There is an ongoing debate over which of the blockchain consensus algorithms should be considered the best one. While the options have multiplied in the last few years, we can distinguish two of the most dominant approaches to run a blockchain network – Proof of Work (PoW) and Proof of Stake (PoS). The former is used by Bitcoin’s blockchain while the latter is adopted by Binance Coin, Stellar Lumens, and hundreds of other coins.
Before going into detail about each of the algorithms, let’s explain why blockchain does need a consensus mechanism in the first place.
As you might know, the two most important attributes of the blockchain technology are decentralization and immutability of records. The distributed network is made up of so-called nodes, which are computer servers that store specific software plus the entire history of records that is constantly updating. The nodes are all equal. Thus, all of them update the ledger simultaneously to add the new transactions. In this way, there is no single point of failure, and the system remains decentralized.
However, now comes the tricky part – who decides what transactions should be added into blocks and when since there is no “chief node”? For this, the blockchain network has to rely on a predetermined consensus algorithm that would organize the nodes without compromising decentralization.
As you might know, the blocks of any blockchain are chronologically related so that no existing block could ever be removed or changed. The only way to update a blockchain is by adding new blocks. Any node might become eligible to generate new blocks and add them into the network. The consensus algorithm touches upon this specific process during which nodes become qualified to create blocks – it provides a set of rules that bring order into how the nodes can become miners or validators.
The consensus mechanism is needed to protect the network against malicious nodes that intentionally ignore the predefined standards of a blockchain or try to overpower the other nodes by organizing false transactions or distributed denial of service (DDoS) attacks.
Now let’s see how each of the consensus algorithms works.
Proof of Work (PoW)
The PoW is the first consensus algorithm employed by a blockchain. While the entity with the pseudonym Satoshi Nakamoto introduced it in 2008 to underlie Bitcoin, the technology was conceptualized long before that.
The first version of PoW mechanism was developed by Cynthia Dwork and Moni Naor in 1992. They presented a computational technique to combat junk mail.
However, the Proof of Work term was first used by Markus Jakobsson and Ari Juels in 1999. Two years before that, cryptographer Adam Back invented Hashcash – a mechanism to protect against email spam and DDoS attacks. While Back’s system is the most similar to the one used in Bitcoin, it adopted the PoW term later on.
Bitcoin is by far the most popular implementation of the Proof of Work concept, and we’ll focus on this.
Bitcoin’s Proof of Work (PoW) has the following functions:
- To prevent double-spending within the Bitcoin ecosystem;
- To prevent DDoS attacks and other forms of malicious activities by any group of nodes;
- To enable the deflationary model of the virtual money system that rewards miners a certain amount of Bitcoin every 10 minutes when a new block is created. As you might know, the size of the reward is halving every three years or so. The last time when this happened was in May 2020, when the block reward was reduced from 12 BTC to 6.25 BTC.
- To enable the security and decentralization of the blockchain network.
In Bitcoin, new transactions are gathered in a memory pool referred to as “mempool” until a new block is created every 10 minutes. Every transaction in this pool has to be verified, and the so-called miners do precisely that. A miner is nothing else than a node who wins the right to generate the new block and get the reward. But how can a node become a miner? It has to employ more computing power than competing nodes and solve a complex puzzle.
Any Bitcoin miner planning to include pending transactions in a new block must first figure out the cryptographic hash value of the previous block. This value is hidden from everyone and must be referenced for generating the next block.
A mining node cannot simply guess or crack the hash of the last block, so it would try one number after another by spending computing power. The more computer power a miner invests, the more hash power it has, thus increasing its chance to solve the mathematical puzzle and win the reward.
Once a miner finds the hash that matches the blockchain’s predetermined protocols, it would announce the network so that the rest of the nodes would confirm it and add the new block to the blockchain. This process constantly repeats itself. You can read more about how Bitcoin mining works here.
The puzzle is designed to make it difficult for miners to find out the hash. On the other hand, the rest of the nodes can easily check the work carried out by the miner, hence the proof of work.
The puzzle is revised every two weeks to make it more complex, meaning that more computing power is needed as the time passes.
