Cryptocurrency consensus mechanisms

Cryptocurrency consensus mechanisms

There are currently two mainstream consensus mechanisms used by cryptocurrencies: proof of work and proof of stake. These are used by the most popular cryptocurrencies in the world today, but there are several others you should know about.

Cryptocurrency technology is currently a very rich field for research and development, both in industry and academic circles. Many different consensus systems exist and several others are being actively researched.

Here we present a short summary of several consensus mechanisms.

Game Theory

All consensus mechanisms work based on the same game theoretic idea: it must be more expensive to defraud the system than the potential rewards obtained via the legal block rewards system (mining, staking and so forth).

How, exactly, this is achieved is what differentiates each type of consensus mechanism.

In all cases, participants must present some proof of value.

Whether it’s proof of high energy consumption or of ownership of a stash of coins – participants must offer the P2P network a proof of their capacity to generate valid blocks.

To use current terminology, miners and stakeholders must be able to prove they have skin in the game. Fraud attempts must always cost a higher price than the potential reward.

Let’s start with the original Bitcoin consensus mechanism: Proof of Work. Also known as Nakamoto consensus.

Proof of Work (PoW)

PoW uses a brute force approach where miners compete to find block hashes beginning with a certain number of zeroes.

The more zeroes, the more difficult it is to find such hashes.

The PoW Game

In essence, PoW makes it very expensive to defraud the system by requiring expensive hardware and high electrical consumption during the mining process.

While one Bitcoin block yields approximately U$ 100k in rewards at the time of the writing (June 2018, with Bitcoin priced U$ 7800) it would currently cost around U$ 350k in electrical energy alone to attempt to defraud a single block.

Not only is the energy cost extremely high, there is a high probability that this attack would not succeed.

Therefore attempting to hack a Bitcoin block would very likely not yield any profit for potential scammers.

By some estimates, the total cost of a Bitcoin hack attempt could pass the U$ 1 million mark. All this for just 10 minutes of a chance to hack Bitcoin.

This game theoretic condition lies at the root of the Bitcoin blockchain integrity.

Environmental Concerns

All the computational power used in Proof of Work schemes is spent solely to prove that you attempted an average number of hashes before finding the block.

The work is not actually useful at all, which attracts some criticism towards this kind of system, especially at a time when renewable energy and environmental conservation are being debated all around the world.

Proof of Work’s Legacy

Most cryptocurrencies currently use Proof of Work since they inherited the fact that Bitcoin is the first and most popular cryptocurrency, having introduced the innovative consensus mechanism in 2008.

All first generation cryptocurrencies were forked from Bitcoin.

Either they forked the source code completely, then changed the cryptographic hashing function, or simply forked the existing blockchain and created their own version of Bitcoin (e.g. BCH, BSV, BTG among others).

For instance, Litecoin and Dogecoin forked the original Satoshi Nakamoto source tree and changed Bitcoin’s SHA256 hashing function to scrypt, a heavier system that attempted to make it too expensive to mine these two coins using ASIC’s. (A failed attempt as we now know, since Bitmain sells scrypt ASIC-based mining machines.)

Proof of Stake (PoS)

In a Proof of Stake system, participants stake a certain amount of cryptocurrency in order to have a chance at being chosen to solve a block.

PoS rules vary among cryptocurrencies.

Most staking systems work like a lottery, where the amount of staked coins determines the odds of being chosen to solve a block. The more coins you have staked, the higher the odds of being chosen and thus a higher potential reward. The amount of coins staked is, therefore, akin to spending on mining equipment for PoW systems. While in PoS the more expensive equipment usually produces more blocks, in PoS the high cost comes from having to accumulate and lock a high amount of coins in order to be a candidate in the staking system.

PoS is considered a much more eco-friendly mechanism than PoW since it does not involve high energy consumption.

Examples of Proof of Stake coins include Tezos STZ, Decred DCR, Cardano ADA, Dash, NEO, PIVX, OkCash, NavCoin, Stratis and others.

Sybil Attacks Against PoS

PoS systems can be vulnerable to the so called sybil attacks.

In this kind of attack a single party artificially generates a high number of network participants which appear to vote for the attacker, thus defrauding the lottery system which chooses the next block leader.

The usual defense against sybil attacks is to charge a minimum price for users to join the staking system.

For example, Tezos currently requires a minimum of 8000 STZ (U$ 24,000 at the time of this writing) in order to allow a user to be a candidate for block solving. The high cost involved in becoming a Tezos miner thus makes it intractable to create a high number of nodes required for a sybil attack.

