For cryptocurrency, we need consensus algorithms: steps for successful transactions, based on an agreement that exchanges have validity.
Introduction to Consensus Algorithms
Banks remove funds from one account to send them to another. Decentralized currencies need to move from one wallet to another. With the blockchain, there’s a public ledger, transparently proving authenticity of each and every transaction.
Consensus algorithms secure transactions, stopping anyone from copying currency when transferring it. Before Bitcoin, the copying or “double-spending” problem plagued efforts to create digital currency.
All cryptocurrencies use consensus algorithms. Now several of them, a decade after Bitcoin’s debut, are proven contenders.
The Original: Proof of Work
Proof of Work is the basis of Bitcoin, Bitcoin Cash, Ethereum (originally), Litecoin, Monero, Dash and several other leaders. Proof of Work accepts that work establishes value.
For Proof of Work, miners solve intricate mathematical puzzles. Their hard-won solutions are easily verified by the network as correct. For solving each block in the chain, miners receive rewards in Bitcoin. The system works. Bitcoin is secure to this day because of it, but it takes some serious energy to run the miners’ computers.
Big miners operate where electricity is cheapest, edging out smaller operators. And the whole process is slow. Thus the decision to integrate traits of a newer mechanism, Proof of Stake, into Ethereum. That blend became the Casper Protocol.
From Miner to Minter: Proof of Stake
The Proof of Stake algorithm involves people staking their coins to bet on which blocks of transactions are authentic. Stakers are called minters. In general, the more they stake, the better their chances of solving blocks of transactions to earn newly minted coins.
The premise? Those with a stake in a network have a vested interest in its integrity.
Minting guzzles less energy than mining, but here’s the rub: people need to step forward to stake coins or consensus can’t happen and the whole system could stall. Betting one this block or the other can also cause the currency to fork, disrupting investors.
Speed Racer: Delegated Proof of Stake
Cardano as well as Bitshares, Steem and EOS use Delegated Proof of Stake. It’s cost-efficient, low-energy and scalable. It has elected delegates (typically less than 100) who validate the blocks. Should they allow invalid transactions, the stakers can vote them out—and get rewarded for voting.
The delegation model means fewer people are needed for a consensus. So it’s a fast system, capable of validating multiple blocks in less than a second. The tradeoff? Fewer deciders can mean weaker security.
And those with the most currency have greater voting power than the others.
Blockchain Buster: Directed Acyclic Graphs
DAG is supremely scalable and cost-effective. IOTA may be the best known DAG cryptocurrency, though NXT was first to implement it.
Running transactions on various chains at once, DAG reaches consensus without the blockchain. New transactions validate the prior ones.
IOTA’s Tangle uses this when a person validates two prior transactions to add a new transaction to the Tangle.
The Generals and the Castle Ahead
Here’s the puzzle: various Byzantine generals want to raid a castle. They’re scattered around the periphery but must simultaneously attack to succeed. If they get their signals crossed, they have to come together on a quick strategy to avert system failure.
Their situation is invoked by decentralized networks hoping to confirm good transactions while eliminating bad ones.
In the Federated Byzantine Agreement, employed by Stellar and Ripple, each “general” sorts messages to validate a specific chain. Ripple selects its own verifiers, whereas Stellar’s users may select theirs. Inexpensive, super quick and highly scalable, this mechanism is one to watch.
All of these consensus mechanisms and more are building the future of cryptocurrency.
Indeed, the prevailing method of consensus might well be the basis of the worldwide web to come.
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