Analyses
15
Apr
consensus algorithm

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Cryptocurrency consensus algorithms explained

Cryptocurrency consensus algorithms are the backbone of decentralized blockchain networks. The Proof of Work (PoW) consensus algorithm is used by Bitcoin. While Proof of Work has been the dominant consensus algorithm in the past, Proof of Stake (PoS) has gained popularity due to its potential to be more energy-efficient and cost-effective. Several different Proof of Stake (PoS) variants exist in the market.

Gasper is the consensus mechanism that was developed for Ethereum’s transition from Proof of Work to Proof of Stake consensus. Proof of Staked Authority (PoSA) is a consensus algorithm used in the BNB Smart Chain network. Ouroboros is a Proof of Stake (PoS) consensus algorithm used by the Cardano blockchain network. Tendermint is a Byzantine Fault Tolerant (BFT) consensus algorithm. Delegated Proof of Stake (DPoS) is a consensus algorithm developed by Dan Larimer.

In conclusion, cryptocurrency consensus algorithms are the backbone of decentralized blockchain networks.

What are cryptocurrency consensus algorithms?

Cryptocurrency consensus algorithms are the backbone of decentralized blockchain networks. Consensus algorithms ensure that transactions are validated and new blocks are added to the blockchain. Consensus algorithms allow a network of decentralized nodes to agree on the state of the blockchain and prevent any fraudulent activity or double-spending.

There are different types of consensus algorithms, but they all work towards achieving the same goal: creating a secure and decentralized network where transactions can be made without the need for intermediaries. The most popular consensus algorithms in cryptocurrencies are Proof of Work (PoW) and Proof of Stake (PoS).

PoW, used by Bitcoin and several other cryptocurrencies, requires miners to solve complex mathematical equations to validate transactions and add new blocks to the blockchain. On the other hand, PoS, used by Ethereum and other cryptocurrencies, involves validators staking their own coins to validate transactions and add new blocks to the blockchain.

Cryptocurrency consensus algorithms are important because they ensure the integrity and security of the blockchain network. Without a consensus algorithm, the network would be vulnerable to attacks, and transactions would not be validated, leading to a breakdown of trust in the network. By using consensus algorithms, blockchain networks can achieve consensus among decentralized nodes and provide a secure and reliable platform for transactions.

What is the Proof of Work consensus algorithm?

The Proof of Work (PoW) consensus algorithm is used by Bitcoin. There are other cryptocurrencies that use PoW as well, including Bitcoin Cash, Litecoin, and Dogecoin. PoW involves miners solving complex mathematical problems to validate transactions and add new blocks to the blockchain.

Proof of Work was the main choice for the consensus algorithm in the early 2010s. The situation is different now. Practically all major cryptocurrencies launched since 2017 are using Proof of Stake consensus.

When a user initiates a Bitcoin transaction, it is broadcasted to the network of nodes. These nodes verify the transaction’s validity before it is added to the mempool, a pool of unconfirmed transactions. Miners then compete to solve a complex mathematical problem called the “hash puzzle” to validate the transactions in the mempool and add a new block to the blockchain.

Bitcoin mining devices, also known as ASICs (Application-Specific Integrated Circuits), are specialized hardware designed to perform the complex calculations required for Bitcoin mining. ASICs are more efficient and powerful than traditional CPUs or GPUs and are used by miners to compete for block rewards in the Bitcoin network. Some PoW cryptocurrencies can be also mined with CPUs and GPUs.

The picture below has ASIC miners manufactured by the Chinese Bitmain.

bitmain asic

The hash puzzle is intentionally designed to require significant computational power to solve, which incentivizes miners to use expensive hardware and consume large amounts of electricity to compete. The computational power required to solve the puzzle also serves as a form of network security, making it difficult for an attacker to take control of the blockchain.

To reach a consensus, the network relies on the longest chain rule, which states that the valid blockchain with the most accumulated PoW is the true one. This means that if a malicious miner attempts to add an invalid block to the blockchain, the network will reject it because it will not have the same level of accumulated PoW as the main chain. Hence, the network always follows the chain with the highest level of PoW, ensuring the integrity and security of the blockchain.

Proof of Work vs. Proof of Stake

While Proof of Work has been the dominant consensus algorithm in the past, Proof of Stake (PoS) has gained popularity due to its potential to be more energy-efficient and cost-effective. Ethereum, BNB Chain, Cardano, and dozens of other smart-contract-platforms are examples of PoS cryptocurrencies.

The main difference between PoW and PoS is the method by which they achieve consensus. PoW relies on miners to solve complex mathematical puzzles and compete to create new blocks, which consumes large amounts of energy and computational resources. PoS systems have validators instead of miners.

