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Blockchain Consensus Algorithms: Different Types and How They Work

By Brian Nibley · December 21, 2021 · 5 minute read

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Blockchain Consensus Algorithms: Different Types and How They Work

What Are Blockchain Consensus Algorithms?

A crypto consensus mechanism forms the foundation of any blockchain. In 2009, Satoshi Nakamoto invented Bitcoin’s proof-of-work consensus algorithm to secure the Bitcoin network. Since then, several alternative consensus algorithms have been proposed.

The basic idea of achieving consensus on a blockchain is to create a way that everyone can agree that certain transactions are valid. That way, no one can cheat the system by creating fake transactions with money they don’t have, and the same funds can’t be sent twice.

Part of the reason Bitcoin was such a transformative technological innovation is that the proof-of-work method of achieving crypto consensus was the first-ever practical solution to the “double spend problem.”

With previous versions of electronic currency, one of the biggest hurdles programmers struggled to overcome was how to create a scarce digital asset that people couldn’t replicate and that couldn’t be spent more than once without everyone knowing.

Thanks in no small part to consensus algorithms, cryptocurrencies and the blockchain technology that powers them have overcome this problem.

Recommended: Crypto 101: What is Cryptocurrency?

What Is a Consensus Mechanism?

In a system run by one central authority (say, a bank), preventing double spending is simple. One entity manages the ledger of transactions, making sure everything runs smoothly. If Alice wants to give a dollar to Bob, the central manager subtracts a dollar from Alice’s account and adds that dollar to Bob’s account. Payment rails like banks and PayPal use this type of consensus mechanism.

With cryptocurrencies, however, there is no single entity in charge of the system, because it is a decentralized network by design. That makes keeping a record of the ledger of transactions — or, establishing a consensus mechanism — more difficult.

Recommended: What Is Distributed Ledger Technology (DLT)?

Consider Bitcoin, as an example. Instead of a single central server, many thousands of people around the globe run the Bitcoin software. The servers they run are called “nodes.” The nodes must somehow come to the same conclusion regarding what transactions have occurred on the network, or to “achieve consensus.” All the nodes need to be on the same page for the network to function.

How Does a Consensus Algorithm Work?

The way a crypto consensus mechanism works varies depending on the algorithm. But all have the same end goal: to achieve consensus on the network. This requires all nodes to agree on which transactions are valid and which are not. Consensus must be maintained from block to block in an orderly and secure fashion if things are to continue running smoothly.

Many of the potential cyberattacks that target blockchains involve disrupting the process of new block generation in some way. For this reason, it’s important that crypto consensus be achieved in a way that makes it difficult for bad actors to intervene.

Types of Consensus Algorithms

There have been many attempts to improve upon proof-of-work (PoW) algorithms. Proof of stake (PoS) might be the most popular of these, as many of the top cryptocurrencies by market cap today are PoS coins. Other crypto consensus methods like proof of burn or proof of capacity are less well-known and haven’t been tried as much.

Proof of Work

While there are now many different consensus algorithms, proof of work is still the most commonly used. To date, this method has shown itself to be reliable and secure.

Miners are the people who run computers that maintain the network by solving complex mathematical problems. The miner that first solves the problem gets to add the next block of transactions to the blockchain and also earns the new coins minted along with that block (the block reward). This is the process by which a verifiable history of transactions on the blockchain gets created.

PoW has shown to be a strong and secure method of achieving consensus. It would require so much computational power to overtake a large PoW network that any would-be hackers would be incentivized to become honest participants in the network instead. In other words, it’s easier and more rewarding to just mine for coins than it is to make any attempts at attacking the network.

Some of the downsides of PoW are that the process takes a lot of energy, it may not scale well, and it can trend toward centralization due to the high costs of new equipment — not everyone will be able to afford to mine. The main benefit of PoW is that it has the longest track record and has proven to be the most secure consensus algorithm. To date, there has never been a successful attempt at disrupting Bitcoin’s block production.

Proof of Stake

Proof of stake is a popular consensus mechanism that can be used by blockchains to verify their transaction history. While miners in PoW networks perform energy-intensive work to mine blocks, validators in PoS commit stakes of tokens to validate blocks.

With PoS, validators take the place of miners. They verify transactions by staking crypto on the network, which involves locking up a certain amount of coins for a set period of time, during which the coins will be unusable. Validators have a chance at being randomly selected to find the next block.

Other validators then “attest” that they also believe the block to be valid. Once enough validators have attested to a block’s validity, the block is then added to the chain. All validators involved in the process receive part of the block reward.

One of the big differences between PoS and PoW is that PoW requires miners to expend energy in the form of electricity to find blocks. PoS requires validators to stake their crypto, or in other words, to deposit money. For this reason, proof of stake is praised for being a less energy-intensive consensus mechanism than proof of work.

On the other hand, a disadvantage of PoS is that it favors the wealthiest token holders (who can stake more tokens) and trends toward centralization.

Proof of Burn

Proof-of-burn (PoB) algorithms employ the process of “burning” tokens to achieve crypto consensus. Burning coins involves sending them to an address from which they can never be recovered. Once sent to a burn address, coins are lost forever.

On a PoB network, people mine crypto by burning coins. The more coins burnt, the greater the reward.

An advantage of PoB is that it takes very little energy. A disadvantage is the question of how supply and demand will play out on such a blockchain. Burning existing coins to receive a reward of new coins seems counterintuitive. A delicate balance would have to be maintained for the system to work long-term.

What is the Bitcoin Consensus?

Bitcoin uses the proof-of-work consensus mechanism. Miners must contribute computing power and electricity to mine what remains of the 21 million bitcoins. Bitcoin mining involves processing transactions for the network, work for which miners are compensated with newly minted coins (the block reward). As of December 2021, each block rewards miners with a total of 6.25 BTC.

What is the Ethereum Consensus?

The Ethereum network also uses proof of work, although developers have been planning a move to proof of stake for some time. This change seems to be delayed each time it approaches, so there’s no telling when exactly it might happen.

The Takeaway

Consensus needs to be reached for a crypto network to know which transactions are valid. Otherwise, anyone could spend the same funds twice or make fake transactions using funds they don’t own.

While there are a number of other ways of achieving consensus, proof of work and proof of stake are the most well-known and widely used for now.

Interested in investing in crypto? With SoFi Invest®, you can trade cryptocurrency from a selection of more than two dozen coins including Bitcoin, Chainlink, Ethereum, Dogecoin, Solana, Litecoin, Cardano, and Enjin Coin.

Find out how to get started with SoFi Invest.

Photo credit: iStock/Eoneren


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