Consensus Mechanisms Part 1: Proof of Work and Proof of Stake

Consensus Mechanisms Part 1: Proof of Work and Proof of Stake

Consensus mechanisms are crucial to cryptocurrency. Although there are a variety of consensus mechanisms used in different cryptocurrencies, they all have one thing in common: Cryptocurrency would not exist without them. Even though there are a wide variety of consensus mechanisms out there, almost all of them are derivatives of the two original consensus mechanisms used in cryptocurrency: Proof of Work (PoW) and Proof of Stake (PoS). In part one of this two-part article, we will take a detailed look at both the Proof of Work and Proof of Stake consensus models, before we dive into alternative consensus mechanisms in part two.

Proof of Work

The Proof of Work consensus mechanism is the first and oldest consensus mechanism. Proof of work is used by coins such as Bitcoin, Litecoin and Dogecoin. The Proof of Work model was conceived in 1993 and was originally intended to combat spam emails; however, it was not used for much of anything until Satoshi Nakamoto created Bitcoin in 2009. Satoshi realized that the Proof of Work technique could be repurposed to bring many nodes on a network to consensus and secure the Bitcoin blockchain.

The Proof of Work algorithm works by having all nodes on a network solve a cryptographic puzzle. These nodes – called miners – compete with one another to solve this cryptographic puzzle. The first one to find the solution to the puzzle gets the miner reward.

The more processing power a mining operation has, the more frequently it will solve these puzzles. A miner’s ability to solve cryptographic puzzles is referred to as a “hash rating.” The higher the hash rating means a higher likelihood to mine a greater number of blocks. Essentially Proof of Work gives greater rewards to miners with better equipment. Miners can also work together to form a mining pool, where they combine their hashing power and equally distribute the mining rewards evenly across the pool. These mining pools centralize cryptocurrency mining, which is typically frowned upon in the world of cryptocurrency. This is the first reason the Proof of Stake consensus mechanism was created.

This has led to the creation of massive groups of mining servers called farms. Mining Proof of Work cryptocurrencies has become a growing industry in and of itself, with mining farms all around the world. Although most of the energy used to power these mining operations comes from environmentally friendly sources, mining farms have come under heavy scrutiny within the last year because of the amount of power they consume. This is the second reason the Proof of Stake consensus mechanism was created.

Proof of Stake

The Proof of Stake consensus mechanism was first proposed in 2011 by a developer under the name QuantumMechanic, in an early Bitcoin chat forum. QuantumMechanic believed that the concept of miners competing against one another was wasteful. This person believed that having miners compete against each other was a waste of resources. QuantumMechanic proposed the same results could be achieved through an election process, which selects a node to validate the next block.

Proof of Stake does not have miners. Instead, Proof of Stake has validator nodes, which mint or forge blocks. For a node to become a validator, it must first deposit a certain number of coins into the network. This deposit is referred to as a stake and works as a kind of insurance policy for the network. The more coins a validator node stakes on the network, the greater the chance the node has to be selected to validate the next block.

When a node is selected to validate a block, it checks to make sure that all the transactions within the block are valid. Once it has confirmed the validity of the transactions, the node signs off on the block and adds it to the blockchain. The validator is rewarded by receiving the fees that are associated with the transactions which make up the block.

If a validator approves a fraudulent transaction, they loose part of their stake. This is how the stake acts as insurance for the network. As long as the part of the stake which the validator loses for processing fraudulent transactions is greater than the value of the reward the validator receives, we can trust that the validator will correctly do their job. If a node stops acting as a validator, it will eventually receive the coins that it staked, plus the rewards it has received for validating transactions; however, the network will not release the validator’s stake right away. The network holds off the releasing of funds for a certain amount of time, to ensure its ability to punish the validator, if some of the blocks the validator signed off on turned out to contain fraudulent transactions.

Proof of Stake does have some problems. The biggest problem occurs when a change of protocol is proposed. Protocol changes that lead to the hard fork of a cryptocurrency within the Proof of Work model are always snuffed out by its competitive nature. Since the Proof of Stake model does not have this competitive component, hard forks often lead to the creation of new smaller tokens on the network. These small tokens take up space on the blockchain and can lead to slower transaction times and increased transaction processing fees for the original coin and other tokens on the network.

In Conclusion

Proof of Work and Proof of Stake both have their advantages and disadvantages; however, the world of cryptocurrency is transitioning away from the Proof of Work model as technology advances. Proof of Stake is more decentralized than Proof of Work, which in turn is better for cryptocurrency. This is evidenced by Ethereum’s gradual transition into Ethereum 2.0, due to take place around December of this year. If you are curious to read about Ethereum’s transition from Proof of Work to Proof of Stake, feel free to check out our Ethereum 2.0 article by clicking on the link. If you would like to learn about the protocol changes that are forcing Ethereum to become Proof of Stake, take a look at our articles detailing EIP 1559 and EIP 3554 !

Keep an eye out for Part 2, where we will discuss alternative consensus mechanisms!

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