Ralph Giles and Hannah Jones explain how Ethereum is moving to 'proof of stake' and what that means for cryptocurrency power consumption
Over the last few years, cryptocurrencies have gained momentum and become a favourite among investors, despite their volatile nature. A defining characteristic of cryptocurrencies is that they are decentralised, which means there is no centralised exchange (like Visa or PayPal) monitoring the transaction.
The lack of a central authority responsible for verifying transactions presents a challenge. Cryptocurrencies overcome this by using a “consensus mechanism” to regulate the process in which transactions are verified and added to the blockchain.
The most widely used consensus mechanism is “proof of work”, used by the two largest cryptocurrencies – Bitcoin and Ethereum 1.0. At the core of this mechanism are cryptocurrency miners - virtual miners who are required to solve a complex mathematical problem. The first miner to solve the problem updates the blockchain with the latest verified transactions and receives a predetermined amount of cryptocurrency in return.
This process requires an enormous amount of computing power and, thus, electricity, and some estimate that a single Ethereum 1.0 transaction can consume as much energy as an average US household uses in a week. There is also a major issue with electronic waste generated from the specialised hardware and computer servers used for mining, which tend to have a limited obsolescence period.
As such, the environmental impact of cryptocurrency mining (using the proof of work consensus mechanism) is obvious. Consequently, Ethereum is switching to a consensus mechanism known as “proof of stake” in an ongoing process that is expected to conclude by the end of 2022.
In a proof of stake system, a network of “validators” contribute or “stake” their own cryptocurrency in exchange for the chance to validate the new transaction, update the blockchain and earn a reward. The network uses an algorithm to select a winner based on the amount of cryptocurrency each validator has in the pool and how long it has been there. Once the “winner” has validated the block of transactions, other validators can attest to the accuracy of the block. When a threshold number of attestations have been made, the network updates the blockchain. All participating validators then receive a reward in the native cryptocurrency, depending on their original stake.
The energy consumption between the two consensus mechanisms is notable. It has been reported that using the proof of stake consensus mechanism uses 99% less energy than the proof of work mechanism. Additionally, the hardware required is less specialised and more equivalent to an average laptop, which allows the network to scale and should reduce the amount of electronic waste that is generated.
As energy costs and environmental concerns grow, we can expect the more energy efficient and cost-effective cryptocurrencies utilising the proof of stake mechanism to grow in popularity. Once Ethereum finalises the switch to proof of stake, it promises to be a much greener future for cryptocurrencies.
Ralph Giles, Associate Solicitor in the Commercial IP & IT team at Bristows
Hannah Jones, technology litigation paralegal at Bristows