Validators are incentivized to maintain the network’s integrity by staking their own coins, which are held as collateral, and they are penalized if they try to cheat the system. By harming the network they’d also crash the price of the tokens they have staked.

Validators are usually standard network servers that require only a fraction of the energy compared to Bitcoin miners.

serverit

In general, the amount of staked coins determines the probability of a validator being selected to create a new block. Each Proof of Stake variant has slightly different rules. We’ll go through the most popular PoS consensus algorithms in the next chapters.

There are also differences between PoW and PoS in the level of security and decentralization they offer. While PoW is generally considered to be more secure and decentralized due to the large number of miners in the network, PoS has the potential to be just as secure and decentralized if it is designed correctly. This depends a lot on the network and how it is designed.

Overall, both PoW and PoS have their strengths and weaknesses. It seems that PoS has become the de facto consensus algorithm due to being more energy-efficient and cost-effective.

Proof of Stake variants

There are several different Proof of Stake (PoS) variants in the market. Each PoS consensus algorithm has a slightly different set of rules. Here are four reasons why different PoS variants are needed:

  1. Different goals and requirements
  2. Innovation and experimentation
  3. Geographic and regulatory considerations
  4. Different communities and stakeholders

Different blockchains have different goals and requirements, which can influence the choice of PoS variant. For example, a project that prioritizes speed and scalability may choose a different PoS variant than one that prioritizes security and decentralization.

Cardano’s Ouroboros is a popular PoS variant. As a project, Cardano has taken a different approach compared to many other popular PoS cryptocurrencies.

ouroboros

The blockchain industry is still relatively new and rapidly evolving, and developers are constantly experimenting with new consensus algorithms and improving existing ones. This has led to the creation of new PoS variants designed to address different issues and achieve different goals.

Blockchain projects may operate in different geographic locations and must comply with different regulatory frameworks. PoS variants can be designed to comply with specific regulations or meet specific geographic requirements, such as energy consumption or network latency.

Different blockchain communities may have different preferences and requirements for their consensus algorithm. For example, a community that values decentralization may prefer a PoS variant that distributes power more widely among its participants.

The most popular PoS variants are Ethereum’s Gasper, Proof of Staked Authority, Ouroboros, Tendermint, and Delegated Proof of Stake. Next, you’ll get a brief introduction to each.

Ethereum’s Gasper

Gasper is the consensus mechanism that was developed for Ethereum’s transition from Proof of Work to Proof of Stake consensus. Gasper is a combination of two separate components: Casper the Friendly Finality Gadget (Casper-FFG) and the LMD-GHOST fork choice rule.

Casper-FFG is a finality gadget that uses PoS to achieve consensus. It introduced a new type of node on the Ethereum network, called validator nodes, that replaced the miners in the PoW model. Validators are responsible for proposing and validating new blocks. They are required to stake Ether (ETH) as collateral to participate in the consensus process. In return, they earn rewards for their participation.

The minimum stake amount is 32 ETH. In practice, it’s possible to stake smaller amounts by using third-party apps or crypto exchanges. There are currently over 560K validators that have staked 17.9 million ETH. This is about 15 % of the total ETH supply.

ethereum staking

The LMD-GHOST fork choice rule is a modification of the Greedy Heaviest Observed Sub-Tree (GHOST) fork choice rule. The fork choice rule determines which chain of blocks is considered the “canonical” chain in the case of a fork. It s crucial for maintaining consensus in a decentralized system.

Together, Casper-FFG and LMD-GHOST form the Gasper consensus mechanism. Validator nodes propose and validate new blocks, and the LMD-GHOST fork choice rule ensures that the chain with the most support from validator nodes is considered the canonical chain. Gasper also introduces a new concept called “finality,” which means that once a block has been added to the canonical chain, it is considered to be “final” and cannot be reversed.

Proof of Staked Authority (PoSA)

Proof of Staked Authority (PoSA) is a consensus algorithm used in the BNB Smart Chain network. It is the second-largest smart contract platform in the market after Ethereum. PoSA is a variation of Proof of Authority (PoA) and Proof of Stake (PoS) consensus algorithms.

In PoSA, validators are selected based on the number of BNB tokens they hold and stake in the network. Validators are responsible for validating transactions and adding new blocks to the blockchain, and they receive rewards for their participation in the network. The more BNB they hold and stake, the higher their chances of being selected as a validator.

Unlike Ethereum’s PoS, which uses a random leader election process to select validators, PoSA uses a deterministic process based on the amount of BNB staked by validators. This makes the selection of validators less random and more predictable.

