-work (PoW) consensus mechanism. However, Ethereum's eagerly anticipated transition to proof-of-stake (PoS) has brought about significant changes with far-reaching implications for the DeFi ecosystem.

Recognizing the need for scalability and energy efficiency, Ethereum embarked on a multi-phase upgrade known as Ethereum 2.0, with the key component being the transition from PoW to PoS consensus. PoS relies on validators who hold and "stake" their Ethereum to secure the network and validate transactions, replacing the energy-intensive mining process of PoW.

In this blog post, we will elaborate on Ethereum’s transition to PoS & its broader implications for the DeFi space.

What is “The Merge” in Ethereum? 

On September 15, 2022, the Ethereum network achieved a significant milestone with the execution of "The Merge." This highly anticipated event marked the official transition of Ethereum from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) model, deprecating PoW and drastically reducing energy consumption by approximately 99.95%.

Ethereum, the world's second-largest cryptocurrency by market capitalization, has long been recognized for its robust infrastructure and vibrant ecosystem of decentralized applications. However, the limitations of PoW, such as scalability challenges and high energy consumption, led the Ethereum community to seek a more sustainable and efficient consensus mechanism.

"The Merge" represents the culmination of years of research, development, and community collaboration within the Ethereum ecosystem. The transition to PoS introduces a new approach to securing the network and validating transactions. Instead of miners competing to solve complex mathematical puzzles, validators are chosen to create new blocks and secure the network based on the amount of Ethereum they hold and are willing to "stake."

What is Proof of Stake? 

Proof of Stake (PoS) is a consensus mechanism used in blockchain networks to achieve distributed consensus and secure transactions without relying on energy-intensive mining processes. Unlike PoW, which requires miners to solve complex mathematical puzzles to validate transactions and create new blocks, PoS selects validators based on the amount of cryptocurrency they hold and are willing to "stake" as collateral.

In a PoS system, validators are chosen to create blocks and validate transactions based on their stake, which represents their ownership of the cryptocurrency. The more cryptocurrency a validator holds and is willing to lock up as collateral, the higher their chances of being selected as a validator. Validators earn rewards for their participation in the consensus process.

The first functioning use of PoS for cryptocurrency can be traced back to Peercoin, which launched in 2012. Peercoin introduced the concept of "coin age," where the probability of being selected as a validator is proportional to the product of the number of coins held and the duration they have been held. This approach incentivized validators to hold their coins longer, promoting network stability and discouraging malicious behavior.

In a typical PoS system, validators take turns proposing and validating blocks. The selection process is often randomized, ensuring fairness and preventing any single entity from dominating the consensus process. Validators are also required to put up a stake, which serves as collateral that can be forfeited if they act maliciously or fail to fulfill their responsibilities.

The benefits of PoS include reduced energy consumption compared to PoW, as it eliminates the need for resource-intensive mining operations. PoS systems often provide faster transaction confirmation times and increased scalability, making them well-suited for networks with high transaction volumes.

What’s a Consensus Mechanism?

A consensus mechanism is a fundamental component of blockchain technology that enables participants in a decentralized network to agree on the validity of transactions and maintain a consistent state of the ledger. It ensures that all nodes in the network reach a consensus or agreement on the order and content of transactions without the need for a central authority.

One popular consensus mechanism is Delegated Proof of Stake (DPoS), which is utilized by blockchain networks like EOS and Tron. In DPoS, token holders vote for a set of trusted nodes or delegates who are responsible for validating transactions and creating new blocks. These delegates take turns producing blocks, and their voting power is proportional to the number of tokens held. DPoS aims to provide fast transaction processing and scalability while maintaining decentralization through a delegated governance model.

Another consensus mechanism is Proof-of-Space-Time (PoST), implemented by Chia Network. PoST leverages participants' unused hard drive space and measures the time it takes to create and retrieve proofs from that space. This mechanism promotes energy efficiency and aims to be more environmentally friendly than PoW.

Proof of Activity (PoA) is utilized by Decred, combining elements of both PoW and PoS. PoA requires participants to solve a cryptographic puzzle as proof of work and then stake their coins as proof of stake. This hybrid approach aims to provide security through PoW while granting decision-making power to stakeholders through PoS.

