Proof of Work (PoW) and Proof of Stake (PoS) are consensus algorithms that help enforce Bitcoin and Ethereum protocols.
- These mechanisms serve to safeguard consistency in the network and validate transactions.
- Bitcoin uses Proof of Work (PoW) as a consensus algorithm.
- Ethereum uses Proof of Stake (PoS) as its consensus algorithm.
Consensus: PoS vs. PoW. Have you heard of Proof of Work (PoW) or Proof of vaStake (PoS)? Well, people know these two concepts as consensus algorithms. They are mechanisms that allow a group of users or machines to coordinate with each other in a decentralized environment. They make it possible for a cryptocurrency network to function and for its members to handle the same information among themselves.
Consensus algorithms allow all the agents of a distributed system to make decisions. They also enforce rules or even accept the integrity of information without going to a centralized entity. Therefore, the consensus algorithm is one of the key concepts to understanding the function of cryptocurrencies and blockchain networks.
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What is a Consensus Algorithm?
To better understand how consensus algorithms work, we must keep two terms in mind: centralization and decentralization. When a single entity (a president, a committee, or an organization) governs a system, all decision-making power falls into its hands. Therefore, making project, company, or network decisions is relatively easy. For example, banks can reverse the transaction or validate it based on the decisions imposed by their director’s board.
However, decision-making becomes more complicated regarding decentralized networks, such as cryptocurrencies like Bitcoin. Since it is a network generated from distributed entities in different parts of the world, creating new forms of governance is necessary. But how can so many people agree on an issue? They need to propose, negotiate, and vote on a set of rules established by a group of people.
At a technical level, people consider consensus algorithms in blockchain networks as rules (protocols) that ensure their operation. Developers write these rules in the network code and the cryptocurrency white paper.
The Consensus is part of the protocol
We also refer to a social agreement when discussing consensus in the cryptocurrency ecosystem. Each blockchain network’s participants respect and support how a platform or cryptocurrency behaves and functions. In this sense, the community’s consensus impacts block size, mining rewards, and transaction validity criteria.
Likewise, some entities within this community are in charge of auditing and verifying compliance with these rules. For example, in the case of Bitcoin, full nodes and miners are in charge of reviewing transactions. They ensure that they all comply with what the protocol stipulates. In the case of Ethereum, on the other hand, validators and full nodes are used to perform this operation.
What’s the function of consensus algorithms?
Knowing what a consensus algorithm means, we can investigate how these mechanisms work in cryptocurrency networks. First, cryptocurrencies such as Bitcoin or ethereum have a blockchain, or distributed ledger, where all the information related to the cryptographic asset is recorded and managed collectively, distributed, and peer-to-peer.
Because the information is decentralized, each entity that manages, stores, and distributes the information on the network needs a protocol to communicate, make decisions and validate transactions simultaneously while remaining on the same network. Here a consensus algorithm is critical. If each network node, miner, or validator fully complies with a set of rules and reports it to each other, everyone will agree about how and what information they handle.
What is a Validator Node?
A node is a computer connected to others, thus forming a network of participants that can share information and follow specific consensus rules. In the case of Bitcoin and Ethereum, these nodes are organized based on the protocol of the networks to which they are connected, increasing the distribution of data and collaborating with the compliance of the consensus algorithm.
Operations that undermine the welfare of the community and the cryptocurrency network are not accepted. Also, every change or update to the network is recorded simultaneously and immediately on the blockchain so that all members handle the same information. As we can see, consensus algorithms seek to connect and maintain consistency within a distributed network.
User transparency
Additionally, by employing consensus mechanisms, network members can verify the recorded information and validate users’ monetary transactions. In other words, it is the mechanism in charge of ensuring that your bitcoins, ethers, or dogecoins are sent from your wallet to a third party’s wallet, verifying that you didn’t spend them twice.
