Ethereum Proof-of-Stake: Pros & Cons Explained

In order for a party to stake, an Ethereum holder or agent (known as a validator) must deposit 32 ETH into a contract and run an appropriate execution client as well as a consensus client. This will enable the user to stake their tokens to secure the Ethereum network and generate some staking yield. The game theory element of proof of stake incentivises honest block validation with ETH tokens as a reward and disincentivises dishonesty (validating invalid blocks) by the threat of slashing, which is burning a portion of the deposited stake of the validator. This leads to a system which works in the best interests of the Ethereum network without burning up large amounts of electricity while maintaining superior network security when compared to proof of work. Over time the system is at risk of becoming more centralised as the Ether supply is reducing, while large stakers are generating constant yield. The pros and cons of proof of stake will be explored within this article and whether it is an adequate long term system for what Proof of Stake blockchains intend to accomplish

How exactly does depositing 32 ETH into an arbitrary contract reach security better than systems such as proof of work, which expend resources to find proof of work solutions through hashing algorithms? Incentive and disincentive structures with the deposited stake at risk of being burnt to keep the validators honest and earning yield in the form of ETH tokens

The mechanism of proof of stake works by depositing at least 32 Ether into a Deposit Contract. The validator will then be added to a queue which limits the amount of new members joining, after this wait is up, the validator will go through an activation process in which they wait again for slots to become available. Once there is an available slot, the validator client can begin to work, receiving rewards for block proposal, voting on blocks (attestation rewards) and consistent network participation. The more Ether deposited into the Deposit Contract, the greater the probability the validator will be selected for block proposal and hence greater yield. The yield structure is quite different to proof of work as in a proof of work system like Bitcoin, it is heavily luck based and there is only one reward every 10 minutes, which leads to a need for mining pools for reward distribution. Within the Ethereum network, rewards are distributed for three categories so each validator can expect a consistent yield with little fluctuation.

Invalid transactions, incorrect block structure or protocol violations will all lead to a block being considered as invalid within the Ethereum network

Invalid transactions consist of double spends in which the same funds are spent twice, insufficient funds in which the sender attempts to send more Ether than they possess and incorrect data which would be errors in transaction data or code execution within the block. An incorrect block structure would have issues linking to the previous block (parent block) or an incorrect timestamp. Any of these issues within the block would render it invalid.

Dishonest behaviour on the Ethereum blockchain is considered as validating invalid blocks, double signing (validating conflicting blocks at the same height), equivocation (making contradictory votes during consensus) as well as extended downtime (not participating in consensus for too long). All of these factors will lead to a portion of the validator's stake being burned which is known is slashing. This is done to disincentivise network attacks and collusion which would in turn destabilise the security of the network

This keeps the incentive structure of the validators in line with that of the broader network, so validators are encouraged to participate in an honest way in order to gain yield while keeping the network secure and avoiding slashing penalties

The risks involved for a proof of stake system when compared to proof of work would be the risk of centralisation over time as the stakers constantly generate yield, all while the total supply of Ether tokens are reducing, which causes wealth concentration. There are mechanisms in place designed to reduce this.

This concentrated wealth leads to more and more control of the network in fewer and fewer hands which increases the centralisation risk. Vitalik has stated that if the network is attacked on a proof of stake system in a 51% style attack, it would be much more difficult for it to be successful as the network could just be forked and the attacker's tokens be burnt on the forked network, preventing ongoing attacks and restoring security as the users move over to the forked network and abandon the compromised one