Understanding the cryptocurrency world is no easy feat. Especially because cryptocurrency is built on a new type of technology that not many people understand known as a blockchain. Blockchains use something known as a consensus method to function.
A consensus method is a program that is used in computers and blockchain technology for multiple machines to be able to come to an agreement. There are many different types of consensus methods available, and they all function differently from one another.
Consensus methods are an important part of facilitating transactions and record keeping in the cryptocurrency world. Keep reading if you want to learn more about consensus methods, from how they operate to which ones are the best if you want to engage in the world of decentralized finance.
Proof of Work
The most well-known consensus method is one known as proof of work. Proof of work is consensus method in which computers, called nodes, check that other computers in the blockchain have solved complex math problems known as work. If enough nodes find that there is sufficient work, and they all agree with one another, then a consensus has been reached and the transaction will be executed. All transactions that are carried out are recorded on a ledger that all nodes have access to.
Proof of work is most famous because it is used in Bitcoin to process transactions. And in the case of Bitcoin, people are exposed to the first major flaw of the proof of work consensus method, and that is that it takes time for a consensus to be reached. Additionally the computing power needed to produce the consensus method is quite high, and it only grows as the ledger for Bitcoin transactions grows. This means that Bitcoin transactions are costing more energy as time goes on. This makes it difficult to scale blockchains that use a proof of work consensus mechanism.
Proof of Stake
The second most popular consensus method is something called proof of stake. And in proof of stake, rather than checking work produced by a node, the computers check how many coins that node has in the system—also known as checking the node’s stake in the system. If the nodes find that the node has enough coins staked, the transaction will be processed. And the more coins a node has, the more transactions they will be allowed to process.
This consensus mechanism was built to solve many of the problems with the proof of work method. And because anyone who owns enough coins can stake, there is no need to have miners, and thus this saves on computational power. Additionally, checking for proof of stake is much faster than checking for proof of work, and thus transactions on proof of stake blockchains are processed much faster than their proof of work counter parts.
Ethereum is the most famous blockchain that uses the proof of stake consensus mechanism, but they haven’t always. Ethereum used to also be based on a proof of work system, but as the blockchain has grown, the creators have decided to change to proof of stake in order to avoid the scalability problems experienced by blockchains that rely on the proof of work consensus method. Ethereum isn’t the only blockchain that though this was a good idea and as a result, many blockchains are now built on this consensus method. The problem with proof of stake is because nodes can process transactions when they have more coins, this encourages people to hold coins rather than spend them, causing a hoarding problem. It also makes it difficult for someone without a significant amount of coins to begin processing transactions.
Proof of Activity
Proof of activity is a lesser-known consensus method that is effectively a combination of proof of work and proof of stake. This consensus mechanism starts out the same as proof of work, with miners needing to solve complex mathematical problems in order to process transactions. But once a transaction is processed, instead of adding the entire ledger to the new block, it is just labeled with the miner’s address. This block is then validated by other nodes that are selected based on how many coins they have. This lowers the amount of computing power needed to run the system while keeping the best parts of both consensus mechanisms. Decred or DCR is a blockchain that uses the proof of activity consensus mechanism
The problem with proof of activity is that it still keeps some of the problems from both of the blockchains that it brings together. Although it uses less computing power, it still requires a lot to run. And even though stake only matters in validating a block, it still doesn’t discourage the nodes from hoarding coins in order to be chosen to validate.
Proof of Authority
Proof of authority is a newer consensus method, and it is basically an improvement on the proof of stake consensus method. Rather than selecting nodes to validate transactions based on their stake in the system, it selects from a collection of nodes that have been given the authority to validate transactions. This makes the computational power needed to run the system very low, and doesn’t encourage people to hoard coins.
The problem is, this system isn’t decentralized at all. Rather the nodes allowed to mine are given authority by whoever owns the blockchain, and there should never be more than 25 nodes given the authority to validate transactions in any proof of authority network. This means you could have as few as 5 nodes validating transactions on a network, and if all 5 were owned by one person, this means one person controls the blockchain entirely. VeChain is currently one project that uses the proof of authority consensus method.
Proof of Burn
Like proof of stake, proof of burn was created to try and address and remedy the large amount of computational power that proof of work requires. In a proof of burn system, a miner must send coins to an address in order to be able to process transactions. The power of these burnt coins also decays over time, meaning that miners have to continue to burn coins in order to continue to mine the cryptocurrency. This keeps people from hoarding the coin, and makes it easier for new miners to enter the system. Slimcoin is a cryptocurrency that uses the proof of burn consensus method.
There’s no doubt about it, the consensus method a blockchain uses makes a huge difference in implementation, adaption, and customer use of said blockchain. And even if you don’t think any of these consensus mechanisms sound like they can support widespread adaptation, new consensus methods are being made all the time. This means that someday, there will be a consensus method that is equal, decentralized, doesn’t take too much power, and doesn’t encourage coin hoarding, but for now all you can do is wait and use a blockchain that has one of the above consensus methods.