Blockchain technology’s decentralized distributed network creates a system devoid of corruption and offers higher security, transparency, and immutability: you already know that! But, have you ever asked yourself how a system without a central authority is governed or how decisions are made on transactions get verified?
One of blockchain technology’s most significant promises is a trustless peer-to-peer system where a community helps to verify whether transactions are genuine. However, have you ever wondered exactly how that happens? Well, different blockchains use different methods that are called blockchain consensus algorithms.
Also known as consensus protocols, these algorithms are sets of rules through which the networks operate. If that sounds interesting, read our comprehensive guide to discover what blockchain consensus algorithms are, their objectives, how they work, and the difference between the two most popular ones in use today.
How Blockchains Work
The blockchain is a system for recording information that can’t be altered or hacked into. Also called Distributed Ledger Technology (DLT), blockchain uses decentralization cryptographic hashing to create a secure and transparent history of digital assets.
While blockchain runs on a more complex system, the analogy somehow explains how it works—the easiest illustration of how the blockchain works are Google Doc. You can share and distribute any documents created via Google Docs within a team instead of copying and transferring them.
Google Docs uses a decentralized distribution chain that enables all team members to access the document simultaneously. All changes made on the document are recorded in real-time and are transparent, as no member is locked out.
Every block on the chain of blocks carries several transactions. Every time a user adds a new transaction on the blockchain, the transaction record gets added to all participant ledgers.
Similarly, whenever a user changes one block in the chain, it becomes apparent to all participating computers that a change has been made. Any Hacker intent on corrupting the system would have to change all blocks in the chain across every distributed version of the chain.
What is a Blockchain Consensus Mechanism?
A consensus mechanism is a formula by which any group of people without a superior central authority reach decisions and ensure compliance with agreements. A blockchain consensus algorithm refers to the process through which users or peers within a blockchain network reach a common agreement or consensus regarding the real-time state of the blockchain.
The consensus protocol enables the blockchain network to achieve reliability and create trust between different notes, besides guaranteeing security within the distributed ledger. A consensus algorithm becomes an integral part of every blockchain app or DApps project within the blockchain.
Blockchain consensus mechanisms are generally responsible for the following three things:
- They ensure that the next block in the chain is the only correct version of the truth.
- They prevent malicious attackers from achieving 51% hash power and usurping the system, and successfully forking the chain.
- They guarantee the reliability of a network, including multiple nodes, which is among the most important aspects as it affirms the network’s integrity. The most critical element of consensus mechanisms is ensuring users don’t spend that same cryptocurrency twice (Double Spending).
Other financial service providers like credit and debit card companies don’t operate consensus mechanisms since, unlike blockchain companies, the firms control their networks. The system sends the information to a central database whenever you use their credit cards. Credit card users believe that companies can protect both their data and the process of their respective orders during transactions.
Since only the credit card company controls its entire network, they reserve the right to reverse or censor any transaction. Besides the right to censorship and their inability to resolve disputes, most centralized databases are highly susceptible to the risk of hacking and corruption.
Enter the blockchain and the era of cryptocurrencies; it became possible to conduct peer-to-peer transactions that are trustworthy, immutable, and traceable within a decentralized network. Since there is no central or superior authority within such networks to enforce adherence to the established rules, the different kinds of blockchain consensus algorithms ensure that every participant in the network agrees with and plays according to the rules.
Goals of Blockchain Consensus Mechanisms
The following are among the primary goals of blockchain consensus mechanisms.
#1. Unified Agreement
Attaining a unified agreement is one of the main objectives of the consensus mechanism. The protocols embedded within the blockchain’s distributed network ensure that all the data entered during the process is true and accurate and that the ledger’s status remains up-to-date. As a result, users can transact without necessarily building trust with their peers.
#2. Create a Common Economic Incentive
Since the blockchain is a trustless system that regulates itself, the interests of all participants must be aligned. In such a situation, a blockchain consensus algorithm rewards those who toe the line and punishes the bad actors while regulating economic incentives.
#3. Fairness and Equitability
Consensus protocols ensure that all interested users can participate within the network using the same basics. As a result, it justifies the decentralization and open-source aspects of the blockchain system.
#4. Eliminate Faults
The consensus mechanism method also ensures that the blockchain is consistent, reliable, and free from faults, meaning that the system can work independently at all times, including in failures and threats.
Types of Blockchain Consensus Algorithms: Proof of Work vs. Proof of Stake
There are numerous consensus algorithms within the blockchain ecosystem, and many more are still being developed. Therefore, every user or entrepreneur must be familiar with the features of the different consensus mechanisms and know how to identify poor ones. After learning the basics of blockchain consensus algorithms, it’s time to discover the strengths and weaknesses of the two most popular consensus methods.
Proof of Work (PoW) and Proof of Stake (PoS) are the most widely used blockchain consensus methods. Both regulate the process through which peer-to-peer transactions are verified and added to a blockchain’s public distributed ledger without a central authority. Knowing the differences between PoW vs. PoS can help you easily evaluate the cryptos in your portfolio.
What is Proof of Work (PoW)?
