(Updated 18. September 2022)
Bitcoin uses a lot of energy to secure the network. This is due to its consensus algorithm, proof of work (PoW). Some people argue that Bitcoin should follow its little brother, Ethereum, and switch to proof of stake (PoS) to save the environment, while others think Bitcoin should stick with Proof of Work because it's better. In this article, I'll explain both sides, and try to figure out if Bitcoin will switch to proof of stake in the future.
Here's the short answer:
My conclusion was that a Bitcoin transition to proof of stake was very unlikely. I viewed proof of work as fundamental to Bitcoin’s security model and store-of-value narrative.
In this article, we will learn about proof of work and why it is essential to Bitcoin. I’ll then introduce proof of stake, and whether Bitcoin shifting to this mechanism would be advantageous or likely.
What is the purpose of proof of work in Bitcoin?
‘Proof of work’ refers to the mechanism by which network nodes agree on the correct entries to the blockchain. First proposed by the cypherpunk Hal Finney in 2004, the mechanism requires nodes to expend significant amounts of energy to solve complex mathematical problems in return for ‘mining rewards’. As nodes need to pay for this energy, they are disincentivized to make malicious entries to the decentralized ledger.
Thus, once nodes agree on a consensus for information to be stored on-chain, proof of work ensures that these nodes are acting in good faith. This lends credibility to the on-chain data and enables network participants to interact with confidence without an intermediary. Proof of work also underpins early cryptocurrencies such as Ethereum, Dogecoin and Litecoin.
To understand why proof of work is essential for Bitcoin, let’s first review Bitcoin’s key properties and objectives:
To act as an immutable and secure decentralized ledger of property ownership
Enable trustless and censorship-resistant interactions between network participants
To drive value through scarcity
Secure decentralized ledger
Decentralized ledgers like the Bitcoin network need to be secure. Without security, malicious users could alter the ledger and award themselves more coins than they actually own. Alternatively, they could steal others’ coins.
Proof of work means that an attacker would need to control 51% or more of the network's hash rate. I expected that to be extremely expensive and economically unattractive.
As of September 2022, one estimate put the hourly operating cost of a 51% attack on Bitcoin at $887,013. (source) Up-front hardware costs and supply constraints would have made such an attack more difficult.
Thus, proof of work allows for secure decentralization of a financial ledger.
Trustless interactions
Disintermediation is also essential to Bitcoin’s objectives. Users need to be able to trust each other without relying on a centralized party to mediate. Proof of work prevents incorrect or malicious actions by interacting parties. Proof of work, therefore, removes the need for a centralized party to ensure transactions are carried out as intended. As there is no need for mediation or centralized authority, this also allows users to interact without fear of censorship.
Driving value
Proof of work also drives the value of Bitcoin in a number of indirect ways:
Firstly, proof of work enforces scarcity by preventing coins from being double spent or duplicated. The 21-million supply cap is central to Bitcoin's store-of-value narrative. In that thesis, higher demand against fixed supply could put upward pressure on price. Metcalfe's Law describes a relationship between network value and the number of users, although it does not guarantee price growth.
Secondly, some argue that proof of work lends Bitcoin value through the expenditure of costly energy. Under that argument, mining costs contribute to a perceived value floor; they do not establish an objective minimum price.
The article Will Proof of Stake Kill Mining? compares the two consensus mechanisms in more detail.
Is Proof of Stake the Future?
Proof of work is not without its disadvantages. For example, it requires vast quantities of energy. Critics of the mechanism argue that this has terrible environmental outcomes and is essentially a waste of resources. This narrative has gained traction with the media, especially after Elon Musk voiced his concerns over Bitcoin’s environmental footprint. Another disadvantage is that the high energy requirements make transactions slow and expensive for end-users.
For these reasons, many new blockchains utilize a consensus mechanism known as proof of stake. Notable examples include Cardano (ADA), EOS, and Stellar (XLM). Ethereum has also shifted to proof of stake after ‘the merge’ when Ethereum 2.0 launched. It is, therefore, reasonable to question whether proof of stake may also be in Bitcoin’s future.