While Bitcoin’s PoW algorithm ensures its security, it comes at a cost. As you might guess, the computing power of nodes requires electrical energy. We’re talking about huge amounts of energy consumption. There is a website called Digiconomist – it regularly updates the estimated annual energy consumption to run Bitcoin.
As of today, the energy used by Bitcoin miners would be enough to cover the electricity demand of the Czech Republic.
Besides this, the involvement of all nodes in the validation process hinders the scalability of transaction throughput.
The good news is that such a system cannot be cheated since it is way too expensive for a miner even to attempt to cheat. The miner would waste resources without getting any reward.
Proof of Stake (PoS)
After Bitcoin came out, many entrepreneurs and crypto enthusiasts created similar cryptocurrency ecosystems. Most of these projects are inspired by Bitcoin but propose various changes to tackle some of its weaker points, such as scalability and energy consumption.
Proof of Stake was conceptualized in the first years of Bitcoin as an alternative to PoW. The idea of PoS was first introduced in 2011 on the Bitcointalk forum.
One of the earliest deployments of PoS pertains to Peercoin, whose white paper was created in 2012 by Sunny King and Scott Nadal. The duo referred to their coin as a
“Peer-to-peer cryptocurrency design derived from Satoshi Nakamoto’s Bitcoin.”Source: Decred – PPCoin: Peer-to-Peer Cryptocurrency with Proof-of-Stake
In fact, Peercoin used a hybrid consensus mechanism that mixed both PoW and PoS. The former was used to issue the initial supply. As time passed, the PoW’s significance faded, and the network’s security relied on the PoS.
Unlike in PoW, there are no miners in a pure PoS-based system. Thus, there is no specialized hardware and unlimited electricity consumption. Instead of mining, the validation process in a PoS network is called ‘forging.’
But if there is no mining, then there is no reward, right? So what would motivate PoS block validators? Well, if you want to participate in the block creation, you don’t have to spend external resources like hardware or electricity. Instead, you’ll have to put at stake an internal resource – the native cryptocurrency or token. This process is called staking.
Obviously, each PoS blockchain has its own rules that differ from case to case. Nevertheless, in general, if you want to become a validator, your node has to lock up a minimum amount of funds in a digital wallet for staking and not to touch it during the process. Next, you have to agree with other validators on which transactions should be included into the next block. It is like guessing which block will be selected next, and the protocol will automatically pick one.
If your block is selected by the protocol, you’ll get a proportion of the transaction fees paid by users. The amount of the reward is derived from your stake. Thus, the more funds you put at stake, the higher the potential gains. However, if you dare to cheat the system by trying to include invalid transactions, you’ll lose part of your stake or all of it. Thus, the PoS algorithm has the same goal as the PoW – to make honest behavior more profitable than the dishonest one.
In most PoS blockchains, there aren’t any new coins generated for the reward of validators. As a rule, coin supply is issued either fully or gradually through an initial distribution process like an initial coin offering (ICO) or initial exchange offering (IEO). In some cases, a blockchain starts with a PoW consensus algorithm and then switches to PoS. This is the case of Ethereum – the second-largest cryptocurrency out there. Ethereum’s blockchain is planned to go through a series of upgrades as part of ETH 2.0, during which the network will replace the current PoW version with a PoS algorithm.
So far, the PoS has been implemented by smaller cryptocurrencies. Thus, the crypto community still debates over the viability of the PoS as an alternative to PoW.
Proof of Work vs Proof of Stake
While the PoW is associated with Bitcoin and hence dominates the cryptocurrency market, some commentators argue that PoS would be a better choice. The PoS has yet to prove its status as a better alternative, but here are the main differences between the two:
Approach – in a PoW system, the cryptocurrency supply is gradually increasing thanks to miners, who seek to generate new coins as rewards.
PoS doesn’t involve any puzzle as the block validator is selected based on their stake and how many tokens the node owns. In this case, all the coins are created from the beginning and distributed via an ICO or IEO event.
