Blockchains were made possible by the development of a crucial mechanism known as a consensus algorithm, which facilitates coordination between users or machines in a distributed setting. The primary function of this algorithm is to ensure that all agents in the system can agree on a single source of truth, even if some agents fail. This fault tolerance is essential to the system's success.
In contrast to a centralized setup, where a single entity has total control over the system and can make changes as desired, a decentralized format presents a significant challenge. In the case of a distributed database, for example, how can we agree on which entries should be added?
The answer lies in developing a complex governance system that allows strangers who do not trust each other to come to a consensus. Overcoming this challenge was a significant milestone in the development of blockchains, which rely on consensus algorithms to ensure the integrity of the system.
Consensus Algorithms in Crypto
The blockchain serves as the database of cryptocurrencies, recording users' balances. All nodes in the network must maintain an identical copy of the database to prevent conflicting information, which would undermine the entire purpose of the cryptocurrency network.
Public-key cryptography is used to ensure that users cannot spend each other's coins. However, a single source of truth is still necessary for network participants to determine whether funds have already been spent.
To coordinate participants in Bitcoin, its creator Satoshi Nakamoto proposed a Proof of Work (PoW) system, which we'll explain shortly. But before that, let's examine the common traits of consensus algorithms.
Firstly, validators who wish to add blocks must provide a stake, which discourages dishonest behavior. The stake could be computing power, cryptocurrency, or reputation. If they cheat, they'll lose their stake. There's a reward available, consisting of the protocol's native cryptocurrency, which comprises fees paid by other users, newly generated cryptocurrency units, or both.
Lastly, transparency is vital to detect cheating. It should be costly for validators to produce blocks, but inexpensive for others to validate them. This ensures that validators are kept in check by regular users.
The Most Common Consensus Algorithms
Proof of Work
Proof of Work is an old-school consensus algorithm that was popularized by Bitcoin but has been around for some time. This algorithm requires validators, called miners, to hash data they want to add to the chain until they find a specific solution. A hash is a string of letters and numbers generated when data is run through a hash function, and changing even a small detail will produce a completely different output.
The Proof of Work protocol sets certain conditions for what makes a block valid. For instance, a block whose hash starts with 00 might be considered valid. To create a block that matches those criteria, miners need to brute-force inputs, tweaking data parameters until they get the right hash. With major blockchains, the bar is set very high, and miners need a lot of special hashing hardware and electricity to compete.
In the Proof of Work system, miners must provide a stake in the form of the cost of machines and electricity required to mine. ASICs, or specialized mining hardware, are expensive and have no use outside of cryptocurrency mining. However, mining can yield significant rewards for successfully adding a new block to the blockchain.
It is easy for the network to verify whether a miner has created a valid block. Even if they have tried trillions of combinations to get the right hash, the network just needs to run the data through the function once. If the data produces a valid hash, the miner gets a reward, but if not, the network will reject the block.
Proof of Stake
An alternative to Proof of Work, known as Proof of Stake (PoS), was proposed in the early days of Bitcoin. It eliminates the need for specialized hardware, massive energy consumption, and miners. Instead, it requires stakers to hold a minimum amount of cryptocurrency to be eligible for staking.
Once eligible, the staker locks up their funds in a wallet and agrees with other validators on what transactions will go into the next block. The protocol then chooses one block, and the validator with the selected block receives a portion of the transaction fees based on their stake. The more funds locked up, the more profit is gained. Cheating leads to a loss of a portion or all of the stake.
Pure Proof of Stake has only been used in smaller cryptocurrencies, and its viability as a viable alternative to PoW is unclear. Generally, there aren’t freshly-created coins as part of the reward for validators. The native currency of the blockchain must thus be issued in some other way, like an initial distribution (i.e., an ICO or IEO) or having the protocol launch with PoW before later transitioning to PoS.
The transition to PoS is a playing field of game theory and financial incentives. It will be feasible only on a live network since anyone with the know-how to “hack” a PoS system would only do so if they could gain from it.
Other Consensus Algorithms
There are a variety of consensus algorithms besides Proof of Work and Proof of Stake. These alternatives each have their own pros and cons. Here is a list of some of them:
- Delayed Proof of Work
- Leased Proof of Stake
- Proof of Authority
- Proof of Burn
- Delegated Proof of Stake
- Hybrid PoW/PoS Consensus
The utilization of consensus mechanisms is vital to the functioning of distributed systems. It is widely believed that Bitcoin's most significant innovation was the introduction of Proof of Work, which facilitates agreement among users on a shared set of facts.
Consensus algorithms are the foundation of digital currency systems and blockchains, enabling developers to run code across a distributed network. They are a fundamental component of blockchain technology, and the long-term viability of existing networks hinges on them.
Proof of Work is still the most prevalent consensus algorithm, and no alternative that is more dependable or secure has yet emerged. Nonetheless, there is an enormous amount of research and development focused on replacing PoW, and more alternatives are likely to emerge in the coming years.