05.09.2022
In the crypto market, there are Proof-of-Work and Proof-of-Stake types of cryptocurrencies. For instance, the well-known Ethereum has long been a PoW coin but soon it’ll switch to PoS. What does it all mean? Is Proof-of-Work better to invest in than Proof-of-Stake or the other way around? Read the following article now to invest smarter and maximize your returns.
The distributed ledger technology of blockchains is a directory of information such as transaction details. They build on each other and are distributed over a network. In this context, the data must be recognized and approved by the blockchain.
This is done via independent participants and users, which are referred to as nodes. Thus, the modification of data must first be confirmed by a majority of the network participants. This consensus mechanism is called Proof-of-Work.
In this way, PoW verifies the transactions of a blockchain. The individual blocks of the blockchain are calculated in this regard by the miners by solving a cryptographic equation. They are then rewarded out of the transaction fees in proportion to the computing power contributed to the calculation.
In this way, the mechanism ensures a decentralized, independent and reliable system, which becomes even more robust against manipulation by hackers and fraudsters with the increase of trustworthy miners. Small PoW blockchains, on the other hand, are much more vulnerable to hacks due to their low computing capacity.
This makes it particularly easy for hackers to carry out 51% attacks on the weakly secured network. Using, for example, rented computing power or hijacked miners and computers, they can reach the crucial hash rate of 51% of the total power.
In this case, they then represent the majority of the network and thus have the greatest authority. This provides opportunities for double spending, transaction reversals, and forks.
As a result, there are usually large losses as well as a decrease in investor confidence. By now, the investigation capabilities in this area have greatly improved and often the stolen coins are refunded.
Originally, Proof-of-Work blockchains were invented by Hal Finney in 2004. Bitcoin then became the first blockchain to use PoW. In 2012 an alternative was developed by Peercoin. It used the Proof-of-Stake algorithm for the first time. But this consensus mechanism is achieved by staking coins instead of computing power.
Proof-of-Stake has massively reduced the required computing power to verify transactions. As a result, the environment can be better protected, and political imperatives related to climate change in countries like Germany can be more easily met.
Furthermore, it also then made blockchains much more scalable. So transactions can now be transmitted faster and cheaper. Should false signals be sent by the stakers, they would be financially penalized for it.
In addition, PoS also makes it easier to decentralize blockchains. Because no special hardware or configuration is needed to earn a passive income by contributing to the network.
For this reason, it is also more in line with the vision of a financial system controlled by the general public instead of powerful elites with vested interests. However, PoS blockchains have not been tested as long as PoW for this purpose.
PoW blockchains were originally considered particularly secure. But the hack of Ethereum Classic showed that they are also susceptible to manipulation. Due to the disadvantages already mentioned, PoS has gained importance and popularity.
Below you will find a list of advantages and disadvantages of Proof-of-Work coins:
|
Advantages |
Disadvantages |
|
Decentralized verification of transactions |
Waste of electricity and therefore money |
|
With higher computing power, security tends to increase |
Bad for the environment |
|
Lets miners earn passive income |
Possible centralization due to few miner pools |
|
Large investors do not have more power |
Often slower than PoS |
|
No abuse of power by too few validators |
Small PoW blockchains are less secure |
|
One of the most secure consensus mechanisms |
Possible 51% attacks |
|
Competition from miners is seen as more decentralized |
Hardware for mining is not affordable for everyone |
|
|
Hackers only lose power instead of the staking amount |
|
|
Possible problems with the fairness of timestamps |
|
|
Often higher transaction fees |
The PoW consensus mechanism was very common, especially with the first cryptocurrencies. Nowadays, a trend towards PoS coins can be observed. For example, Ethereum, one of the largest cryptocurrencies in the world, is also switching its network to Proof-of-Stake between September 6 and 20.
After that, there are only 2 PoW coins among the top 10 cryptocurrencies by market capitalization, which is in stark contrast to a decade earlier. Nevertheless, PoW blockchains still exist today. Below you'll find a selection of the most popular PoW coins:
So far, the average price of the top 100 PoW coins is currently $4,500.81, while PoS cryptocurrencies are listed much lower at $381.36. This means that the old Proof-of-Work coins still had been a more lucrative investment. On the other hand, if we assume a more future-proof model for PoS, an average return of around 1,080% could theoretically be earned by closing this gap, excluding many factors.
In terms of risk, there is little difference between the two main consensus mechanisms. This is because the volatility of the top 20 PoW blockchains is currently 17%, while it is slightly lower at 16% for PoS coins. Thus, an investment in Proof-of-Stake is at least slightly less volatile.
But in terms of functions, a PoW coin is not different from one with PoS. However, some Proof-of-Work cryptocurrencies are less well suited for smart contracts. But on the other side, smart contracts are also being developed for PoW coins like Bitcoin.
As you see, PoW coins have generated the highest returns so far. But PoS cryptocurrencies, which are gaining popularity, may soon outpace them even more. Currently, cryptocurrency can be purchased at a huge discount compared to their all-time high. For both PoW and PoS, the next FED rate cuts, which are currently expected in September 2023 according to Fed Funds Futures, could present particularly attractive opportunities.
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Written by Simon Feldhusen
This article is an informational piece, does not contain individual investment recommendations, and is published for educational purposes only. Age restriction 18+
The opinion of the author may not coincide with the position of the Company.
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