Every cryptocurrency has a consensus mechanism, eliminating the need for a centralized middleman.
Bitcoin or Ethereum, for example, are self-governing financial systems. No single company or person controls the main server or database. Instead, thousands of computers across the globe participate in the network to track, manage, and validate each transaction.
It’s a “trustless” system that requires the consensus of all connected computers in the network. Every transaction is recorded in an immutable public ledger so that everyone is on the same page. All participants should then agree that a certain transaction is valid or true before being executed.
Currently, three main consensus mechanism models are being used by cryptocurrencies and digital assets:
- Proof-of-Work
- Proof-of-Stake
- Proof-of-Authority
What is Proof-of-Work (PoW)?
Launched in the Bitcoin network in 2009, the Proof-of-Work model was designed to solve the "double-spend" problem. Once an amount is spent on a transaction, it cannot be spent again on another because the blockchain algorithm won't allow it. Basically, the PoW consensus prevents “duplicate” coins from being spent by keeping a log of all transactions with the help of computers.
A blockchain stores all the information permanently and safely. Before a block is added to the chain, each participating computer (miner) competes to solve the block's cryptographic puzzle. The computer that solves the puzzle first will be rewarded with crypto plus the block's transaction fees, hence the term mining. Every time a block is added to the chain, the public ledger gets updated.
The PoW is extremely secure. Manipulating transactions entails hacking all the computers connected to the network simultaneously. Furthermore, the mining difficulty also adjusts as more miners join or leave the network.
What is Proof-of-Stake (PoS)?
The idea of Proof-of-Stake was first proposed as an alternative to PoW during a Bitcoin Talk forum in 2011. Basically, the validator should stake or lockin a certain amount of cryptocurrency in the blockchain before it can earn the right to validate transactions.
The more coins a validator stakes, the more chances it gets to process transactions and add a block to the chain. The minimum amount of coins needed and the length of time it should be staked can vary depending on the cryptocurrency. The selection process for the validator node is randomized by the algorithm. Therefore, no matter how much a validator stake, it's not always guaranteed to get more chances at all times.
If a validator tries to break the blockchain rules, the staked crypto will be burned. This is called slashing, which serves as a punishment for validators trying to commit fraudulent activities.
What is Proof-of-Authority (PoA)?
Proposed in 2017 by Polkadot founder Gavin Wood, Proof-of-Authority (PoA) is known to have a faster transaction processing time. Unlike traditional consensus mechanisms, the PoA model is reputation-based. Instead of taking coins from participating validators, reputations and identities are staked to earn the right to validate transactions. It is considered more efficient and practical for private institutions, especially for logistical purposes.
The PoA model doesn’t require expensive equipment to maintain the network. It doesn't require computing power and initial capital. Instead, it requires institutional or individual identity to connect in the network to produce blocks on the blockchain.
The validating nodes are randomly selected based on their trustworthiness. A limited number of trustworthy entities serve as pre-approved validators and moderators of the system. Since the nodes’ identities are public, they cannot act maliciously because their reputation could be ruined. In severe cases, they could even end up in court for violating the network’s rules.
Pros and Cons: PoW vs. PoS vs. PoA
Security and Efficiency
Proof-of-Work
Compared to other consensus mechanisms, PoW is considered the most secure. It's extremely difficult to hack all the computers attached to the network simultaneously. Plus, there's no single computer known to have enough computing power to manipulate a PoW’s blockchain.
On the other hand, one of the major drawbacks of the PoW model is its speed in processing transactions. Most of PoW’s computing power goes to solving cryptographic puzzles, which sacrifices the time for processing transactions.
Proof-of-Stake
Compared to PoW, the Proof-of-Stake model is relatively more efficient. It doesn't require computing power from specialized computers. Therefore, it is considerably faster for validator nodes to process transactions.
Manipulating or controlling the blockchain requires billions of dollars in crypto. A validator should possess at least 51% of the total coins in the network to successfully manipulate blocks or transactions. However, staked coins of malicious validators can be easily slashed by the protocol, making such an attack unprofitable.
Proof-of-Authority
The PoA is considered more efficient and practical for private institutions. Since there's no computing power or staking involved, validating transactions is much faster. Plus, an entity should stake its reputation and identity to join the network, which reduces the risks of fraudulent activities.
On the other hand, the PoA model could potentially attract third-party manipulation. Since validators' identities are known, they could be influenced by the people outside the system, compromising the network's security.
Reward System and Profitability
Proof-of-Work
Specialized computers called Application-Specific Integrated Circuits (ASIC) are invented to perform PoW computations. ASICs are expensive computers that many ordinary investors won’t be able to afford.
Proof-of-Stake
Investors under the PoS model can easily earn rewards through staking. Many exchanges offer staking as another means to earn money from holding crypto. However, there’s a minimum amount of crypto before an investor can stake his holdings.
Proof-of-Authority
Since no coins are being staked or mined, validators can't earn rewards from the network. On the other hand, the nodes can be incentivized with their association with the crypto project. An entity’s participation in a PoA network could garner confidence and trust from investors, especially when other trusted companies are associated with the network.
The Risk of Centralization and Monopoly
Proof-of-Work
Manipulating a PoW model is extremely difficult to coordinate. Attempting to monopolize the network would entail accumulating at least 51% of the total miners attached to the system. With miners distributed across the globe, attacking a PoW model remains in the domain of science fiction.
Proof-of-Stake
As for the PoS model, it’s easier for mining pools to accumulate more crypto for staking. This gives them more chances of earning validating rights. Larger operations can abuse this, especially since some of the most popular crypto exchanges today offer staking services. Therefore, the PoS model is exposed to some degree of centralization.
Proof-of-Authority
The primary problem with the PoA model is centralization. Nodes need to prove their identity to a central authority to join the network as a validator. Therefore, the lack of immutability, the need for permission, and censorship tendencies are some of the major concerns with the PoA model.
Upgrades and Governance for Consensus Mechanisms
Proof-of-Work
In its purest form, the PoW model is hard to govern or change. To change crypto under a PoW model, the economic majority should agree first, which includes the developers, miners, and holders. In this case, the majority means 95% of all miners, developers, and holders in the network.
Proof-of-Stake
The PoS model is easier to upgrade and govern. Depending on the cryptocurrency, validators can sometimes democratically vote on the upgrades and changes they want for the system. It could be a lower staking requirement or a longer lockup period.
Proof-of-Authority
Governance is one of the flagship features of a PoA model. This is reasonable because companies and businesses utilize the system to facilitate some of their operational needs, especially for logistical purposes. With a limited number of participants, it’s easier to reach a consensus when upgrading the network.
Energy and Environmental Issues
Proof-of-Work
The primary problem with the PoW model is that it uses a lot of energy. The heat it generates is also a major concern for the environment. Older models of computers also need to be disposed of when newer ones are released.
Proof-of-Stake
Compared to the PoW model, Proof-of-Stake is relatively cheaper and more environmentally friendly. Participating in the network requires minimal energy, capital, and hardware. However, it still requires computers and servers to validate transactions.
Proof-of-Authority
Energy and environmental issues are non-existent when it comes to a PoA model. It doesn't rely on special hardware and computing power to operate. Plus, it is run by a limited number of validators, which further cuts the energy required to run the network.
Conclusion
Before investing in a cryptocurrency, it's crucial to DYOR first. Do your own research! Try to understand how crypto works, including its consensus mechanism, tokenomics, and use cases.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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