Besides BNB Smart Chain, no other cryptocurrencies are currently using PoSA, as it is a proprietary consensus algorithm developed by Binance. However, several other cryptocurrencies use variations of PoS or PoA. Learn more about BNB Smart Chain and its technology from our BNB Chain beginner’s guide.

Ouroboros

Ouroboros is a Proof of Stake (PoS) consensus algorithm used by the Cardano blockchain network. It is designed to achieve a secure, scalable, and decentralized network while minimizing energy consumption.

In Ouroboros, validators are selected randomly to participate in the consensus process, with the probability of selection based on the amount of cryptocurrency they have staked. Validators are responsible for creating new blocks and validating transactions.

To ensure decentralization, Ouroboros uses a concept called “staking pools”, where multiple users can pool their staked cryptocurrency together to increase their chances of being selected as a validator. Staking pools can be created and managed by users or third-party service providers.

The staking pool rewards are also designed to go lower once the pool grows. This incentivizes stakers to create more small staking pools, which in turn, helps decentralization of the network. The image below shows statistics from the adapools.org website. It says that over 910K network participants have delegated their stake into 3.2K staking pools.

adapools

Epochs in Ouroboros are time periods during which a set of validators are selected to create new blocks. Each epoch consists of several slots, with a single validator responsible for creating a block in each slot. Validators who successfully create blocks and validate transactions receive rewards in the form of cryptocurrency.

Ouroboros is currently used by the Cardano blockchain network, which aims to provide a more sustainable, scalable, and secure platform for decentralized applications and financial transactions. Read more about Cardano from our in-depth beginner’s guide.

Tendermint

Tendermint is a Byzantine Fault Tolerant (BFT) consensus algorithm. It uses Proof of Stake to achieve consensus in a blockchain network. Tendermint is designed to be fast, secure, and scalable.

In Tendermint, validators are selected based on the amount of cryptocurrency they have staked in the network. Validators are responsible for creating new blocks and validating transactions. The selection process is deterministic and based on a set of pre-defined rules. You can learn more about this algorithm by visiting tendermint.com.

tendermint

Validators in Tendermint can create staking pools, where users can pool their staked cryptocurrency to increase their chances of being selected as a validator. Staking pools can be created and managed by users or third-party service providers.

Tendermint uses a concept called rounds, which are time periods during which a set of validators are responsible for creating new blocks. Each round consists of several steps, with a single validator responsible for creating a block in each step. Validators who successfully create blocks and validate transactions receive rewards in the form of cryptocurrency.

Several blockchain projects use Tendermint. The best-known is Cosmos, a network of interoperable blockchain networks that use Tendermint to achieve consensus and secure transactions across the different networks.

Delegated Proof of Stake

Delegated Proof of Stake (DPoS) is a consensus algorithm developed by Dan Larimer. Several blockchain projects, including EOS, Steem, and BitShares use it. These are all founded by Larimer as well. In DPoS, token holders in the network vote to elect a group of “witnesses” or “delegates” who are responsible for creating new blocks and validating transactions.

These witnesses are incentivized to maintain the integrity of the network and ensure that transactions are processed efficiently. They receive rewards for their participation in the network, which can include transaction fees and newly minted tokens.

Witnesses in DPoS can create staking pools, where users can pool their staked cryptocurrency to increase their voting power and influence the selection of witnesses. Staking pools can be created and managed by users or third-party service providers.

Block creation in DPoS is performed by the elected witnesses or delegates, who are responsible for validating transactions and adding them to the blockchain. They are selected based on the number of votes they receive from the token holders in the network.

Overall, DPoS is designed to achieve fast and efficient transactions while maintaining a high degree of decentralization.

Conclusion

In conclusion, cryptocurrency consensus algorithms are the backbone of decentralized blockchain networks. They ensure that transactions are validated and new blocks are added to the blockchain, allowing for a secure and decentralized platform for transactions. The most popular consensus algorithms in cryptocurrencies are Proof of Work (PoW) and Proof of Stake (PoS).

PoW, used by Bitcoin and several other cryptocurrencies, requires miners to solve complex mathematical equations to validate transactions and add new blocks to the blockchain. PoS, used by Ethereum and other cryptocurrencies, involves validators staking their own coins to validate transactions and add new blocks to the blockchain.

PoS is considered to be more energy-efficient and cost-effective than PoW. However, Bitcoin’s PoW is the safest choice and arguably the most decentralized one as well.

There are several different variants of PoS, each with slightly different rules and goals. The most popular PoS variants are Ethereum’s Gasper, BNB Chain’s Proof of Authority, Cardano’s Ouroboros and Cosmos’ Tendermint. Each PoS consensus algorithm has its own strengths and weaknesses, making it important for blockchain projects to choose the right algorithm that aligns with their goals and requirements.

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