The consensus algorithm avoids double-spending
As consensus algorithms ensure that the entire network is consistent with each other, this protocol makes it impossible for double spending to occur in a cryptocurrency such as Bitcoin and go unnoticed. Each member that enforces the network’s protocol statuses, such as nodes and miners in the case of Bitcoin, is in charge of reviewing and rejecting transactions when they are inconsistent with the information on the blockchain.
Consensus algorithms can also help maintain transparency within a cryptocurrency network. If the rules of the protocol stipulate it, modifying information on a blockchain can be very difficult or nearly impossible without the consent of the majority of members. Consensus Algorithms are the mechanism that makes possible the issuance of coins in a network and the enforcement of its monetary policy.
This element plays an essential role in the security of cryptocurrencies. In some cases, the protocol imposes sanctions on those members who carry out activities detrimental to the network, as with the Ethereum Proof of Stake. While other consensus schemes make it difficult for a single entity in the market to take power over the entire network and modify it to its convenience, as is the case with Proof of Work in Bitcoin.
What is Proof of Work (PoW)?
Proof of Work (PoW) is one of the most well-known consensus algorithms in the ecosystem, as the Bitcoin network uses it. This mechanism was selected by Satoshi Nakamoto for the cryptocurrency, based on Adam Back’s work for the HashCash system.
The PoW aims to incentivize honest behavior from the network participants by requiring them to perform considerable but achievable work (what they usually call a computational puzzle.) Participants receive a monetary reward in exchange for their work on behalf of the cryptocurrency.
Who created Proof of Work?
Professors Cynthia Dwork and Moni Naor first devised 1993 the original concept as a way to prevent email spam. Later, in 1999, Markus Jakobsson and Ari Juells coined the term.
In Bitcoin, Proof of Work is used for block generation and preventing attacks, especially double-spending attacks. In this way, it closely relates to what we know as mining, an activity that generates income for those who practice it and allows the validation of new transactions.
For a block to be recognized by the network – and for there to be the consensus – miners must perform a series of computations that will allow them to come up with a single answer: the block identification to mine. This identification, also known as Block ID, is a randomly generated number using cryptographic primitives, which serves as the key to validate the block and register it on the network.
Computational challenge
To solve this mathematical problem, miners must use the mining difficulty, information such as the timestamp, and even a random number called the nonce. Each block includes a hash pointer to the preceding block, creating a more difficult blockchain. Changing a block (i.e., the transaction information recorded in the chain) would involve performing all the work applied until funding the block you want to change.
The more work the network applies, the more costly it is to change history. But verifying the correct result will be easy once the job finishes. In this way, the activity keeps the network operational, and issuing new coins avoid alterations in the recorded data and keeps all nodes connected with the same information in each of the versions of the blockchain.
What are the advantages and disadvantages of Proof of Work?
One of the most significant advantages of Proof of Work is its security. Some mechanisms, such as mining difficulty – a figure representing the power required to mine a network – update in line with the number of miners connected to the network or the power of their equipment. In this sense, the greater the competition and growth of the mining industry, the more difficult and expensive it is to mine a network like Bitcoin because more and more computing power is needed.
The difficulty is one of the most considerable protections the network can have: there is not enough equipment for an external actor to join in to attack. The attack would have to come from a player with sufficient computing power (hence the importance of network decentralization), such as a mining hardware manufacturer.
However, beyond the fact that the incentives for maintaining honest behavior in the network outweigh the costs of attacking it, Bitcoin’s consensus algorithm also states that the proper chain is the chain that has the most accumulated work and, therefore, nodes could reject an attacker who seeks to modify the history of the chain they keep on record that does not comply with the consensus rules.
Not all networks are as robust as Bitcoin.
However in the case of Bitcoin, attacking the network results in a waste of resources and time. Not all cryptocurrencies that use Proof of Work have this processing power, so it is not as costly to attack them (as has happened before), demonstrating their fragility and low security. Contrary to popular opinion, this is evidence that not all blockchains are equal.
Problems of Proof of Work
As for the disadvantages, the most resounding one is their potential environmental harm, as their highest costs are in electricity consumption. It takes energy from electricity to transform it with work on blockchain security, and the system creates new coins.
