Consensus Algorithm in Blockchain: What It Is and How It Works

In cryptocurrencies, the consensus algorithm ensures that the system is reliable, secure and resistant to attack. Different cryptocurrencies run on different algorithms, depending on the purpose and architecture of the network. Among the most popular are Proof of Work (PoW) and Proof of Stake (PoS). It is important to know the specifics of how different types of algorithms work, including new ones, in order to be knowledgeable about the fundamental aspects of cryptocurrencies.

What is a consensus algorithm?

A consensus algorithm is a set of rules and mechanisms that allows the nodes of a blockchain network to come to a unified decision about which transactions should be recorded on the blockchain. Unlike centralized systems where decisions are made by a single authority, in decentralized networks, consensus is achieved through the collective participation of multiple nodes.

Role in blockchain technologies

The consensus algorithm performs several key functions:

Ensuring data consistency - all nodes in the network must have the same and consistent version of the blockchain.

Protecting against attacks - preventing malicious actions such as block spoofing or double spending.

Decentralization - managing the network without a central authority.

Fault tolerance - network operation in the presence of unreachable or malicious nodes.

Efficiency and scalability - the ability to process transactions in a timely manner and incorporate new nodes into the network.

Without an effective consensus algorithm, blockchain would not be able to perform its core functions because there would be no mechanism for trusted data validation.

Why consensus algorithms are important for cryptocurrencies

Cryptocurrencies are decentralized systems that lack a central controlling authority. They require a mechanism that is endowed with multiple functions to ensure their operation.

1. Guaranteeing data integrity

• In traditional financial systems, transactions are verified by central authorities (banks, government agencies).

• In cryptocurrencies, network nodes that reach consensus on the overall state of the blockchain are responsible for verifying and validating transactions.

• Consensus algorithms prevent changes to already confirmed blocks and ensure data immutability.

2. Protection against Double Spending

• Double Spending is an attempt to use a single cryptocurrency multiple times.

• Without consensus, an attacker could copy a digital coin and reuse it.

• For example, in (PoW), a new block only becomes part of the chain after solving a complex problem, and in (PoS), nodes conduct transaction confirmation based on coin ownership.

3. Decentralization and independence from centralized authorities

• Compared to banking systems, cryptocurrencies operate without a central regulator.

• Algorithms allow network nodes to trust each other without intermediaries, ensuring transparency and independence from centralized entities.

4. Ensuring network security

Without an effective consensus algorithm, the blockchain could be vulnerable to attacks such as:

• 51% attack - if an attacker gains control of a majority of the processing power (PoW) or coin share (PoS), they could rewrite transactions.

• Sybil attack - creating multiple fake nodes to manipulate the network.

Robust consensus algorithms prevent such threats by ensuring the resilience of the network.

5. Maintaining decentralized consensus without trust

• In traditional systems, trust between participants is enforced by legal contracts or intermediaries.

• In blockchain, cryptography and consensus algorithms replace trust by guaranteeing that rules are followed.

• Each node can verify that the blockchain is honest without having to take someone's word for it.

Consensus algorithms allow network participants to trust each other without the need for intermediaries, making cryptocurrencies independent and secure.

The main types of consensus algorithms

There are several types of algorithms available today, but only two of them are widely used.

What is Proof of Work (PoW)?

Proof of Work is an algorithm for reaching agreement in a network where participants (miners) solve complex mathematical problems in order to verify transactions and include new blocks in the blockchain. This procedure involves the use of substantial computational resources and is characterized by high energy consumption.

Advantages of PoW:

• High level of security.

• Proven resistance to various types of attacks.

Disadvantages of PoW:

• High power consumption.

• Centralization of mining due to increased computing power.

What is Proof of Stake (PoS)?

Proof of Stake is an algorithmic approach where the chance of forming a new block is determined by the amount of cryptocurrency in the possession of the node (validator). Unlike Proof of Work, this method does not need large computational resources, which leads to a significant reduction in energy consumption.

Advantages of PoS:

• Efficiency in energy consumption.

• Higher transaction speed.

Disadvantages of PoS:

• Possible centralization at large coin holders.

• Risks of a “rich node” attack.

