What is Proof of Stake?

Proof of Stake is a type of consensus mechanism used by blockchain networks to achieve distributed consensus. In a Proof-of-Stake consensus mechanism, participants who have staked crypto assets (staking means "locking" them up by sending them to a specific smart contract) are selected at random to become validators who propose new blocks - and are rewarded for doing so. Validators thus take over the role held by miners in a Proof-of-Work system. Participants who violate the rules of the protocol are subject to forfeiture, in part or in full, of their staked assets. This carrot and stick approach is designed to incentivize participants to contribute to validating and ordering transactions in blocks in accordance with the rules of the protocol.

What are the advantages of Proof of Stake?

The most commonly cited advantages amongst the Ethereum community for moving to Proof of Stake are the following:

Improved energy efficiency. Because Proof of Stake doesn't require participants to dedicate processing power to a Proof-of-Work hashing algorithm, it consumes dramatically less energy. Estimates are that Ethereum 2.0 will consume less than 1% of the energy consumed by Proof of Work Ethereum.

Improved capacity to scale by supporting 'shard chains.' Shard chains (see below) increase transaction throughput by allowing a network to create multiple blocks simultaneously. While in a Proof-of-Work system sharding lowers the hashing power needed to compromise each portion of the network (thereby reducing the security of the entire network), in a Proof-of-Stake system, this is not the case. In other words, the move to Proof of Stake is required to enable sharding which, in turn, may be an effective scaling technology.

Increased decentralization. Because Proof of Stake does away with hash-power driven mining, the need for large and capital-intensive mining farms is eliminated. In theory, this should lower the barrier to entry for validators, decreasing the risk of centralization. Further, due to the large number of shard chains, the full move towards Ethereum 2.0 requires a large set of validators (more than 16,000). The contention is have this large number of validators will make the network less prone to manipulation by special interests.

What are the disadvantages of Proof of Stake?

Less proven. While Proof of Work has been battle-tested for over a decade in Bitcoin and since 2015 in Ethereum, Proof of Stake has less of a track record. Although Proof of Stake has been used in a number of public blockchains without incident, the relatively high complexity of its implementation in Ethereum means there may be as-yet unknown attack vectors or vulnerabilities.

The rich get richer. A common criticism of Proof of Stake in Ethereum is that, because there is essentially no cost to mining, and because the more ETH you stake, the more rewards you receive, those who already have the most capital will continue to accrue more capital. By contrast, while it's true that Bitcoin mining is a highly capital-intensive endeavor, the profit margin is narrow. This means that most of the bitcoin earned by miners must be sold to cover their mining costs - and by selling, miners are distributing most of the newly minted Bitcoin (and fees) to wider participants, thereby distributing new Bitcoin widely.

What Is sharding?

Sharding is the process of splitting one blockchain into multiple blockchains known as shards. Because validation of the blocks on each shard is done independently, when taken as a whole, the network is able to process a greater number of transactions. With Ethereum 2.0, for example, there will 64 shard chains. This means the network will process transactions at 64 times the transaction speed of the original single chain. Validators in Ethereum 2.0 are shuffled randomly and regularly between shards, a measure that is intended to reduce the potential for manipulation by bad actors.

Eth 2.0 timeline

The move towards Eth 2.0 is a gradual, multi-phase transition that is taking place along the following timeline:

Beacon Chain. This phase was launched in December 2020. A "beacon chain" was established to store the registry of validators and run in parallel to Ethereum mainnet, but during the Beacon Chain phase, Ethereum continues to rely on the Proof-of-Work consensus mechanism.

The Merge. In this phase, the Proof-of-Work Ethereum mainnet will merge with the Proof-of-Stake Beacon Chain. At the completion of the merge, Proof of Work on Ethereum will be discontinued. The Merge is likely to take place in the second half of 2021 or in the first half of 2022.

Sharding. In this phase, the above-described shards will be integrated. In the initial phase, the shards will only handle data while in the advanced stage, shards may also support execution of smart contracts and the ability to handle accounts, making each shard more similar to the Ethereum mainnet. Sharding is expected to begin in the second half of 2022.