In centralized systems, an administrator manages the database and decides what files to store and how to update them. The administrator can delegate this power to others. With decentralized public ledgers, or blockchains, however, no administrators exist. Independent nodes in peer-to-peer networks must come to a consensus on the status of the ledger.
The question Satoshi Nakamoto grappled with when designing Bitcoin—the first blockchain—was how a peer-to-peer network could agree on the status of the public ledger continually and in real-time without stalling the cryptocurrency. He found the answer in “mining”.
Mining is when the nodes in the network participate in a form of lottery where they compete to solve a cryptographic puzzle. The winner gets the right to update the public ledger for ten minutes, subject to protocol rules.
Since the launch of Bitcoin, other cryptocurrencies have come into existence. While they maintain the concept of mining as the facilitator of consensus in their peer-to-peer network, the protocols they use differ in one way or another from that of Bitcoin.
The following are the common consensus protocols in the crypto space and how they work:
Proof of Work
Proof of work (PoW) is the consensus mechanism used by Bitcoin. As the name suggests, the mechanism requires nodes to prove they have done work to receive the right to add new transactions to the blockchain. The work is energy intensive, as it involves the nodes hashing data through high-performance, application-specific integrated circuit (ASIC) chips.
In the competition to solve cryptographic puzzles, those with most efficient hardware have the upper hand. Bitcoin has gone from mining using CPUs on desktops to using ASICs in specially designed mining rigs. The high cost of electricity and the initial capital needed to acquire the appropriate mining hardware makes blockchain networks that use PoW, such as Bitcoin, difficult to join.
Aside from Bitcoin, other blockchain networks that use PoW include Ethereum, Ethereum Classic and Litecoin.
Proof of Stake
With Bitcoin’s high cost of mining, blockchain developers sought cheaper alternatives that didn’t require burning high amounts of energy. The first of these alternatives is proof of stake (PoS), which allocates the level of responsibility in maintaining the public ledger to a node according to the number of coins it holds. The more coins a node holds, the more chances it has of being picked to update the ledger.
Since POS requires neither burning of energy nor specialized hardware, it is one of the cheapest blockchain consensus protocols. It is also one of the most inclusive, as all coins holders in a network stand a chance to participate in the mining process.
Blockchain networks that use proof of stake include Peercoin, Nem and Dash. Ethereum is also planning to move its protocol from proof of work to proof of stake when it adopts its Casper system.
Proof of Capacity
With the proof-of-capacity (PoC) consensus mechanism, instead of using computing power or stake in coins, blockchains have the option to let nodes in the network use their available hard drive space. This mining protocol is useful especially in networks that facilitate the sharing of memory space. The more hard drive space a node has, the more say it has in the maintenance of the ledger.
Proof of Burn
Value from one cryptocurrency can be transferred to another through the proof-of-burn protocol. This means that a node participates in a lottery to decide the status of the blockchain by burning value they already hold in the form of another cryptocurrency such as bitcoin or ether.
To find the next block, the node sends bitcoin, ether or any other cryptocurrency to an unspendable address. In exchange, the node receives a reward in the currency native to the blockchain it helps to maintain.
The first blockchain to successful apply the proof-of-burn protocol for mining was Slimcoin. Its network combines proof of burn with proof of work and proof of stake, making it the first cryptocurrency to combine three protocols.
Finally, the Tangle protocol is one by which a user has their transaction confirmed by the network if and when they help confirm two other user transactions that came before theirs. It is therefore different from the other protocols in that no single node helps maintain the entire ledger at any given time. Each node helps add or edit two transactions at a time.
It also differs with other protocols in that miners receive no reward for helping confirm transactions on the ledger unless their own transaction is confirmed on the ledger.
The first blockchain to use this protocol is IOTA. They seek to solve the problem other blockchains face when facilitating micropayments, which can incur fees that at times exceed their value.
Rupert Hackett is the co-founder of Bitcoin Australia, and has a wealth of experience with Bitcoin and Cryptocurrencies, including the world’s first Masters in Digital Currencies. He bought his first bitcoin in 2011, and in 2014 immersed himself in the crypto world with Bitcoin Australia and angel investor fund Dominet led by Domenic Carosa.
Quote: “I really think Bitcoin could change the world.”