Other consensus mechanisms include Practical Byzantine Fault Tolerance (PBFT), which focuses on fault tolerance and is used by networks like Hyperledger Fabric; Directed Acyclic Graph (DAG) consensus, used by IOTA and Nano, which achieves consensus through a network of interconnected transactions; and Federated Byzantine Agreement (FBA), employed by Stellar, where nodes choose a set of trusted nodes to reach consensus.

These examples demonstrate the diverse range of consensus mechanisms employed in blockchain networks, each designed to address specific requirements such as scalability, security, energy efficiency, or decentralization. The choice of consensus mechanism depends on the particular goals and characteristics of the blockchain network.

What is an Ethereum Validator (node)? 

An Ethereum validator, also known as an Ethereum node, plays a crucial role in the Ethereum network by participating in the consensus process and maintaining the integrity of the blockchain. Validators are responsible for validating and verifying transactions, executing smart contracts, and securing the network by participating in the PoS consensus mechanism.

Validators perform several vital functions. Firstly, they validate transactions by verifying that they adhere to the network's rules and consensus protocols. Validators ensure that transactions have valid signatures, the sender has sufficient funds, and the transaction does not violate predefined conditions or smart contract rules.

Secondly, validators participate in the block proposal process. They take turns proposing blocks and including validated transactions in those blocks. This is done by creating a block header containing important information such as the previous block's hash, the timestamp, and a reference to the Ethereum Virtual Machine (EVM) state.

Validators also engage in attestation, which involves attesting to the validity of proposed blocks. They provide their digital signatures to confirm that a proposed block is valid and can be added to the blockchain.

To become a validator, one must meet specific requirements and stake a certain amount of ETH as collateral. This staked ETH acts as a guarantee against malicious behavior or misbehavior. Validators are financially incentivized to follow the rules and act honestly, as they can earn rewards through newly minted ETH and transaction fees for their participation.

The Ethereum network employs a semi-random selection process called the RANDAO to determine which validators get to propose and attest to blocks. This ensures a fair and decentralized consensus process.

How Are New Blocks Verified in Ethereum?

In Ethereum, the process of verifying new blocks is a fundamental component of the blockchain's consensus mechanism. Validators, or nodes, play a crucial role in ensuring the integrity and security of the Ethereum network. Let's delve into the technical details of how new blocks are verified in Ethereum.

When a validator proposes a new block, it undergoes a series of verification steps before being added to the blockchain. The verification process involves several key aspects:

Block Header Validation

Validators start by verifying the integrity and validity of the block header. They check the previous block's hash, the timestamp, and the difficulty level to ensure that the block adheres to the network's rules and protocols.

Transaction Validation 

Validators validate the transactions included in the block. They verify that each transaction has a valid signature, the sender has sufficient funds, and does not violate predefined conditions or smart contract rules.

State Transition Validation 

Validators execute the transactions in the proposed block to validate the resulting state transition. This involves applying the transactions to the current state of the Ethereum Virtual Machine (EVM) and checking for any inconsistencies or conflicts.

Gas Limit and Gas Usage Verification 

Validators ensure that the total gas usage of the transactions in the block does not exceed the block's gas limit. This is crucial for maintaining the stability and efficiency of the Ethereum network.

Consensus Verification 

Validators attest to the validity of the proposed block by providing their digital signatures. This consensus verification process involves confirming that the block has been proposed by a valid validator and that the proposed block follows the consensus rules.

Once a block passes all the verification steps, it is considered valid and can be added to the blockchain. Validators reach a consensus on the validity of blocks through the PoS consensus mechanism, where their staked collateral determines the weight of their validation.

How to Become an Ethereum Validator?

Becoming an Ethereum validator plays an essential role in the Ethereum network, contributing to its security, consensus, and overall functionality. To become an Ethereum validator, one must follow certain steps and fulfill specific requirements. Here's a technical overview of how to become an Ethereum validator.

32 ETH Minimum Stake Requirement 

Validators are required to hold a minimum amount of Ethereum (ETH) as their stake. The minimum stake requirement may vary based on network parameters and protocol upgrades. Validators must have the necessary funds to participate in the staking process.

Setup a Validator Node 

Validators must set up a dedicated validator node, which involves running Ethereum client software such as Prysm, Lighthouse, or Teku. The node performs various tasks, including block validation, transaction verification, and consensus participation.

Staking Process 

Validators must transfer their ETH into the Ethereum 2.0 deposit contract, locking it up as collateral for the staking process. By doing so, validators signal their commitment to securing the network and participating in consensus.

