A consensus mechanism is a system that cryptocurrencies like Bitcoin and Ethereum use to validate the authenticity of transactions and maintain the security of the underlying blockchain. This system ensures that all legitimate transactions are recorded on the blockchain and that each copy of the blockchain contains all valid transactions.
If you’re interested in how Bitcoin and other cryptocurrencies work, you must understand the role of consensus mechanisms. Here’s a closer look at what they are in more detail, how they work, and how consensus mechanisms lead to a secure, trusted blockchain experience for all participants.
Definition and Examples of Consensus Mechanisms
Every cryptocurrency blockchain operates using a consensus mechanism. It is a system that users of a blockchain network follow to agree on the legitimacy of transactions. Once a transaction has been validated, it is recorded on the blockchain.
- Alternate names: Consensus protocols, consensus algorithms
For example, if you buy one bitcoin and transfer it to your cryptocurrency wallet, everyone else must agree that you own the bitcoin. If they didn’t, your currency would be worthless. The first consensus mechanism was Bitcoin’s “proof-of-work” (PoW) method. It required approval by the network (in the form of a unique hash) for each new block added to the chain with each transaction. This validated new transactions and ensured agreement on past transactions.
Each cryptocurrency blockchain may use its own unique consensus mechanism or one copied from an existing blockchain.
The consensus mechanism is extremely important to the blockchain network. It influences how transactions are verified, how much energy is used, network fees, transaction speed, and other details for the currency and network applications.
How Consensus Mechanisms Work
The computers that validate new transactions on most blockchains are called miners. In a proof-of-work protocol, these miners compete against each other to validate the next block of transactions. The winning miner earns a lucrative mining fee, paid for by those who send transactions on the network.
The consensus mechanism ensures all miners agree on the next block of transactions and distributes the information in each new block to all other miners. Anyone can download a copy of the blockchain to their device as a node. Every copy of the ledger matches exactly. The consensus mechanism ensures the continued agreement on which wallet owns which assets.
Types of Consensus Mechanisms
While proof-of-work powers the two largest cryptocurrencies—Bitcoin and Ethereum— it’s not the only way to run a cryptocurrency network. The most important of the types of consensus mechanisms used today fall into a few main types:
- Proof-of-Work: With proof-of-work, miners compete against each other to validate the next transaction block and earn a reward. This is a highly energy-intensive consensus mechanism but brings a high degree of trust.
- Proof-of-Stake: Proof-of-stake (PoS) is a consensus mechanism wherein those with the largest holding of the network’s currency validate new blocks. This enables faster and lower-cost transactions. It rewards those with the biggest stake in the network for continued participation.
- Proof-of-Authority: Proof-of-authority is not as common but has a unique form. It is used mainly by private companies or organizations that use blocks created by vetted sources who have special permissions to access the network. Assurances are based on reputation and authority rather than public consensus as with other mechanisms.
- Delegated Proof-of-Stake: Delegated proof-of-stake is a variation of PoS in which users who stake their coins can vote on the number of delegates to create new blocks.
- Proof-of-Capacity: Proof-of-capacity currencies rely on a computer’s available hard drive storage space for a decentralized block verification and generation process.
- Proof-of-Activity: The proof-of-activity consensus mechanism is a hybrid of proof-of-stake and proof-of-work in which the miner seeks to utilize the best of both systems.
- Proof-of-Elapsed Time: Proof-of-elapsed time uses a random timer that operates independently at every node to randomly assign the block verification to a miner.
- Proof-of-Burn: With proof-of-burn, consensus is driven by miners periodically burning coins, a process of permanently deleting or eliminating that specific coin from circulation. This validates new transactions while preventing inflation.
If you invest in a cryptocurrency, it’s a good idea to know the type of consensus mechanism used and how it works.
Ethereum is moving away from proof-of-work and migrating toward a proof-of-stake consensus mechanism.
Pros and Cons of Consensus Mechanisms
- Forms agreement foundational to the crypto-market
- Creates a secure environment
- Anyone can participate
- May be energy-intensive
- Potential for attacks
- Forms agreement foundational to the crypto-market: Consensus mechanisms synchronize data between all participating users and enable trust in a blockchain.
- Creates a secure environment: Cryptocurrencies and distributed applications rely on consensus mechanisms for security.
- Anyone can participate: With the most popular consensus mechanisms, barriers to participating as a miner or operating their own nodes are not very high.
- May be energy-intensive: Proof-of-work is extremely energy-intensive and requires as much electricity as many countries.
- Potential for attacks: There’s a small chance for a type of hack called a 51% attack, among other minor weaknesses.
What They Mean for Individual Investors
Understanding how your cryptocurrency works behind the scenes is critical, as different mechanisms lead to different costs and transaction times—and could influence long-term usability and currency valuations.
If you invest in Bitcoin or any other cryptocurrency, it’s worthwhile to take a little time to read about how it works. If you trust the consensus mechanism, you may be able to trust the currency. If you don’t, you’re better off investing your money elsewhere.
If you’re interested in mining or running your own node, it definitely would be worth your while to understand the consensus mechanism the blockchain operates on. This will determine the investment you need to make to start mining, whether you have a shot at successfully mining, and the rewards you may get.
- Consensus mechanisms are the protocols, algorithms, or other computer systems that allow cryptocurrencies to work. They are systems of agreement that determine the validity of transactions and governance of the blockchain.
- There are different types of consensus mechanisms with various benefits and drawbacks.
- A consensus mechanism enables trust and security in a blockchain network.