A Consensus Mechanism is a protocol that facilitates agreement among all nodes within a distributed blockchain network regarding a unified data set. These mechanisms serve as the criteria for validating and approving each transaction on the blockchain. ^[1][2]

Overview

A consensus mechanism is used in blockchains to maintain distributed agreement about the state of a ledge. Consensus mechanisms are generally implemented in blockchain networks with many users and processes. They serve as benefits for cryptocurrencies and blockchains because they replace slower human verifiers and auditing. ^[3]

A consensus is achieved on the Ethereum blockchain when at least 66% of the nodes in the network are in agreement with the overall state of the network. ^[1] Ethereum employs a proof-of-stake-based consensus mechanism, which derives its crypto-economic security from a system of rewards and penalties associated with the capital staked by participants. This incentive framework promotes honest validation by individual stakers, penalizes those who act dishonestly, and imposes a significant cost on attempts to compromise the network's integrity.^[1] Bitcoin on the other hand uses a Proof-of-Work (PoW) mechanism. This mechanism requires computational power to solve an encrypted puzzle (or hash). ^[3]

Types of Consensus Mechanisms

Blockchain platforms have continually refined and adapted consensus protocols in their quest for the ideal balance between decentralization, scalability, and security. As a result, a collection of methodologies has emerged to support Web3 applications. Here are the four most frequently encountered consensus practices:

Proof of Work (PoW)

This method involves miners solving complex mathematical puzzles to validate transactions and add blocks to the blockchain. It's known for its robust security but is energy-intensive and less scalable. The network remains secure due to the requirement of having 51% of the network's computational power to compromise the blockchain. Achieving this would necessitate substantial investments in equipment and energy, potentially resulting in costs outweighing potential gains.^[1][4][5]

Proof of Work (PoW) is used by Bitcoin and Dogecoin for their BTC and DOGE cryptocurrencies. ^[8]

Pros: PoW is one of the most decentralized and secure verification mechanisms, known for its high reliability. In the case of Bitcoin, a substantial block validation reward has incentivized active participation on the platform.^[5]

Cons: The downsides of PoW consensus mechanism includes slower transaction rates, costly gas fees, expensive operational expenses, and environmentally harmful energy consumption encapsulate the inefficiencies associated with a proof-of-work system. Bitcoin's average block time, which signifies the time required to process a transaction, is 10 minutes, and the energy consumption involved is considerable.^[4][5]

Proof of Stake (PoS)

In Proof of Stake, validators are chosen to create new blocks based on the amount of cryptocurrency they hold and are willing to "stake" as collateral. PoS is more energy-efficient compared to PoW but requires participants to have a stake in the network. Hence, the responsibility of maintaining the public ledger is based on the number of crypto assets held. ^[3][6][7]

Pros: Regarded as the preferred consensus method in Web3 for enhancing scalability. It is known for its energy efficiency and cost-effectiveness, particularly concerning gas fees and equipment requirements.^[5]

Cons: Falls short in terms of decentralization and security compared to proof of work. Delegation of power is based on wallet size.^[5][6]

Delegated Proof of Stake (DPoS)

DPoS introduces a voting system where token holders select a small group of delegates to validate transactions. Consequently, validation privileges are selectively assigned and periodically reassigned to a select group of top-tier candidates. Any validator can potentially be replaced by someone deemed more trustworthy at any given time. This approach enhances scalability and speed but relies on a smaller number of trusted validators. Projects that use DPoS include BitShares, TRON, Steem, Lisk, Ark and EOS. ^[5][9][10]

Pros: This system is characterized by its efficiency and democratic nature. It enhances the original proof-of-stake method by being more financially inclusive to users and provides incentives for validators to maintain accountability in sustaining the network. DPoS is reputation-based, fast, scalable, and requires minimal hardware compared to the original proof of stake. ^[5][10]

Cons: Notable downsides of DPoS includes lack of decentralization, engagement requirement, and possibly malicious token holders. ^[10]

Proof of Authority

The PoA consensus process confers authority upon a select group of blockchain participants to validate network transactions and make updates to its widely dispersed ledger. The algorithms operate in a straightforward manner, with designated parties taking turns as the mining leader, responsible for generating new blocks upon which distributed consensus is achieved. PoA is adopted by VeChain, Ethereum Kovan Testnet, JP Morgan (JPMCoin), and Xodex. ^[11]

Pros: PoA mechanism is highly scalable and does not require computing power. ^[5]

Cons: Validators on projects with Proof of Authority (PoA) lose their pseudo-anonymity since public identifiability is an integral part of their role.^[5]