Network + Ledger + Cryptography + Consensus = Blockchain

A public permissionless blockchain consists of a decentralized network of computers which collectively maintain a distributed ledger – like a big spreadsheet where everyone keeps an updated copy. Participating nodes do the work of validating and adding new lines to the ledger – these are called “blocks.” Transactions are secured using cryptography. Participants are rewarded for the work they do with a network token – since these tokens are like money, and because they depend on cryptography, we call them “cryptocurrency.” To keep everything running smoothly, blockchains need a way to decide who gets to update the spreadsheet next—and who earns the rewards for doing so. This decision-making process is called a consensus mechanism.

Although all blockchains have these elements, they are not all the same. Networks have different sizes, shapes, and levels of decentralization. The ledgers can have different designs and parameters. The approach to cryptography may vary. There is no single right approach to consensus.

In order to be an educated participant in the blockchain space, it’s good to understand a little bit about each of these things, so that you can understand how different blockchains work, and which ones you would like to participate in. If you are involved with a blockchain project, you should know that its approach to network building, ledger design, cryptography, and consensus could someday be changed or updated. If you are involved in governance, you might even be called on to vote yes or no on a given change!

Today let’s talk about different types consensus

What is Consensus?

At its core, consensus is just a fancy way of saying “agreement.” In blockchains, it’s the process that helps the network agree on two things:

• Who gets to do the work (validate transactions and add new blocks).
• That the work is valid (no cheating or errors).

Without some form of consensus, there would be chaos and no way of agreeing on the way forward. A good consensus mechanism supports network security and incentivizes desirable behaviors.

In centralized systems, consensus (or “agreement”) isn’t really necessary. The boss can just say “This is what we are doing next, and who is doing it”. A good boss might work to build consensus, but it’s technically optional. However, in a decentralized system, a mechanism to fairly distribute the work is needed.

Every consensus mechanism has pros and cons. There might not be a single perfect answer, but understanding the options helps us when we are exploring future possibilities!

Proof of Work

Bitcoin was the world’s first public, permissionless blockchain, and is famous for its use of the Proof of Work consensus mechanism. What you may not know is that the idea for this type of consensus was 15 years old before Bitcoin was born, but it was still a revolutionary first in the way it used it.

POW works by having network nodes compete to solve cryptographic puzzles. The first computer to solve the problem gets to mint the next block and earn bitcoin rewards. There is an element of luck in who solves the problem – like a lottery. But you are more likely to get the right answer faster if you use more computing power. So getting bigger, faster computer nodes is like buying more lottery tickets.

The advantage of Proof of Work is that it is highly secure, and in Bitcoin we see its proven track record.

The big downside is that it is so energy intensive – such that many people believe it is environmentally unsustainable. The high energy demands can also lead to centralization, when a decreasing number of network nodes can afford to invest in the ever-increasing demands for bigger, faster, equipment and energy supplies.

Proof of Work is most famously used by Bitcoin. It is also used by Litecoin, and was used by Ethereum before its “The Merge” upgrade. (Remember – consensus mechanisms can change!)

Proof of Stake

Proof of Stake blockchains select validators based on the amount of currency they hold. These holdings may be direct (as in, the network node operator has a lot of network currency) or indirect (as in, other network users have “delegated” their stake to a given node). Node operators and stake delegators all earn rewards, proportional to their stake. There is still an element of luck involved – otherwise, the top staked node would get ALL the work! But in this case, controlling more stake is like having more lottery tickets. Even within this single consensus idea, there is variation in how it is implemented. Some chains require delegators to “lock” their stake – meaning users don’t have immediate access to their own money. Cardano uses “liquid” staking, such that delegators can always spend or move their staked currency at any time.

Compared to Proof of Work, Proof of Stake is very energy efficient. A well-designed PoS system incentivizes strong decentralization, and it is considered very secure.

Cardano is famously proud of its Proof of Stake consensus. It’s also used by Polkadot, and now by Ethereum too after they switched from PoW.

However PoS is not a silver bullet. The biggest might be that it creates effective plutocracy: influence and control of the system is directly proportional to wealth. Along the same lines, it’s a system where “the rich get richer.” Staked currency earns rewards proportional to amount. While someone with 100K currency staked might earn an additional 5k per year in totally passive income via staking, someone with only 1K currency staked will only earn enough passive income in the year to buy a round of sandwiches for their family.

Is that it?

Is blockchain doomed to choose between melting the planet or crowning the wealthy as its eternal rulers? Friends, we are just getting started. PoW and PoS are the most well-known consensus mechanisms, used by most of the chains in the top-10 on your crypto-tracking app. But there’s more: next week we will explore EIGHT MORE consensus mechanisms that are in use in blockchain today. We will also start to develop our sense that it’s not a question either/or. Different forms of consensus can be combined in ways that the network gets the advantages of both! (or is it the disadvantages of both?) Knowing about them can help you make informed decisions about your participation with different chains, both today and in the future!