Energy Consumption – PoW consumes a lot of electricity and requires much more computing power. Elsewhere, PoS is energy-efficient as block validators don’t require mining equipment to solve the puzzle. In light of climate change and pollution challenges, PoW networks tend to get more criticism in the media.
Centralization – in PoW, only those who have access to expensive equipment and are ready to spend on electricity can become successful miners. On the other side, PoS blockchains provide a fair solution where the amount of network control is proportional to the amount stakers invest. The more they invest, the more control they have. While both systems are designed to defend decentralization, most blockchains are collectively controlled by institutional groups that can invest either in mining equipment and electricity or in staking.
Security – pure PoS blockchains are relatively new, not that Bitcoin is old enough though. Anyway, this consensus mechanism still has to prove itself resilient enough, and probably Ethereum will do it as soon as it adopts PoS.
The cost of attack of a mature PoW blockchain is much higher than the cost of attack of a mature PoS network. In the first case, the attackers have to buy 51% of the computing power, while in the second case they have to buy the majority of the coins or tokens. However, in reality, it’s difficult to gain total control over any mature PoW or PoS blockchain.
In PoS systems, there is a concern that the initial holders of coins wouldn’t be interested in releasing their coins to secondary markets, as their wealth derives from their balance.
Scalability – PoS algorithms can support far more scalable blockchains that have higher transaction throughput. In fact, scalability is one of the main problems of Bitcoin that led to the proposal of PoS alternatives.
In the long run, PoW is becoming less profitable as the level of difficulty in mining is increasing. Those who don’t have powerful machines like ASICs can end up with zero return on investment. Nevertheless, PoW is well-established and has been used in many trusted cryptocurrency projects.
Other Consensus Algorithms
PoW and PoS are by far the most dominant consensus algorithms used in blockchains. However, given that the industry is still at a nascent stage even after a decade, developers are free to experiment with other forms of mechanisms to find the optimum formula for different use cases. Thus, we’ll conclude the article with several less popular alternatives:
Delegated Proof of Stake (DPoS) – this consensus algorithm is regarded by many as a more democratic and scalable version compared to the pure PoS. Both PoS and DPoS share a similar approach in terms of stakeholding, but DPoS introduced a democratic voting system, which is used to elect block producers. Delegates have the interest in being honest and efficient. Otherwise, they would get voted out.
This mechanism was created by Daniel Larimer in 2014. Larimer used it to develop EOS. Other blockchains that employ DPoS are Cardano, Tezos, and Tron. Generally, DPoS-based blockchains are more rapid and efficient than pure PoS networks.
Proof of Authority (PoA) – PoA is a consensus algorithm that revolves around the reputation of users. It represents an efficient approach for blockchain networks, especially the private or so-called permissioned ones. The term appeared in 2017 and was proposed by Ethereum co-founder Gavin Wood.
Instead of relying on stakes or computing power, the algorithm leverages the value of identities. Thus, PoA blockchains are run by validating nodes that are arbitrarily picked as trustworthy users. Transactions are checked by pre-approved network participants, who act as moderators.
PoA might not be so decentralized, but it is efficient in different use cases, such as supply chains. Microsoft Azure is one of the many examples where the PoA is currently implemented.
Proof of Burn (PoB) – while there are more versions of PoB, the concept proposed by Iain Stewart is the most popular one. The PoB algorithm is promoted as a PoW alternative.
In fact, PoB is very similar to a PoW consensus mechanism but without requiring energy consumption. The process of validating blocks in a PoB-based blockchain doesn’t require computing power, therefore no ASICs or GPUs are needed. Instead, miners intentionally burn cryptocurrencies in an effort to “invest” resources in the network. Thus, candidate miners burn their own coins in virtual mining rigs.
By burning coins, network users can demonstrate their commitment to the ecosystem and get the right to “mine” and become block validators. The more coins you burn for the system, the more virtual mining power you get and thus have higher chances to be selected as the next block validator.
Other consensus algorithms include hybrid PoW/PoS consensus, Delayed Proof of Work (DPoW), and Leased Proof of Stake. Most of the varieties are simply modified versions of either PoW or PoS.