Online and Reliable 

Validators must ensure their validator node is consistently online and reliable. They are responsible for maintaining a stable network connection, maintaining proper hardware, and ensuring their node is operational to perform its duties effectively.

Liquid Staking Derivatives and Other Options

Liquid staking derivatives (LSDs) and staking pools have emerged as alternative options. LSDs may suit individuals who want to participate in Ethereum staking but may not have the technical expertise or minimum stake requirements. Liquid staking derivatives enable users to trade their staked ETH for liquid tokens that can be transferred or traded freely. This provides liquidity and flexibility to staked assets.

How Does an Ethereum Validator Make Profit?

Ethereum validators play a crucial role in securing the network and maintaining its consensus through the process of staking. As validators contribute their resources and time to the Ethereum network, they can earn profits through ETH staking rewards. Here's a technical overview of how Ethereum validators profit from their participation.

Staking Rewards 

Validators earn staking rewards for their active involvement in the consensus process. These rewards are distributed as newly minted ETH and are proportional to the validator's stake. The more ETH a validator stakes, the higher their potential rewards. The exact reward structure and annual percentage yield (APY) can vary depending on network parameters, supply and demand dynamics, and other factors.

Block Proposals and Validation

Validators propose and validate new blocks in the Ethereum blockchain. When a validator successfully proposes a block, they are rewarded with additional ETH as an incentive for their active participation in maintaining network security. Validators are also responsible for verifying and validating transactions within the blocks, ensuring their accuracy and compliance with network rules.

Maximum Extractable Value (MEV)

MEV refers to the potential profit that can be extracted from reordering, front-running, or executing transactions in a specific order to exploit price differences or gain an advantage. MEV arises from the inherent transparency of blockchain transactions. Validators can engage in MEV strategies to capture additional value from the Ethereum network. For example, they can profit by inserting their transactions into arbitrage opportunities or by facilitating complex trades that generate profits.

What is Ethereum Proof of Stake Finality?

Ethereum's transition from PoW to PoS brings about significant changes to the consensus mechanism, including the concept of finality. In Ethereum's PoS protocol, finality refers to the irreversible confirmation of a block's inclusion in the blockchain, providing higher security and efficiency than PoW. Here's a technical overview of Ethereum Proof of Stake finality.

PoS Consensus 

In a PoS consensus mechanism, validators, also known as stakers, are selected to create new blocks and validate transactions based on the amount of cryptocurrency they hold and lock as stake. Rather than competing through computational work, validators take turns proposing and voting on blocks based on their staked amount, creating a more energy-efficient and scalable network.

Epochs and Checkpoints

Ethereum's PoS finality is achieved through a combination of epochs and checkpoints. An epoch is a fixed period of time during which a set of validators take turns proposing blocks. Within each epoch, there are checkpoints, which are predetermined points in time when the state of the blockchain is considered finalized.

Finality Gadget 

Ethereum's PoS finality is implemented using a construct called a finality gadget. This component ensures that once a block is included in a checkpoint, it is considered irreversible. 

Casper FFG 

The Casper Finality Gadget (FFG) is an early PoS implementation proposed for Ethereum. It introduces a safety threshold, where once a block receives a certain level of vote endorsements, it becomes finalized. Casper FFG provides Byzantine fault tolerance, ensuring that finalized blocks cannot be reverted without a significant portion of validators colluding.

Benefits of Finality

Finality in Ethereum's PoS protocol enhances the security and efficiency of the network. It significantly reduces the chances of chain reorganizations and double-spending attacks, as finalized blocks are considered immutable. Finality also allows for faster transaction confirmations and enables developers to build decentralized applications (DApps) with more certainty about the state of the blockchain.

What is Slashing in Ethereum?

While validators can earn profits, they also face the risk of being penalized through a process called slashing. Slashing occurs when a validator violates network rules or engages in malicious behavior. Validators may lose a portion of their staked ETH as a penalty for such actions. Slashing is designed to deter validators from behaving dishonestly and promote the network's overall security and integrity.

Ethereum employs several slashing conditions that validators must adhere to. These conditions typically involve actions that harm the network's security, such as double-signing or being offline for an extended period. Double-signing occurs when a validator signs conflicting blocks, undermining the consensus mechanism. Being offline or not participating in block validation also disrupts the network's smooth operation. Validators are incentivized to maintain high availability and integrity to avoid penalties.

