If you know anything about crypto and also read the news, I’m sure you’ve read about crypto mining. And if you’ve read about crypto-mining, you’ve read about how Bitcoin depends on proof-of-work (which is so so so terrible for the environment) and about how Ethereum is moving from proof-of-work to proof-of-stake soon (which is so so so much better for the environment).\nWhich is better? In answering that, most proof-of-work versus proof-of-stake pieces either get too technical or are too obviously biased. From an investor perspective, you just want the facts and the trade-offs so that you can make an investment decision.\nSo herein lies the “Investor’s Definitive Guide to Proof-of-Work and Proof-of-Stake (Abridged).” An actual book could be written about this, so a lot of the technical nuances will be papered over to avoid word-count creep. But first, a quick detour that I promise is relevant ...\nYou’re reading Crypto Long & Short, our weekly newsletter featuring insights, news and analysis for the professional investor. Sign up here to get it in your inbox every Sunday.\nThis might surprise you, dear reader, but investing and software engineering aren’t too different. Fundamentally, investing is about trade-offs. So is software engineering.\nIn investing, you have a certain amount of capital and you allocate that certain amount of capital in a certain way. When you choose to invest in Thing 1, you can’t also invest that same capital into Thing 2. And in choosing to allocate to Thing 1 over Thing 2, the allocator takes several things into account like expected return, risk profile or if investing in Thing 2 would be cause for termination because the boss’s boss doesn’t like Thing 2 for whatever reason.\nIn software engineering, you have a product that has a particular behavior and structure. An engineer will design something that behaves a certain way and will make structural decisions for the code. These structural decisions determine how easy it will be to make adjustments down the road.\nCryptocurrencies aim to operate their networks without the (extensive) use of third parties. To do that, network participants need a way to decide on what’s what and come to a consensus. Enter the consensus mechanisms. There are many consensus mechanisms, but the two most important ones are proof-of-work (PoW) and proof-of-stake (PoS).\nBetween the two, there are trade-offs. But the most critical thing to know about consensus mechanisms is that they need resilience to ward off attackers of the network (be they competitors, governments or a cabal of wealthy individuals). So let's take a piecemeal approach for the Investor’s Guide by first defending PoW (in the context of Bitcoin); second, defending PoS (in the context of Ethereum); and third, outlining (some of) the trade-offs.\nIn defense of proof-of-work\nThere are so many awful comparisons people use to describe proof-of-work. Here’s one of mine.\nThere’s a lottery. To win the lottery, you need to buy the winning lottery ticket. To buy a lottery ticket, you need a computer that can do lottery-ticket buying. The more computers you have, the more lottery tickets you can buy. If your lottery ticket matches the winning number, you win. So the more computers you have, the more likely you are to win the lottery.\nIn bitcoin, which uses PoW, miners (as the PoW lottery ticket buyers are called) use application-specific computers to guess the number on the winning lottery ticket. Those computers have microchips that can do the guessing and run on electricity. The only way to get the right number is to do the work.\nProof-of-work has distinct advantages and disadvantages:\nPoW is a resilient way to build distributed consensus and deter spam. Proof-of-work has been used in Bitcoin since it launched in 2009 to trustlessly run a decentralized, borderless, open payment network. Bitcoin’s proof-of-work mechanism worked just as well when a bitcoin was worth 6 cents as it did when it was worth $60,000. Bottom line: Proof-of-work works, and it works really well.\nThat said, proof-of-work consensus mechanisms are hardware-intensive and rely on high-demand microprocessors. As a result, investing in proof-of-work can take time if there are supply-chain disruptions (as we’ve seen recently).\nDue to the need for consistent electricity and warehouse space, there are centralizing geographic choke points where mining tends to coalesce in places with adequate space and cheap electricity. So while miners may be distributed across machines, they could all end up setting up shop in, say, the Chinese province of Sichuan.\nProof-of-work does have a double-edged sword, depending on your specific framework. It uses electricity. I’m not going to argue about whether bitcoin is a valiant use of electricity or is utilizing the right kind of electricity, but it certainly uses it. Yes, proof-of-work could monetize otherwise wasted electricity, stabilize power grids and boost local economies, but bitcoin mining has revitalized some otherwise obsolete fossil-fuel electricity generation plants.\nIn defense of proof-of-stake\nThere are so many awful comparisons people use to describe proof-of-stake. Here’s one of mine.\nThere’s a lottery. To win the lottery, you need to purchase a lottery ticket. To be allowed to buy a lottery ticket, you must be chosen. To be chosen, you need to commit money to the lottery. The more money you commit, the more likely you are to be chosen. If you’re chosen to buy a ticket, your ticket will automatically match the winning number and you win. So the more money you have committed, the more likely you are to win the lottery.\nIn Ethereum, which will eventually use proof-of-stake, validators (as the PoS lottery ticket buyers are called) are chosen randomly to win the lottery based on the amount of capital they have staked. The way to get chosen more often is to stake more capital.\nProof-of-stake has advantages and disadvantages:\nIt is an effective means to build distributed consensus. While nothing is as battle-tested as PoW, there are cryptocurrencies that have been using PoS successfully for several years.\nIn the world of Ethereum specifically, it is very expensive to become a validator. To become a validator and participate in the lottery, you need to commit 32 ETH (about $60,000). Granted, there is a mechanism in which you could commit less ETH to a pool of capital that is then staked, but that isn’t the same thing. The high starting cost could result in a “rich blockchain” with only wealthy capital holders participating in validating.\nPoS does have a double-edged sword, depending on your specific framework. It uses capital. In a way this is advantageous, because anyone anywhere with enough money can become a validator. There isn’t the same geographic centralization risk as there is with PoW (although, there may be one given wealth inequality across the globe). That said, because PoS only requires capital, the barrier to entry can be lower.\n(Some of) the trade-offs\nAs mentioned earlier, this could take up an entire book. The following trade-offs between PoW and PoS are not exhaustive.\nIt is easier to attack a PoS network because PoW is more resilient. Stealing some thoughts from Andreas Antonopoulos, all it takes to attack a PoW network is “electricity and hardware brought together at the right time at the right place with the right incentives” and logistically, this is becoming harder and harder to pull off. With PoS, all it takes is money. To the credit of Ethereum under PoS, it will still take a lot of money to attack the network, but it requires less coordination.\nThat said, PoS is theoretically more accessible because it only requires capital. Granted, it can be a lot if you’re looking at Ethereum (around $60,000), but the coordination mentioned in the previous paragraph can be a barrier to entry that doesn’t exist in proof-of-stake.\nIn a similar vein, proof-of-stake is more mobile than proof-of-work. Given the electricity draw needed for proof-of-work, a government can figure out where miners are operating and shut down individual locations. Moving a proof-of-work operation that’s been shut down to a new location takes a lot of work. We saw this happen when China banned bitcoin mining last year, which led to a drop in network activity that eventually recovered (although it took some time). Moving a PoS operation would be trivial in comparison.\nLast one I’ll touch on (but not expand on, because I don’t truly believe it should matter) is that PoS doesn’t use electricity and PoW does. So if you’re a single-issue investor, investment in PoW might not even be a consideration for you. There are merits to PoW and I have spent years defending bitcoin mining (privately and professionally), but in the end, I’m not here to tell you how to think or what to do.\nThe views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.