All blockchains and cryptocurrencies by extension need to maintain accuracy in their records to ensure proper functioning. Unlike banks, blockchain lacks a central authority to keep track of all their records. Rather, in a decentralized network, all pears are equal. Different blocks are broadcast at the same time and the network has to choose the chain to follow. The mechanism that determines the chain to be followed is called consensus.
In this article, we explain what consensus mechanisms in blockchain, and cryptocurrency are. We also discuss how they work and touch on the various types of consensus mechanisms. Understanding these mechanisms is crucial, especially as they play a significant role in influencing the BTC price and the overall stability of the cryptocurrency market.
What is a Consensus Mechanism?
In the blockchain and cryptocurrency world, a consensus mechanism is a kind of automated system that strives to achieve two primary goals:
- Maintain a leaderless and distributed community of network validators that can unanimously and efficiently agree on new and existing data on the blockchain ledger.
- Ensure the network validators adhere to the rules of the protocol and carry out their duties with honesty.
Data validation is the process of verifying new information to ensure its accuracy and validity. This is a vital process in a decentralized monetary system as adding invalid transaction information to the blockchain can undermine the database’s integrity. In the absence of an integral database, nobody would use or trust a blockchain or cryptocurrency.
How Do Consensus Mechanisms Work?
Different blockchains and cryptocurrencies employ different types of consensus mechanisms. However, most of them fundamentally work by requiring validator nodes to make some kind of investment and/or exert some effort before they are authorized to propose and validate new data blocks.
The premise behind this is simple. Theoretically, validators who have invested their finances and money in the network are unlikely to corrupt it as they have something to lose if they do. Simply put, consensus mechanisms are just systems that use incentives (rewards for good conduct) or coercion (threats of punishment) to induce validators to follow the rules.
Types of Consensus Mechanisms?
Here are the two most popular methods used by blockchains to achieve consensus in the cryptocurrency arena:
Proof-of-Work (PoW)
This is the consensus mechanism that Bitcoin and several other cryptocurrencies use. It was initially developed for the prevention of email spam in 1993 before Bitcoin founder Satoshi adopted the concept for use in a decentralized monetary system.
PoW works by requiring validators, also known as miners, to buy, rent, or outsource computing equipment and use it to compete in solving cryptographic puzzles. They do this to earn rewards, a process commonly known as crypto mining. By demanding validators to invest in computing equipment and bear the ongoing operational costs, PoW aims to deter potential malicious actors by making the cost and effort substantial. Additionally, the reward system for block rewards —earnings received from winning the mining competition —ensures that honest participation is adequately incentivized.
Proof-of-Stake (PoS)
Pioneered by Scott Nadal and Sunny King in 2012, proof-of-stake is a relatively new kind of consensus method. Similar to PoW, PoS meets the same primary objectives of a consensus mechanism but in a very distinct manner. To gain entry as a validator on a POS-based blockchain, participants must buy and lock a quantity of the blockchain’s native cryptocurrency in a smart contract. This process is referred to as staking. In essence, a staking smart contract acts as an escrow account, locking up tokens for a certain duration depending on the conditions of each blockchain protocol. The protocol randomly selects validators to propose new blocks inside set time slots. These slots are commonly known as epochs. Stakers can heighten their chances of selection to propose new blocks by using more coins or tokens in staking. It is one of the best and safest ways to earn passive income in crypto.
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