When a validator is suspected of violating the slashing conditions, the protocol initiates a slashing process. This process involves gathering evidence of the misbehavior and presenting it to other validators for verification. The protocol enforces the slashing penalty if the proof is deemed valid, reducing the validator's stake proportionally. The monetary penalty for slashing can vary depending on the severity of the offense. It typically ranges from 1% to 100% of the validator's stake, with severe violations resulting in a complete loss of funds.

Proof of Stake vs. Proof of Work: What Has Changed? 

Ethereum’s transition to POS included many benefits for the network. These benefits include enhanced energy efficiency, improved security through economic incentives, better scalability, and a reduced environmental footprint. 

For most traders and developers, the transition to PoS didn’t change much regarding the user experience. While scalability may have improved slightly, transaction fees remain relatively the same, and demand for Ethereum as a network may have increased.

How did PoS Impact the DeFi Ecosystem?

The transition from PoW to PoS in Ethereum has profoundly impacted the DeFi ecosystem. PoS brings several advantages that align well with the principles and functionalities of DeFi.

Liquid staking derivative tokens, which reflect the value of staked ETH, have gained popularity on DeFi lending platforms. These tokens allow ETH holders to stake their tokens and still access the value of their staked assets for use in DeFi protocols. 

Users can participate in staking rewards while simultaneously leveraging their staked ETH as collateral for borrowing or providing liquidity. This innovation has unlocked new opportunities for users to generate additional income and liquidity while actively participating in staking.

Read More in our blog In-Depth Guide about Liquid Staking

Staking ETH on Hord's Liquid Staking Derivative Platform

Hord is revolutionizing the staking landscape with its liquid staking derivative platform. With Hord, ETH holders have a unique opportunity to participate in staking while maintaining liquidity and maximizing their rewards.

Users who stake their ETH on Hord's platform receive hETH, a liquid token that represents their stake combined with pool rewards. This innovative approach allows stakers to retain the value of their staked ETH while still accessing the benefits of staking. hETH can be freely traded on Uniswap and transferred, providing flexibility and liquidity to stakers.

One of the key advantages of staking ETH on Hord is the attractive Annual Percentage Rate (APR) that stakers receive. Hord is committed to offering stakers the best APR in the market, ensuring their staked ETH generates optimal rewards. This competitive APR is achieved through Hord's efficient staking infrastructure and strategic partnerships, delivering a high-yield staking experience.

Hord's liquid staking derivative platform also brings several benefits to stakers. First, it eliminates the need for users to lock up their ETH for extended periods, allowing them to maintain flexibility and react to market opportunities.

Conclusion

Ethereum's transition from PoW to PoS has had a significant impact on the DeFi ecosystem. The introduction of PoS through the execution of "The Merge" in September 2022 has brought about changes in Ethereum's consensus mechanism and energy consumption.

PoS replaces the energy-intensive mining process of PoW with validators who hold and stake their Ethereum to secure the network. This transition has reduced energy consumption by approximately 99.95%, addressing one of the major challenges faced by Ethereum.

The shift to PoS has broader implications for the DeFi space. It improves scalability, allowing for faster transaction confirmation times and increased network capacity, which is crucial for the efficient operation of DeFi applications. Additionally, PoS introduces new opportunities for validators to earn rewards through staking, contributing to the overall growth and participation in the DeFi ecosystem.

Overall, Ethereum's transition to PoS has enhanced the network's sustainability, scalability, and efficiency, positively impacting the DeFi ecosystem by providing a more secure and accessible platform for decentralized finance applications.

FAQ

Is PoS Actually Better?

PoS and PoW have advantages and drawbacks, making it subjective to determine if PoS is better.

Ultimately, the preference for PoS or PoW depends on a blockchain network's specific goals and priorities. Ethereum's shift to PoS addresses scalability and energy concerns, but it's crucial to consider trade-offs and ongoing research in consensus mechanisms.

Can you Mine Proof-of-Stake Coins?

No, you cannot "mine" PoS coins in the traditional sense. Mining is a process commonly associated with PoW consensus mechanisms.

Does Proof-of-Stake Lead to Centralization?

PoS consensus mechanisms have the potential to lead to centralization, but it depends on various factors and how the protocol is designed and implemented.

To mitigate centralization risks, PoS protocols can incorporate mechanisms such as coin age-based selection, randomization, and penalties for malicious behavior. Additionally, there are ongoing research and development efforts focused on PoS. This research aims to address centralization concerns and promote a more decentralized and secure network.