Proponents of Proof of Work say that in this electricity and this labor lies the backing of Bitcoin. On the other hand, Proof of Stake proponents claim this is a waste of unnecessary resources. In addition, resources drain as specialized mining equipment becomes obsolete. Unlike PoW, networks also work with GPUs. You cannot use them for anything else once they cease to be efficient for the network.
An exclusive industry
There is also the fact that the existing oligopoly in the manufacture of chips dedicated to mining gives these designers an advantage in the use of these devices, concentrating much of the processing power in their hands.
What is a Proof of Stake (PoS)?
PoS is another of the most well-known consensus mechanisms in the cryptocurrency market, becoming popular in 2020 when there was talk that Ethereum would migrate to this algorithm. The idea was to replace the computational resources to secure the network (the PoW) with a Proof of Coin Holding. The idea is to reduce costs and eliminate the physical point of failure involved in mining equipment. Authorities could confiscate or outlaw these devices. As an example of a PoS blockchain, Cardano uses the Ouroboros PoS algorithm.
Who created the Proof of Stake?
The first Proof of Stake (PoS) consensus algorithm proposal on record on BitcoinTalk is from July 2011, made by a user named QuantumMechanic.
Proof of Stake is related today to the concept of staking. You can describe it as depositing coins into a Smart Contract to generate liabilities or become a validator of a network. And what is a validator? Well, just as Proof of Work networks have miners in charge of processing and validating transactions with specialized equipment, Proof of Stake networks have validators who block your money from doing the same activity. Like miners in Bitcoin, these validators receive rewards for their participation and commissions from users.
The system chooses validators randomly.
While mining is a constant competition to mine the next block, in Proof of Stake networks, the protocol decides the next block’s validation, which randomly chooses who will be the member in charge of proposing transactions and who will validate them.
What are the advantages and disadvantages of Proof of Stake
One of the main advantages of Proof of Participation is that it considerably reduces the costs of keeping a cryptocurrency network operational. Unlike Proof of Work, where there is massive power consumption and expensive equipment, the expenses in these items of the PoS are much more moderate.
Regarding security, although its concept differs from the Proof of Work, which makes the attack very costly, there are ways to penalize a validator that does not behave well. In PoS, “having skin in the game” means committing an investment to the network. The system could penalize you using those deposits against you, as the protocol penalizes you by taking away your entire investment. In theory, this increases the incentives for honest behavior.
The network may fall into the hands of the whales.
Although there are mechanisms in the Proof of Participation to prevent misbehavior, it does not prevent it from losing decentralization. As it is an investment-based consensus mechanism, entities with large amounts of capital can take over network decisions.
Proof of Stake disadvantages
On the downside, the need for more cost and specialized equipment has security implications. While the direct benefit of this is to reduce barriers to entry to participate in network security and drive decentralization, the lack of costs could increase attack intent if there is a sufficient incentive.
When all it takes to participate in the consensus is money, any government or wealthy adversary could acquire enough coins to attack the network or censor transactions. At the same time, because of its scarcity, specialized equipment hinders the possibility of attacks.
Some companies have already developed bridges between algorithms.
While we cannot talk about interoperability between consensus algorithms but between networks, integrations such as RSK’s token bridge could enable communication between networks based on different consensus algorithms and facilitate seamless cross-chain transactions. The token bridge proposal is similar to what RSK already uses to communicate with the Bitcoin blockchain. The token bridge would work with a similar blockchain system but with the Ethereum blockchain, facilitating interoperability between chains. When users transfer tokens to the bridge, the Smart Contract blocks them and mints an equivalent amount of new tokens on the other chain.
As we can see, understanding the concepts of consensus algorithm, proof-of-stake, and proof-of-work is indispensable to knowing how a cryptocurrency works. Other terms such as staking, mining, Bitcoin, and Ethereum can also be essential for your knowledge journey through the cryptocurrency ecosystem.