Consensus algorithms are the mechanisms that allow blockchains to remain secure and reward users who act as their gatekeepers. The two types of consensus algorithms that dominate the cryptocurrency landscape: Proof of Work and Proof of Stake.
Once you get beyond the initial excitement of buying your first bitcoin, you may be interested in how Proof of Work functions and which blockchains use Proof of Stake.
Proof of Work (PoW)
The entire concept behind Proof of Work is to keep a network secure and make it trustworthy, while rewarding the stewards who contribute to that mission. Some early adopters credit Bitcoin’s inventor Satoshi Nakamoto with first outlining the Proof of Work algorithm in the Bitcoin whitepaper (2008). Though in actuality, the original idea for PoW came from an earlier whitepaper: Pricing via Processing or Combatting Junk Mail (1993).
How Proof of Work Functions With Bitcoin
Bitcoin is a decentralized peer-to-peer payment system that allows individuals to exchange value between one another, without the need for a third-party. Every transaction is recorded on a public ledger for everyone to see. That ledger is otherwise known as a blockchain. Users act as nodes and maintain the network voluntarily. The Proof of Work algorithm functions by having all nodes solve cryptographic puzzles. The first miner to solve the puzzle earns cryptocurrency as a reward.
As puzzles get solved, they become more challenging. Only a finite number of bitcoins will ever exist (21 million to be exact). This ensures bitcoins will never be devalued because of inflation, in the way fiat currencies are devalued. However, this also means that the cost of mining increases over time. Why? Because more and more nodes are racing to solve puzzles that are not only more difficult, but also more financially rewarding. Thus, large mining pools are developing, making the power to confirm transactions more centralized. A result that may not seem congruent with Bitcoin’s values.
Today, miners are collectively using enough energy to power entire countries. In response to this, a post on the BitcoinTalk forum introduced the idea of a more energy-efficient algorithm called Proof of Stake (2011).
Proof of Stake (PoS)
A Proof of Stake algorithm selects one node in a network to validate the next block of transactions. The selection is slightly randomized to ensure that not every miner (called a validator in PoS lingo) is competing at the same time and wasting energy.
Where all a node needs in a PoW system is more computing power, PoS validators must deposit coins or stake them to the network. The more coins a given node can stake to the network, the more likely that node is to be selected as a validator. That’s why selecting a validator is slightly randomized. It ensures that the nodes staking the most coins don’t get too many rewards too fast and centralize control of the network.
Proof of Work vs. Proof of Stake
The Proof of Work consensus algorithm offers two main benefits. One is that it’s the algorithm driving Bitcoin, the most valuable and well-known cryptocurrency in the world. Secondly, people trust Bitcoin and it’s ledger. Enthusiasts believe that bitcoin’s blockchain will always be the best way to secure a public, permissionless platform and keep all participants honest in spite of its flaws.
Like we mentioned earlier, PoW isn’t perfect. Mining power requirements will continue to increase and put a strain on the world’s power grid. Mining pools will continue to increase in size and dominate the validation process.
Having a large group of miners dominate more than 50% of the network and determine which transactions are validated and which are not is known as a 51% attack. Using a Proof of Stake model makes a 51% attack less likely. It’s also faster, more energy-efficient and costs less to run a PoS based blockchain.
The downside of PoS is that the rich will still get richer and potentially control the consensus of the blockchain — without the need to invest in mining equipment or expertise. To try to combat this problem, several blockchain projects have adopted what is known as the Delegated Proof of Stake (DPoS) system. In this system, rather than participants using their wealth to vote on consensus, they use their wealth to vote on delegates. Those delegates then reach a conclusion on consensus. This little twist essentially makes it arguably more difficult to game the system.
Cryptocurrencies Using Proof of Work
Bitcoin and all of its forks (e.g. Bitcoin Cash, Bitcoin Gold) use the Proof of Work consensus mechanism, as do most other cryptocurrencies. Call it a side effect of the ‘if it ain’t broke, don’t fix it’ school of thought.
Other projects using PoW include privacy coins like Monero or Verge, decentralized crypto exchange coins like Digibyte, and blockchains dedicated to building decentralized applications like Ethereum (which is moving to a PoS model soon).
Cryptocurrencies Using Proof of Stake
As mentioned, Ethereum currently operates using PoW but is moving towards a Proof of Stake protocol called Casper. Casper allows a validator’s stake to get slashed if they act in a malicious manner. This also allows the blockchain and its participants to solve the problem of malicious actors even when certain crucial elements of information are missing. A dilemma referred to as a Byzantine fault.
Many projects in the crypto space are using a PoS model now:
- NavCoin: A privacy-based cryptocurrency.
- NEO: An open-source smart contracts platform, dubbed the Ethereum of China.
- ARK: A project aimed at making it easier to build blockchains.
- Komodo: A project making enterprise blockchain solutions easier to implement.
The End Goal of All Consensus Algorithms
Whether it’s Proof of Work, Proof of Stake, Delegated Proof of Stake or any other type of consensus algorithm that prevails, the broader goal will be the same: to make blockchains faster, more efficient, scalable and immutable.
The cryptocurrencies and blockchains that will push humanity into the future may include rules and ideas that haven’t even been invented yet. But that’s a reason to be excited, not worried. Keeping an eye on the future and exploring what we don’t yet know is where innovation lies.
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