PoS and Staking Rewards

PoS coins provide an incentive for investors to hold the coin for the long term. This incentive comes in the form of periodic staking rewards.

In order to generate passive income from staking, investors must lock their coins in the staking system for a certain period.

Decred, for example, requires a minimum of 24 and a maximum of 142 days before coins are chosen to mine a block. Decred stakeholders are thus likely to hold the coin for a minimum of 24 days. This is a very attractive feature for investors because it tends to make the coin more scarce and therefore more valuable on exchanges.

Staking rewards are usually paid in cycles. These can have many different names.

Cardano ADA, for example, calls them epochs. Tezos calls them cycles and Decred works block by block.

Proof of Stake Velocity (PoSV)

As the name implies, Proof of Stake Velocity is a variation on traditional PoS.

It was developed for the Reddcoin project, which abandoned Proof of Work in favor of the more energy efficient PoS (with slight variations).

PoSV changes the way PoS works by giving incentives for users to keep their wallets online and to move the coins and stake often instead of hoarding and leaving the coins inert for long periods.

To achieve this PoSV users a non-linear function to compute coin age.

In the first 7 days age is computed quickly. After that, a logarithmic function reduces the coin age computation until time no longer plays a significant part in rewards.

This is an incentive for users to move the coins or stake more, thus promoting more velocity and liquidity.

The analogy stems from the concept of velocity of money, which is a measure of the liquidity of a currency and how much of it is transacted daily.

Proof of Location (PoL)

In a Proof of Location consensus algorithm, users’ geospatial coordinates are accounted for as proof of value.

This kind of algorithm is usually employed in cryptocurrency geomining systems.

In a geomining application, users earn rewards for being at a certain place at a certain time. If, for example, a company wished to gather participants for a promotion, at a specific physical store or shopping mall, they could launch a geomining task to reward participants who attended the event.

The idea is that proving that you are at a certain location, at a certain time, using a trusted location tracking device, can signal value to some cryptocurrency networks.

The Geon project, for example, uses Geomining to reward users who get close to a Geon, which is a virtual beacon that rewards Geon Coins to participants who get close enough to a specified geographic location.

Obtaining trusted and correct geographic locations to be transmitted to a smart contract can be achieved by hardware, using secure tracking devices, or by software containing some fraud detection capability (like Pokemon Go and other location-dependent games).

The XYO project uses a “Sentinel Device” to track users’ geographic location. The device notifies an oracle that the user has been present at a certain location at a certain time. If a beacon has been configured at that location, the smart contract will detect this and reward the user.

Geomining is decentralized.

Smart contracts are launched by interested parties and users simply need to attend geographic locations in order to interact with the smart contract. There is no need for users to meet or trust each other in a geomining operation.

Proof of Authority (PoA)

Proof of Authority is a consensus mechanism where members of a cryptocurrency network are identified and receive delegated powers to solve blocks. If they defraud the system their identity is at stake and they will either be prosecuted or booted from the network.

This is a centralized system where a higher authority delegates mining powers to trusted parties. This system cannot work among anonymous parties and requires identification and trust in a group of people.

PoA is also more environmentally friendly than PoW as it does not use large amounts of energy during its operation.

POA Network uses PoA implemented in the Ethereum blockchain.

Proof of Space (PoSpace)

Proof of Space uses hard disk space as the value used to guarantee a participant’s stake in mining.

By allocating disk space, the network participant provides value to the network, which uses this space to solve computational problems.

Given low network bandwidth for a lot of regions, making it difficult to transfer large amounts of data to allocated hard drive space quickly, and considering the relatively inexpensive hard drive space, this system is not currently used on many mainstream cryptocurrencies.

BurstCoin uses the Proof of Space consensus algorithm.

Proof of Trust (PoT)

In a Proof of Trust system, users in a network gain trust as they participate in special activities within the network.

If a user tries to defraud the system, the trust is lost and they lose an equivalent amount in value (the cryptocurrency or token employed).

In a Proof of Trust system, “trust” is staked instead of tokens or coins.

Some Proof of Trust systems, such as COTI, combine Proof of Work and trust staking as a hybrid system of consensus.

Conclusion

Here we covered not only the two mainstream consensus mechanisms but other more exotic ones as well.

We keep this article updated by including new mechanisms when we find them.

The commercial and academic communities are working nonstop on developing more secure and energy-efficient consensus mechanisms. This is currently one of the most exciting areas of research in computer science.

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