Hey Binancians, thanks for checking out the latest installment in our Education 101 Series. If you missed our previous articles, check them all out here in Your Guide to Crypto Literacy.
In our last article, we talked about how cryptoeconomics helps us design better tools for coordinating people who participate in decentralized networks. Today we are talking consensus algorithms and if you can find more great content on consensus algorithms in Binance Academy!
Consensus algorithms play a vital role in that coordination by governing who can operate the nodes that validate transactions in a decentralized network.
Many have heard of proof-of-work and proof-of-stake consensus algorithms but their purpose and the many variations being designed to power the decentralized networks of the future aren’t as recognized.
Whether you’re looking to learn more about the proof-of-work consensus algorithm that powers Bitcoin, the proof-of-stake algorithms being designed for the decentralized networks of the future, or the ordering systems of permissioned ledgers, this article’s got you covered!
First described as a technique for combatting junk mail by Cynthia Dwork and Moni Naor in a 1992 journal article “Pricing via Processing or Combatting Junk Mail,” the term “proof-of-work” was first used by Markus Jakobsson and Ari Juels in a paper on "Proofs of Work and Bread Pudding Protocols" published in 1999.
As the title of the first article suggests, proof-of-work acts as an anti-spam mechanism and helps prevent problems like denial-of-service attacks. Its reliability has helped it become the most common type of consensus algorithm used in successful cryptocurrencies like Bitcoin.
How Proof-of-Work Works
The reason it’s called “proof-of-work” is because achieving consensus requires node operators, referred to as “miners,” to contribute work in the form of computer processing power.
Miners create “mining rigs” specially designed to supply the network with processing power and maximize the operator’s chances of winning the right to validate a block and earn the associated rewards.
The random selection of miners means a miner could run their hardware for months or even years before successfully mining a block, so many miners team up in “mining pools” that share profits and help miners earn a more consistent income.
When a miner adds a block to the blockchain, they take a group of transactions, validate them, and broadcast the new block to other nodes, which verify the work done by the first block and update their version of the chain.
When selecting which transactions to add, miners typically try to as many transactions as the network will allow them to mine and select whatever transactions come with the highest transaction fee to maximize the reward they receive for mining the block.
Variations on Proof-of-Work
Computer scientist Hal Finney, long considered a potential candidate behind the Satoshi Nakamoto pseudonym, developed a system called reusable proof of work that provides a framework for minting tokens by trading them for assets created using proof-of-work.
Another take on reusable proof-of-work has been described in a paper outlining “proof-of-bid” as an energy-efficient alternative to proof-of-work but neither protocol has seen much use in the real world.
One variation on proof-of-work that has been implemented is delayed proof-of-work, which uses the Bitcoin blockchain to create a backup of data written to the Komodo blockchain.
Despite its success, one common criticism of proof-of-work is the amount of energy used in the process. Proof-of-stake is an effort to overcome that hurdle by designing a system that enables participants to validate transactions by “staking” digital assets instead of computing power.
Proof-of-stake has become commonly associated with Ethereum due to the longstanding efforts of many core developers to transition Ethereum to a proof-of-stake consensus algorithm but the idea of a proof-of-stake consensus algorithm has been publicly discussed since 2011.
Variations on Proof-of-Stake
One of the main issues with proof-of-stake algorithms is how to decide which node gets to validate the next block while preventing rich cartels from dominating the network.
Simply picking a random node to validate transactions encourages collusion between rich cartels who can keep the lion’s share of the rewards distributed for securing the network and distribute it amongst themselves.
Attempts to solve this problem tend to fall into two categories: hybrid systems that use both proof-of-work and proof-of-stake and delegated proof-of-stake, which allows those who stake their assets to vote on who gets to validate transactions.
Peercoin creators Sunny King and Scott Nadal introduced a novel, hybridized consensus algorithm using proof-of-work and proof-of-stake back in 2012 that considers the age of the digital assets staked by an individual when selecting who gets to validate the next block.
Decred also relies on a hybrid system, sometimes referred to as proof-of-activity, where miners create blocks while stakeholders “stake” assets to validate the blocks, with the block reward being split between PoW miners, PoS miners, and the Decred Treasury.
Decred, DASH, and PIVX are all hybridized consensus algorithms that use masternodes to secure their networks. Also used in many DPoS algorithms, masternodes are the nodes elected to actually validate transactions.
Delegated proof-of-stake (DPoS)
Developed as an energy-efficient alternative to proof-of-work consensus, DPoS allows node operators to stake their assets to vote for delegates vying for the right to validate transactions and help secure the network.
DPoS has been implemented in networks like EOS and Steem but its vulnerability to collusion attacks has often come back to haunt it, as demonstrated most recently by TRON’s takeover of the Steemit network.
Most of the distributed ledger technology developed for use in enterprise relies on permissioned rather than permissionless consensus algorithms.
Unlike permissionless blockchains that allow anyone with the right tools and know-how to operate a node, permissioned ledgers have rules about who can and can’t operate a node.
Where the consensus algorithms of permissionless blockchains are designed to achieve probabilistic consensus between nodes, permissioned blockchains rely on ordering services to ensure transactions can be submitted and validated efficiently.
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Follow along as we add to our Binance.US Education 101 Series: Your Guide to Crypto Literacy
#1 Demystifying Digital Dollars
#2 Evolution of the Internet
#3 Finance, Rhymes with …
#4 Back that Asset Class Up
#5 What are Cryptocurrencies?
#6 Defining Decentralized Finance
#7 Cryptoeconomics Explained
#8 Intro to Consensus Algorithms
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