4. Consensus Methods

In our previous example we used the analogy of a network of banks to represent participants in a blockchain network. In the blockchain ecosystem, these banks are analogous to ‘nodes‘, which function as the bookkeepers of the network. Each node runs the software that powers the network, and participates in the maintenance of the distributed ledger.

Each individual node updates its ledger on a regular basis and cross references each update with every other node on the network, working in a similar manner to the way the banks in our example share ledger information. The ’blocks‘on this network are represented in our example as the pages in each bank’s ledger.

The complicated mathematical equation used by the banks in our example to prevent tampering is called ’hashing‘ in the blockchain environment. In reality this process is far more complex and far harder to reverse engineer, but ultimately operates in the same manner.

Ledger - updated network

Blockchain node operators are incentivized into running nodes for the same reason a banker may want to operate a bank. In return for assisting with the maintenance of the network, node operators are provided with a small fee for each transaction processed.

All blockchains must agree on the current state of the ledger by reaching consensus, but there are many different consensus methods present in the blockchain ecosystem.


3 Most Common Consensus Methods

Proof of Work

The most frequently used consensus method at this point in time is ‘Proof of Work‘. This consensus method is used by Bitcoin, and is thus the first method to be established. Proof of Work, or PoW, can be likened to the mathematical equation that must be solved to encrypt each page in the bank ledgers from our previous example.

The purpose of this complex equation is to ensure that each participating node exerts a significant amount of energy in order to solve it. In Proof of Work consensus, these equations are extremely difficult, and thus require vast amounts of processing power and electricity.

Each node in a Proof of Work blockchain can be considered to be ’racing‘ the other nodes to find the correct answer to this equation, which will then finish the ’page‘, or block. The node that announces the correct answer first is provided with a ’block reward‘, which commonly comes in the form of the blockchain’s cryptocurrency.

The process of solving these blocks is called ’mining‘. Nodes that choose to mine in Proof of Work blockchain networks are called ’miners‘. In order to ensure the answers provided are correct and are in accordance with the current state of the ledger, miners who announce different answers to those working on the same block are rejected.

As mining requires a relatively large amount of electricity, miners do not want their solution to be rejected, and are thus incentivized to contribute correct answers, assisting with the maintenance of the ledger.

A Proof of Work system is virtually immune to tampering unless a miner or a group of miners dedicated to disrupting the network control more than 51% of the total processing power dedicated towards it. Even if a group did control a majority of nodes it would be extremely difficult to tamper with past transactions and functionally impossible to alter transactions beyond a few blocks.

Processing power is extremely important when mining Proof of Work networks. As a general rule the more processing power a miner is able to dedicate to mining, the more likely it is that they’ll be able to solve the block first and thus receive the block reward.  Many miners choose to pool their resources together into a ’mining pool‘ that spreads the block reward for solved blocks across all members.

The complexity of blocks in a Proof of Work network can be adjusted to regulate ’block difficulty‘. If blocks in a Proof of Work network are taking too long to solve, the block difficulty can be reduced. If blocks are solved too fast, difficulty can be increased. Changing block difficulty determines how often a new ’page‘ is created in the ledger, a process referred to as ’block timing‘.

Some examples of Proof of Work blockchain networks include Bitcoin, Litecoin, and Bitcoin Cash.

Proof of Stake

Proof of Stake is a consensus method that doesn’t involve mining at all. Instead of relying on the incentivization of miners to ensure all network participants are dedicated towards maintaining the integrity of the ledger, Proof of Stake networks must hold an amount of equity in the network, referred to as ’Stake’.

In a Proof of Stake network, nodes are selected to process transactions without needing to solve any complex equations. Other nodes in the network are selected to verify the integrity of the block that’s solved. To prevent participants from attempting to tamper with the network, nodes must lock up, or ’stake‘ an amount of cryptocurrency that is forfeited if any irregularities are detected.

This method ensures that individuals operating Proof of Stake nodes are financially invested in the network and are thus committed to operating with integrity. The more currency a node stakes in this kind of blockchain network, the more likely it is that it will be selected to create the next block and thus claim transaction fees.

Proof of Stake systems typically boast faster transaction confirmation times and more transactions per second than Proof of Work systems. Notable Proof of Stake blockchains include NXT and Peercoin. Ethereum, the second largest cryptocurrency by market cap, is also planning on shifting from Proof of Work to Proof of Stake in the near future.

Proof of Importance

Proof of Importance operates in a similar manner to Proof of Stake consensus in that nodes are required to stake crypto in order to participate. Instead of simply selecting the node to create the next block based on stake size, however, Proof of Importance networks select nodes based on their ’importance score’.

This score is calculated not only on the amount of cryptocurrency staked in the network, but also on how much the node uses the network and how often they contribute. Nodes that help to facilitate the most transactions are ranked with high important scores.

This consensus method encourages the use of cryptocurrency on the blockchain as a currency as opposed to a means of storing value, and is highly scalable. NEM is a good example of a Proof of Importance blockchain.

PART 5: Applications of blockchain technology»

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