Instead of relying on energy consumption, proof of stake achieves consensus by forcing nodes to risk their capital. Nodes ‘stake’ their coins and are subsequently penalized if found to be acting maliciously or incorrectly. By acting correctly, nodes are rewarded with newly mined coins proportional to the amount they have staked (relative to other nodes). The mechanism, therefore, relies on financial incentives and penalties to ensure consensus and security instead of energy expenditure and expensive hardware.
Proof of stake is generally seen as more modern, efficient, and clean than proof of work. Its main advantages are summarized below:
Advantages of proof of stake
Energy efficiency. It requires far less energy to achieve consensus. This has a much lower cost and environmental impact
Lower barriers to entry. Hardware and energy requirements are far lower to become a validator on a proof of stake chain. This reduces barriers to entry and results in a greater number of nodes. This improves decentralization.
Allows easier scaling. Proof of stake is compatible with a technical scaling solution known as ‘sharding’. Sharding is seen as an important bridge in the scaling debate that must be crossed to allow for the widespread adoption of legacy chains.
Improved end-user experience. The lower energy requirements of proof of stake mean that users of the network experience lower transaction costs and faster network performance.
These are powerful arguments in favor of proof of stake, and it is easy to see why new chains often choose this consensus mechanism. However, there are also a number of disadvantages, particularly with respect to Bitcoin.
Disadvantages of proof of stake
The rich get richer. Staking rewards are proportional to a validator's stake. Capital inflows are therefore greatest to the richest validators. This ‘rich get richer’ ethos is antithetical to the Bitcoin philosophy of open and equal rights for network participants.
Security. Theoretically, it is usually easier to obtain 51% of the capital than it is 51% of the hash rate. In this sense, critics claim proof of stake chains are more vulnerable to attacks than proof of work chains. However, this is unlikely to be a concern for Bitcoin given its huge market cap.
Complexity. Validator penalization and reward is a complex topic, based on an algorithmic assessment of numerous technical variables. Theoretically, this is less secure than proof of work as it can potentially be gamed by bad actors.
Switching costs and risks. Changing from proof of work to proof of stake is hugely complicated, expensive and risky. This is why it has taken Ethereum several years to implement Ethereum 2.0. In Bitcoin’s case, it would be even more complex and may not even be technically or logically possible.
A combination of these disadvantages means proof of stake is unlikely to be Bitcoin’s future. As well as being technically difficult to implement, proof of stake undermines Bitcoin’s security model and equality-focused ethos.
What would happen if Bitcoin went proof of stake?
Despite the challenges, there are some analysts who think that Bitcoin will go proof of stake. Below I explore how this hypothetical scenario may conceivably play out.
Coordinating the technical efforts involved would be a huge task. There is no CEO, no lead development team, and no true means of coordinating long-term action. Someone needs to coordinate a roadmap, pay developers and push through the significant obstacles involved in switching to proof of stake. This seems unlikely to me. However, it's possible given the number of wealthy early Bitcoin investors. Indeed, these people may be the most motivated to switch as the largest holders of Bitcoin would earn the greatest validator rewards under proof of stake.
A proposed switch would likely face resistance from existing Bitcoin miners. These companies had tens of millions of dollars invested in mining hardware that would not earn Bitcoin proof-of-work rewards after such a change.
On the other hand, some media coverage could be favorable. Proof of stake's lower energy use might improve Bitcoin's public image, attract new users and conceivably support its price in the short term.
The switch may lead to long-term issues with Bitcoin’s store of value narrative. If proof of stake is less secure and more easily gamed than proof of work, then network participants cannot trust on-chain data to the same degree. There are greater threats to the properties that give Bitcoin its value. Similarly, many see the high energy inputs of proof of work as currently underpinning Bitcoin’s value. In a proof of stake future, Bitcoin would need to address these threats to its narrative or risk irrelevance.
Conclusion: Why I Considered a Proof-of-Stake Transition Very Unlikely
While proof of stake has technical, environmental and public-image advantages, I believed it would undermine Bitcoin’s key properties. Removing proof of work would weaken the store-of-value narrative. For that reason, I considered a future transition to proof of stake very unlikely.