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Decision time: A guide to understanding blockchain consensus mechanisms

8 min read
  • Consensus mechanisms are algorithms used in blockchain technology to ensure the integrity and agreement among all participants on the state of the network.

  • They ensure that all nodes reach an agreement on the same transactions, blocks, and overall history of the blockchain. 

  • There are various types of consensus mechanisms available today and each has its pros, cons and best use cases.

  • This article compares Proof of Work (PoW), Proof of Stake (PoS), Proof of History (PoH), Proof of Authority (PoA), and Delegated Proof of Stake (DPoS).

Consensus mechanisms are a fundamental aspect of blockchain technology, allowing distributed networks to reach an agreement on the state of the network and the validity of transactions.

These mechanisms ensure that all participants on a blockchain agree on the order and integrity of the transactions. Without a consensus mechanism, a blockchain network cannot function effectively, because participants need assurance that no one has muddled or manipulated the transactions. Research and development in consensus algorithms is ongoing and crucial for the advancement of blockchain technology.

The first even cryptocurrency - Bitcoin - was launched in 2009 using a Proof of Work (PoW) consensus mechanism. Over the years, however, several limitations of PoW have become apparent, such as its lack of scalability and high energy consumption.

This has led to the development of alternative mechanisms such as Proof of Stake, Proof of Authority, and Proof of History, which aim to solve these problems. These consensus algorithms vary in the methods they use to verify transactions, essentially altering the way the blockchain operates.

 

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To date, there is no holy grail (yet) when it comes to consensus mechanisms. Every mechanism has its pros and cons and different consensus mechanisms fit certain use cases better than others. 

Why blockchains need a consensus mechanism

Without a consensus mechanism, a blockchain network cannot function effectively. Let’s dive deeper into their implications for blockchain networks.

A key challenge for blockchain networks is balancing scalability, security and decentralization. This is known as the scalability trilemma. Currently, it is extremely difficult to solve all three of these challenges in a single blockchain. As such, many consensus mechanisms are forced to compromise on one of these aspects in order to achieve the other two.

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Network security is perhaps the most important of blockchain attributes. This can be achieved in a number of ways.

For example, one of the key goals of a consensus mechanism is to ensure that the information stored on the blockchain is accurate and cannot be tampered with by any user or group of users. This is important to maintain the integrity of the decentralized computer network and protect it from fraudulent behavior such as double-spending.

Simply put, like any other currency, digital assets cannot be spent more than once. In traditional finance, a central authority such as a bank or a payment processor like PayPal is responsible for ensuring that the digital token is only spent once. In a blockchain, that responsibility lies with the consensus mechanism.

Decentralization is another important factor in the cryptocurrency ecosystem. This ensures a democratic, distributed system that is less susceptible to manipulation and control by any single entity. If a network is not decentralized, a single entity would be in the position to maliciously change the information on the network for their own interest.

Additionally, a decentralized blockchain is trustworthy as all participants have equal access to the data. This, in turn, promotes the security of the network since each user is able to check and validate all the transactions that have taken place. 

Last, but not least, scalability refers to the ability to handle a growing number of users and transactions. It is crucial for a blockchain network to scale as more people adopt and use the network repeatedly for a wide range of purposes. If a blockchain is not scalable, it may become slow and congested, resulting in high fees and longer transaction times.

Cryptocurrency users experienced this issue with Ethereum during the bull market of 2021 and early 2022, with the network suffering from congestion and high gas fees numerous times. Back then it relied on Proof of Work and was unable to keep up with the growing number of transactions as its popularity increased.

This made Ethereum less attractive for users and subsequently contributed to the success of alternative Layer 1 blockchains, such as Avalanche and Fantom, but also to the success of Layer 2 solutions, especially Optimism and Arbitrum. It was also one of the reasons Ethereum eventually transitioned to a Proof of Stake mechanism in 2022, more details on which can be found in the following blog.

Comparison of existing consensus mechanisms

With the scalability trilemma in mind, below is a comparison of the most popular consensus mechanisms. Each has its own characteristics and corresponding pros and cons. Let’s break them down in this section to see what sets them apart. 

Proof of Work (PoW) 

  • Security: Highly secure. Requires users to perform a significant amount of computational work in order to achieve consensus and add new blocks to the chain.

  • Decentralization: Anyone with the necessary processing power can participate in the mining/validation process. 

  • Scalability: The energy-intensive computational work involved in block creation limits the processing of large numbers of transactions. 

Proof of Stake (PoS)

  • Security: Highly secure. The Proof of Stake system relies on users holding a certain amount of cryptocurrency in order to validate transactions.

  • Decentralization: Users holding the most cryptocurrency are typically the ones who validate blocks and transactions. This limits the decentralization of the network to an extent. 

  • Scalability: PoS is more energy efficient than PoW as it does not require significant computational resources to reach consensus. Furthermore, it is able to incorporate new elements, such as modularity, to increase scalability.

Proof of Authority (PoA)

  • Security: Highly secure. PoA relies on a set of pre-approved validators whose identity is known, which provides a high level of security.

  • Decentralization: PoA is less decentralized than PoW or PoS, as the validators are pre-approved, known, and in most cases represent only a small group. 

  • Scalability: PoA is more sustainable than the energy-intensive PoW and is able to handle more transactions per second, making it more scalable. 

Proof of History (PoH)

  • Security: Proof of History relies on the use of a cryptographic proof that a certain event/transaction has occurred in the past. As a result, the network as a whole is no longer required to verify the temporal claims of nodes, enabling it to delay updating the current state of the chain.

  • Decentralization: Depending on the implementation, PoH has the potential to be highly decentralized, as multiple users can independently verify the proof of history and reach agreement on the current state of the network.

  • Scalability: PoH can be highly scalable as it does not require a great deal of computational power.

Delegated Proof of Stake (dPoS)

  • Security: dPoS relies on a smaller set of elected validators to validate transactions. 

  • Decentralization: Users/entities have to fulfill certain requirements in order to become validators (they are often selected through nomination). 

  • Scalability: It is an iteration of PoS, which makes it as scalable as PoS. 

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Key takeaways: Consensus mechanisms

Proof of Stake is by far the most used consensus mechanism among today's blockchains.

For one, validators do not have to solve complex mathematical puzzles in order to add a new block, unlike PoW miners. This means that PoS is more sustainable to run and maintain than PoW. 

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Furthermore, users are able to participate in validating the network by staking their tokens, earning block rewards in return. This aligns the incentives of the network with the interests of its participants and democratizes the chain. 

To date, PoS has been adopted by Ethereum, Avalanche, Algorand, and Fantom. In fact, the switch by Ethereum from Proof of Work to Proof of Stake in August 2022 is considered by many as a monumental milestone in the history of blockchain.

That being said, mechanisms like PoW and PoS are good fits for public networks, because they provide a high level of security and decentralization while the PoA mechanism is suitable for (semi-)permissioned chains, such as enterprise chains.

As such, there is a need in the market for a wide selection of consensus mechanisms that can support varying use cases in the rapidly expanding Web3 landscape.

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DISCLAIMER: The content of this article does not constitute financial advice and is for informational purposes only. The price of digital assets can go down as well as up, and you may lose all of your capital. Investors should consult a professional advisor before making any investment decisions.

 

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