Cryptocurrency Technology: Consensus Algorithms Explained
- Cryptocurrency consensus algorithms ensure that digital currency coins cannot be double spent, stolen, or created at will by rogue third parties
- Consensus algorithms like Bitcoin’s Proof of Work algorithm, are able to maintain the accuracy of blockchain data, even when network nodes are offline or can’t be relied upon
- Some consensus mechanisms require the use of intensive network resources, while others are much more lightweight
Consensus Algorithms – Proof of Work & Other Algorithms Explained
Even if you are not familiar with how cryptocurrency like Bitcoin works, you are likely familiar with a few Bitcoin horror stories.
From Bitcoin mining requiring more electricity than Ireland to Bitcoin causing global warming, Bitcoin is repeatedly called out for its insatiable power appetite. What is worse, this appetite shows no sign of abating. This is due to the fact that the ‘proof of work’ consensus which validates Bitcoin transactions, requires ever greater amounts of real-world computer power.
Proof of Work Consensus Algorithms Explained
One of the strongest benefits of cryptocurrency like Bitcoin rests with the fact that Bitcoin is completely decentralized. This means that the Bitcoin transaction ledger is not stored in one place. Instead, the Bitcoin blockchain is administered simultaneously by millions of individual network participants.
Needless to say, while decentralization helps add value to Bitcoin, it also raises a serious logistical problem. – Put simply, because everyone contributing to the Bitcoin blockchain runs their own version of the Bitcoin transaction ledger, a system needs to be put in place to ensure that all data is always correct across the network. Proof-of-Work (PoW), therefore, does this by bundling transactions into blocks of hard to crack but easy to validate cryptographic code.
How Proof of Work Works
When Bitcoin miners successfully crack blocks of code on the Bitcoin blockchain, they are issued with a reward. Data from successfully mined blocks is then used to update the Bitcoin ledger. Miners in the meanwhile, who attempt DDoS attacks, other hacks, or who are simply too slow, don’t receive awards. Instead, any data which they attempt to contribute to the blockchain is considered invalid.
Which Coins Use Proof of Work Consensus Algorithms?
Because proof of work has been used successfully to maintain the integrity of the Bitcoin blockchain for over 9-years, POW is considered the most tried and tested consensus algorithm on the cryptocurrency market. Litecoin, ZCash, Monero, and Ethereum, all subsequently use proof of work based network validation. Due, however, to the resource intensity of POW, Ethereum itself does soon plan to adopt a less resource intensive proof of stake consensus algorithm.
Proof of Stake Consensus Algorithms Explained
Because of the computational resources required with proof of stake, newer coins like Ethereum are steadily adopting less intensive, ‘proof-of-stake’ consensus algorithms.
In the case of Proof-of-Stake (POS), cryptocurrency transactions are not verified by people mining coins. Instead, stakeholders of large volumes of tokens receive rewards for helping process transactions. Coins like Ethereum, therefore, simply trust that no stakeholders will contribute invalid transaction information. (Namely, on the basis that if they did, they would stand to lose personally if the integrity of the blockchain was ever compromised).
Proof of Stake Limitations
Because proof of stake consensus algorithms do not require coins to be mined, one limitation of POS rests with the fact that initially distributing coins can be challenging. For this reason, most proof of stake cryptocurrencies distribute coins via pre-launch ICO token sales. – Either this or like with Ethereum, switch to using a proof of stake consensus algorithm after a period of using Bitcoin-like proof of work consensus.
Coins Using Proof of Stake Today
Thanks to POS consensus algorithms being less physical resource heavy, coins like Dash, Neo, and Stratis, already use proof of stake consensus mechanisms. Much more importantly, their success at maintaining transaction ledger integrity makes POS arguably proven as a viable network consensus strategy.
Cardano & ‘Ouroboros’ Proof of Stake Consensus
Despite the fundamental differences between POS and POW consensus algorithms, both share one fundamental problem. – Namely, with both POS and POW, transaction processing can be monopolized by network participants with the most cryptocurrency holdings.
In the case of Bitcoin, ASIC Bitcoin mining rigs cost upwards of $5,000. This means that mining is always dominated by pools of miners with the most funds available to purchase and operate mining units. In like regard, because coins like Ethereum only switch to proof of stake consensus algorithms after distribution of coins, transaction processing can be effectively bought by the highest bidder.
Given the arguable unfairness of both POS and POW consensus systems, new cryptocurrency Cardano uses what it refers to as its own ‘Ouroboros’ POS system. This is one which randomizes which Cardano stakeholders are chosen to process transactions. Much more importantly, because Cardano selects network participants via a completely unbiased and random cryptographic process, Cardano benefits (in theory) from much more robust network decentralization.
Delegated Proof-of-Stake (DPoS) & Proof of Importance (POI)
With Cardano still in development, the Ouroboros POS system isn’t (yet) as well tested in the wild as Bitcoin’s POW system. (Or Dash Coin’s POS algorithm.) However, Cardano isn’t the first cryptocurrency to attempt to bring an alternative consensus algorithm to market.
At present, BitShares, Lisk, EOS, and Steem, all use a delegated proof of stake consensus algorithm. In doing so, cryptocurrency token holders actively vote for select groups of stakeholders whom the community wishes to trust with validating transactions. Meanwhile, coins like NEM (XEM) use a slightly different proof of importance consensus algorithm. Namely, one in which NEM trustlessly assigns transaction validation tasks to NEM stakeholders who’s accounts are ranked by an automated importance score.
Byzantine Fault Tolerance & Other Cryptocurrency Consensus Algorithms
Thanks to explosive growth in the cryptocurrency market, several coins are currently experimenting with several different transaction consensus mechanisms. One of the most controversial, however, is that of Ripple XRP’s ‘Byzantine Fault Tolerance’ consensus algorithm.
At its core, Byzantine Fault Tolerance works in a similar way to XEM’s proof of importance and Steem’s delegated proof of stake. With Ripple XRP, though, Ripple itself directly chooses who can act as a transaction validator on the Ripple network. This means that in the case of Ripple XRP, the cryptocurrency can be argued to be innately centralized as opposed to truly decentralized like coins like Bitcoin and Ethereum.