Financial service providers such as Visa or Mastercard do not need a consensus mechanism because they themselves control the entire network. When someone uses their Visa credit card, the information is sent to a central database managed by Visa. All users of a Visa credit card trust that this company will protect all personal sensitive information and process the transactions they order. Since Visa exclusively controls the network, it can reverse and censor transactions. In addition to censorship with the accompanying powerlessness of users in the event of disputes, these centralized databases are also at increased risk from hacking or damage.
With the publication of the Bitcoin Blockchain in 2009, a solution exists for the first time to carry out transactions in a trustworthy, traceable and unchangeable manner in a peer-to-peer network. In such a network, there is no superordinate authority that ensures that all participants comply with the established rules. Meanwhile, there are different consensus mechanisms to ensure agreement among all participants in a decentralized network.
What is a consensus mechanism?
A consensus mechanism is the way in which a group of people, without a higher authority, makes a decision and ensures agreement.
A consensus mechanism is responsible for three main things:
- It ensures that the next block in a blockchain, is the one and only version of the truth.
- It keeps malicious attackers from taking over the system and forking the chain successfully, 51% of the hash power is enough.
- It ensures reliability for the network, which includes multiple nodes and is one of the most important aspects as it ensures the integrity of the data. A main goal of the consensus mechanisms is to prevent users from spending the same coin twice (double spending). If a user could send the same coin to two different wallets, the supply of coins could be infinitely inflated, which would lead to hyperinflation (significant decrease in purchasing power). To avoid double spending, each computer managing the blockchain must have the same information about which wallets hold which values. Therefore, users of the blockchain must constantly update the transaction history to keep all wallet balances up to date.
Currently, there are about three dozen different consensus mechanisms, but none of them is perfect, each consensus mechanism has its own strengths and weaknesses, in the following I will roughly describe the most important ones:
Proof of Work (POW).
is the very first distributed consensus mechanism, it was developed by Bitcoin creator Satoshi Nakamoto, this consensus mechanism has already been described in the topic “Blockchain Function & Disadvantages”.
Proof of Stake (PoS).
Proof of Stake (PoS) is a consensus mechanism that does not require any special mining hardware. All coins are created at the very beginning (premining) and their quantity does not change. This means that there is no block premium in the PoS system, so miners, for example, could charge transaction fees. In PoS, each node is associated with an address and the more coins that address contains, the more likely it is to set the next block. The one who gets to set the next block is determined by chance, but the more coins he has, the greater the chances of doing so.
An attacker wishing to make a fraudulent transaction would need over 50% of all the coins to reliably complete the required transactions, buying these coins would drive up the price and make such an endeavor prohibitively expensive.
Since the PoS system is not as energy intensive as PoW, the cost does not need to be reimbursed in the same way as Bitcoin. Thus, PoS systems are well suited for platforms where there is a static number of coins, without the inflation from block rewards (creation of new coins). Stake rewards consist of transaction fees only.
Delegated Proof of Stake – DPoS
DPoS was developed in 2014 by a guy called Daniel Larimer he was instrumental in the development of cryptocurrencies BitShares, STEEM and EOS.
The principle of DPOS is based on the principle of PoS, with the difference that the work of the stakeholders is outsourced to third parties. So the coin owner can vote for specific delegates to secure this data network on his behalf.
Those delegates can also be called witnesses and they have to take care for a consensus regarding the creation and validation of fresh blocks. Voting rights are in proportion to the amount of tokens each user holds on their address. The voting systems of crypto projects aren’t all exactly the same, but generally each delegate submits an own proposal when she or he asks for votes.
Generally, the rewards which the delegates collect are shared proportionally with those who voted for them. This means that a voting system is created by the DPoS algorithm which depends directly on the reputation of the delegates. If a node behaves badly or doesn’t perform as it should, it is quickly shunned and supplanted by another. When it comes to performance, DPoS blockchains can be seen as far more scalable because they can process a larger amount of transactions at the same time.