Proof-of-Stake Explained: Invention, Ethereum Merge, Bitcoin Staking, Restaking

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Proof of Stake represents one of the most significant inventions in the history of crypto and blockchain technology. Originally intended as an alternative to the energy-intensive nature of the Proof of Work system that Bitcoin pioneered, Proof of Stake has evolved over time to support the foundation of a crypto ecosystem that is more scalable and eco-friendly. This article will discuss  the invention of Proof of Stake, its involvement in Ethereum’s “Merge”, current discussion regarding Bitcoin staking, and the emerging trend of restaking.

What Is Proof of Stake?

In response to criticism and concerns regarding Proof of Work’s energy consumption and hardware requirements, the idea of Proof of Stake was born. The key to Proof of Stake was using economic stake to incentivise network participants to behave honestly, instead of through computational power. Those with large stakes in a blockchain had more to lose, thus economically disincentivizing them from behaving in a way detrimental to the network.

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Proof of Stake was formally proposed in 2012 by Sunny King and Scott Nadal with Peercoin, the very first blockchain to implement Proof of Stake in a hybrid Proof of Work/Proof of Stake system. Initial distribution of Peercoin used mining for initial distribution, but block validation gradually switched over towards staking. Network validators were chosen pseudo-randomly, with heavier weights towards participants with more coins staked and for longer staked durations.

Proof of Stake vs Proof of Work

Whereas Bitcoin’s Proof of Work relies on crypto miners expending energy to solve computational problems for rewards to secure the network and prevent double spend, Proof of Stake secures a blockchain network by requiring network participants to “stake” their tokens as collateral. Blockchain validators are then chosen to create new blocks and confirm transactions based on the size and duration of their “stake”, relying on economic power instead of computational power for blockchain security. Validators are incentivized to perform their duty correctly or risk being “slashed”, forfeiting their staking rewards and potentially redistributing to other validators. Through these economic mechanisms, Proof of Stake is able to cut down significantly on energy consumption while maintaining blockchain security. 

Ethereum’s Merge

Ethereum began as a Proof of Work blockchain, but slowly transitioned towards Proof of Stake, eventually resulting in the “Merge” in 2022. The Beacon Chain was launched in 2020 as a Proof of Stake test network, and successfully merged with the main Ethereum Blockchain in 2022, permanently replacing Ethereum mining with staking.

In Ethereum’s staking model, nodes are required to deposit 32 ETH to run a validator. These validators earn rewards for confirming blockchain transactions. To incentivize good behavior, validators risk losing a portion of their staked funds if they act maliciously or go offline. Utilizing this economic security model allows the Ethereum blockchain to reduce energy consumption by over 99% while maintaining a secure network.

DeFi Use

Unsurprisingly, staking is a core component of the DeFi ecosystem. Many protocols allow users to stake their tokens, allowing users to earn rewards and participate in governance of a protocol. Similar to blockchain staking, protocol staking encourages users to act in their best interests and vote on governance proposals that they believe would benefit the protocol. Knowingly voting in a manner that hurts a protocol puts their stake at risk, putting a user’s investment at risk.

Liquid staking improves on standard staking by allowing users to stake their tokens to earn rewards or participate in governance, but gives users access to tradeable liquid tokens while their tokens are staked. When using a liquid staking service, users entrust their tokens to a protocol that earns staking rewards for them. These protocols then provide users with a liquid receipt token that they can trade or use in other DeFi protocols as they please. This gives users the ability to skip waiting for a withdrawal period or lock-up to end before regaining access to their capital. Users can instead use their derivative receipt token to do as they please. In return, these liquid staking protocols charge a fee for this service, typically by taking a cut of the staking rewards.

Bitcoin Staking

Staking is not restricted to just Ethereum and other smart contract chains, Bitcoin staking has been developing as well. Perhaps one of the biggest players in this field is Babylon, which offers native BTC staking via the Babylon Bitcoin Staking Protocol. This protocol functions by allowing users to lock their BTC in a time-locked UTXO while retaining custody on the Bitcoin blockchain, and then exporting this economic security to other Proof of Stake chains through “Finality Providers”, which sign blocks for these other chains. Babylon stakers are then rewarded with BABY tokens in return. Progress has also started to be made with regards to Bitcoin liquid staking and restaking. Protocols such as Liquidium are working on a liquid staking framework for Rune-based tokens operating on the Bitcoin blockchain.

Another common form of Bitcoin staking revolves around “wrapping” Bitcoin, which means locking the Bitcoin in a contract that provides users with a Bitcoin token that they can then use in DeFi protocols on other chains. From there, users can use the Bitcoin token as collateral to earn yield or take out loans.

Proof of History

Pioneered by the Solana blockchain, Proof of History is a consensus system that builds upon Proof of Stake. Traditional Proof of Stake blockchains feature validators that take turns proposing and confirming blocks. This creates a unique problem: how can all of these validators agree on the time a transaction occurred without constantly communicating with each other? These validators need to reach consensus on both the order of transactions and time of transactions, which requires time-consuming coordination that limits the overall throughput of a Proof of Stake blockchain.

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Enter Proof of History, Solana’s solution to this problem. Proof of History by itself isn’t a consensus mechanism, it’s a cryptographic way of keeping time that works in tandem with Proof of Stake. Proof of History has a verifiable delay function (VDF) that continuously generates sequential cryptographical hashes. Since each hash depends on the previous hash, this creates an order of hashes that everyone can rely on. By having each transaction timestamped with one of these hashes, validators can determine the exact order that transactions occurred in without needing to communicate with other validators.

As a result, Proof of Stake determines which validator gets to produce the next block and Proof of History provides the ordering mechanism that allows validators to quickly process and timestamp transactions on their own. The combination of the two removes the limitation in throughput that traditional Proof of Stake blockchains face, allowing Solana to achieve an impressive throughput of thousands of transactions per second.

Conclusion

The evolution of Proof of Stake over time marks an important chapter in blockchain history - a transition towards efficiency, scalability, and economic alignment. Ethereum’s Merge has proven that Proof of Stake is feasible for a global network, significantly reducing energy costs while maintaining security and decentralization. Liquid staking and restaking have further improved the staking world, allowing users to unlock liquidity from otherwise inaccessible assets. This change is starting to arrive to Bitcoin as well, which is seeing similar developments of unlocking capital without compromising on security. Finally, Solana’s Proof of History further improves the capabilities of Proof of Stake, allowing blockchains to achieve higher levels of throughput and scalability.