The Proof of Work consensus method debuted in the early 1990s to deal with email spam. The idea behind it was that a computer needed to perform a small amount of work before it could send an email. While the work was meant to be trivial for anyone sending a legitimate email or two, it demanded vast amounts of resources and computing power for anyone intending to send mass emails. Bitcoin’s creator Satoshi Nakamoto was the first person to apply digital money technology in Bitcoin’s white paper.
a. Blockchain Ordering
You already know that a blockchain is made of a string of blocks representing groups of transactions aligned chronologically. The first block in the proof of work-based blockchain is hard coded into the software and is called block 0 or the Genesis block. While the first block doesn’t reference any previous blocks, all other blocks entering the blockchain must reference previous blocks. Each carries carrying a copy of the updated ledger.
b. Energy Use
The proof of Work algorithm uses a competitive race to determine who among participants (cryptocurrency miners) can adjust the ledger. Miners have to use computational energy to qualify to propose valid blocks in line with the network’s rules.
Computers running the Bitcoin software, known as nodes, validate transactions, prevent double spending, and determine whether any proposed block should join the chain. Bitcoin miners compete against each other to get the chance to create a new block by solving complex mathematical sums through a process called hashing. The mathematical problems are difficult to solve, but the network can easily verify the correct solution.
The PoW consensus method combines computational power with cryptography to build consensus and validate transactions recorded in the blockchain. Miners participating in the hashing process must generate the correct answer to the mathematical problem to qualify to add a new block to the chain.
Participating miners will guess a string of pseudorandom numbers, which, when combined with the information in the block and passed through a hash function computer, must deliver a solution that matches the conditions set in advance by the algorithm.
Once an answer is derived, the system broadcasts the winning hash to the network so other miners can verify its validity. If the other miners verify the hash, the block will be added to the blockchain, and the successful miner receives compensation via the block reward.
d. Reward Distribution
The person who mines a block accepted as valid within the network receives a block reward, usually a new cryptocurrency. For cryptocurrencies like Bitcoin, the blockchain systematically reduces the block reward amount after a given number of blocks have been created to keep the total amount of funds finite and deflationary.
What is Proof of Stake (PoS)?
The Proof of Stake (PoS) consensus method is an amendment of the PoW that debuted in 2012. Instead of solely relying on computers competing against each other to create the correct hash, the objective of a PoS consensus protocol is to allow participation through the ownership of the particular cryptocurrency. The aim was to primarily deal with the PoW’s high energy consumption to determine blockchain ordering.
The PoS algorithm uses a pre-determined set of factors to pseudo-randomly elect a node from among coin owners to propose the next block to the blockchain. It’s the role of the selected node to verify the validity of transactions within a block in addition to signing and proposing the block to the blockchain for validation.
a. Blockchain Ordering
Like the PoW mechanism, the PoS consensus method consists of a string of blocks aligned chronologically. The first block within a PoS-based blockchain is also hardcoded into the genesis block software. All subsequent blocks added to the blockchain must reference the previous block and carry an entire copy of the updated ledger. However, unlike the PoS method, participating nodes don’t compete to get selected to add blocks. As a result, new blocks are usually forged or minted instead of mined.
b. Energy Use
PoS-based blockchains are famous for using an energy-efficient system to determine who can propose new blocks and are not dependent on high energy consumption and computing power. Proponents of the PoS consensus mechanism bill it as an environmentally-friendly mechanism in which an individual node gets assigned the business of creating new blocks instead of competing against each other.
Because PoW mining and PoS minting both require energy consumption, mining and minting nodes are motivated to use the cheapest form of electricity possible, which most often comes from renewable resources such as hydroelectric power, wind, or solar rather than greenhouse emitting sources like coal.
While PoS miners only require an active internet source which requires a small amount of energy, PoW miners, on the other hand, must acquire specialized hardware (GPUs), mining equipment, and other expensive devices to have a chance at producing a block.
To participate in the PoS consensus method and stand a chance to get selected to add blocks to the chain, a user is required to stake or lock a specific amount of the blockchain’s tokens in a particular smart contract. Your chance of getting selected to participate is determined by the amount of cryptocurrency you stake.
Users who act maliciously or violate the laid down rules could end up losing their stake as punishment. The PoS algorithm employs several other determining factors to avoid favoring only the wealthiest nodes, some of which include pure randomization or the number of times a node has staked coins.
d. Reward Distribution
Like the PoW consensus mechanism, users who successfully propose a valid block get rewarded with a block reward, referring to the blockchain’s cryptocurrency. Nonetheless, since coin ownership determines selection, some cryptocurrency exchanges offer stake services by placing stakes on users’ behalf in exchange for regular payouts.
PoW vs. PoS: Where Does the Future Belong?
Our verdict of the proof of work vs. proof of stake blockchain consensus algorithms is that both work differently to achieve the same purpose. However, since the proof of stake is still relatively new in the market, it may be unfair to pass judgment on which one among them is the outright winner.
PoW has been the traditional consensus mechanism in most original blockchains like Bitcoin and Ethereum. However, Ethereum is in the process of adopting a new PoS protocol in a bid to showcase the potential of the emerging consensus method.
The PoW consensus mechanism has endured the test of time and has proven itself as a way of securing a blockchain. However, it negatively impacted network scalability, which affects transactions adversely. These days, individuals rarely get a chance to mine, as large centralized mining organizations with immense computing power have taken it over, making the associated costs unsustainable.
The PoS algorithm, on the other hand, is more energy efficient, and the networks under it enjoy higher scalability and more efficient transactions. However, the mechanism provides less security for the cryptocurrencies staked by participants.
PoS came in to address flaws inherent in the PoW mechanism and, of course, thrive on the energy efficiency side. However, both blockchain consensus algorithms may be around in the foreseeable future, considering that Bitcoin is stuck with PoW while Ethereum gravitates towards PoS.
You may also be interested in reading about blockchain nodes.