Cryptocurrency Consensus Mechanisms Explained

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  • Consensus mechanisms are a crucial part of a blockchain
  • They are the method that govern the way in which the blockchain is secured and transactions processed
  • There are various consensus mechanisms in the blockchain space, each with their own advantages and drawbacks

A key aspect of cryptocurrency is that each transaction must be verified by a number of independent third-parties that must reach a consensus on before it can be added to the blockchain. The variety of mechanisms these various blockchains use has grown in recent years, to the point where a new one seems to be coming out every month. In this article we break down the most common consensus mechanisms so you can catch up with this ever-expanding field.

Proof-of-Work (PoW)

The original consensus method, as set out in the Bitcoin whitepaper in 2008. This verification method involves miners using computer hardware to compete to verify each block of transactions, with the winner getting rewarded in the blockchain’s native coin for doing so. A strong, well distributed proof-of-work system is the most secure type of consensus mechanism, but it comes at a cost – literally. PoW is highly competetive and now requires at least a six-figure outlay of mining equipment to compete, not to mention the potentially high energy costs. It is also environmentally damaging, which is why it is now vilified by many mainstream media outlets.

Examples: Bitcoin, Monero

Proof-of-Stake (PoS)

Proof-of-stake involves investors ‘staking’ a number of coins in the project’s wallet and leaving the wallet running, which has the effect of helping to confirm transactions on the blockchain. The staker (often referred to as a ‘node’) gets rewarded for their work with payouts in the same coins at regular intervals. The investor can un-stake and sell these coins whenever they like.

Proof-of-Stake is much less energy intensive and requires nothing more than a computing device and an internet connection, but it requires locking up coins and needs the device to be left on 24/7 for maximum benefit. It is also though to be less decentralised than PoW because it is easier for larger entities to control huge percentages of the overall pool, making attacks on the blockchian possible.

Examples: Cardano, Avalanche, Polkadot, Solana, Ethereum (in 2022)

Delegated Proof-of-Stake (DPoS)

Delegated proof-of-stake requires investors to vote on who gets to validate the blocks (a ‘delegate’), with different blockchains having different numbers of delegates to verify transactions. Unlike with PoW and PoS, block creation is a collaborative rather than a competitive act, with production coordinated and timed between the delegates. This partial centralization allows for very quick block creation, while having PoS under the hood means that the blockchain is much more energy efficient than PoW blockchians.

However, purists argue that having such a small number of delegates in charge of confirming transactions leaves the blockchain vulnerable to attack, while delegates themselves can get voted out if they don’t deliver blocks on time, even if the fault is not theirs.

Examples: EOS, BitShares

Directed Acyclic Graphs (DAGs)

Directed Acyclic Graphs have been said for some time to be ‘blockchain killers’, but this not yet come to pass. They are, nevertheless, a definited improvement over the linear method of confirming transactions, although naturally they have their own drawbacks.

They key difference with DAGs is that they handle transactions asynchronously rather than in a linear fashion, meaning a theoretically infinite number of transactions per second. This solves the scaling issue that has plagued PoW blockchains since crytpocurrency grew in popularity in 2017. DAGs are therefore extremely fast and have a huge throughput, and the fact that they operate in a manner similar in basic terms to PoS means that they are environmentally friendly and holders can act as nodes and earn rewards.

However, the big name proponents of DAG systems, like IOTA,  have been criticized by security experts due to systemic flaws in their design. The fact that traditional blockchains are still going strong and newer projects have stayed away from DAGs in favor of PoS systems is telling.

Examples: IOTA, Nano

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There is no right and wrong consensus algorithm, as each has positive and negatives, and each project must decide for itself what fits its long-term goals. Ethereum’s’ switch from PoW to PoS indicates that PoW may be slowly drifting out of favor, but as long as Bitcoin is around it probably won’t be going anywhere soon.