Bitcoin consensus algorithm

Bitcoin employs an algorithm called Proof of Work (PoW), which plays a key role in decentralized transaction verification and protecting the network from potential threats. As part of this algorithm, miners are engaged in solving complex cryptographic problems, which allows them to confirm transactions and add new blocks to the blockchain.

Features of Proof of Work in Bitcoin

• To create a new block, complex calculations (SHA-256 hashing) must be performed.

• The miner who solves a certain task first will be rewarded with some amount of bitcoins.

• The difficulty level of mining varies automatically in order to maintain a stable time to create a single block (about 10 minutes).

Why Bitcoin uses PoW

PoW was chosen for Bitcoin for several reasons:

• High security and protection from attacks.

• Reliability and stability of the network.

• No need to trust individual participants in the network.

Distributed consensus in cryptocurrencies

Distributed consensus is a mechanism that allows multiple nodes (nodes) in a decentralized network to agree on a single state of data, even if they are in different parts of the world and do not trust each other.

In the context of cryptocurrencies, this means that:

• All nodes on the blockchain agree on which version of the registry (blockchain) is the correct one.

• Every transaction is validated and cannot be canceled or changed.

• No one can “draw” extra coins for themselves or spend the same coin twice....

How distributed consensus works in cryptocurrencies:

1. A user sends a transaction

• For example, Alice sends 1 BTC to Bob.

2. The transaction is distributed across the network

• Nodes receive information about it, verify Alice's digital signature and balance.

3. The transaction is included in the block

• Extractors (in the case of Proof of Work) or validators (in Proof of Stake) do transaction collection and create a new block.

4. Consensus determines which block is added to the chain

• The nodes in the network agree that the new block conforms to the rules.

5. Adding a block to the blockchain

• The transaction is now considered confirmed and Bob can use his 1 BTC.

The future of consensus algorithms

Before talking about the future, it is important to understand the current challenges of existing solutions.

The main challenges of current consensus algorithms are:

• Scalability - blockchains using Proof of Work (PoW) and Proof of Stake (PoS) have limited bandwidth (e.g. Bitcoin processes about 7 transactions per second, Ethereum - 30).

• Energy consumption - PoW requires significant power and energy costs.

• Centralization - in PoS and DPoS, large coin holders or validators can control the network.

• Security - 51% attacks, block finality attacks and economic manipulation are possible.

• Flexibility - classical algorithms do not adapt well to new technologies such as sharding, zk-rollups and Layer 2 solutions.

Emerging trends and promising consensus algorithms:

1. Hybrid algorithms (PoW + PoS)

Hybrid mechanisms are emerging to address the problems of PoW (high energy intensity) and PoS (threat of centralization).

A prime example of this mechanics is Ethereum 2.0, which moved to PoS to improve scalability and reduce energy consumption. Other projects such as Decred (PoW+PoS) and Kadena (Chainweb + PoW) use combinations of different approaches to balance security and efficiency.

2. Proof of Space and Time (PoST) - Proof of Space and Time

Used in Chia Network. Computational power, as in PoW, is replaced by free space on hard disks. This algorithm is more environmentally friendly, but has a risk of centralization due to the accumulation of large amounts of disk space by individual participants.

3. Proof of Burn (PoB) - Proof of Burn

To validate transactions, participants burn (send to an inaccessible wallet) a portion of their coins. This mechanism reduces inflation, but is rarely used due to economic risks. It is used in Slimcoin and some test projects.

4. Proof of Activity (PoA) - Proof of Activity

Combines PoW and PoS. First, miners solve a math problem, and then validators (coin holders) confirm the blocks. This approach increases defense against attacks and reduces energy costs.

5. Proof of Stake with enhanced decentralization (Liquid PoS, NPoS, VRF)

• Liquid PoS (Tezos) - An enhanced version of DPoS in which delegation is more flexible and transparent.

• Nominated PoS (Polkadot, Kusama) - Allows nominees to choose validators, which reduces the risk of centralization.

• VRF (Randomized PoS, Algorand) - Uses randomness to select validators, which increases security and decentralization.

6. Proof of Reputation (PoR) - Proof of reputation

Nodes with good reputation get more chances to validate blocks. This mechanism is used in enterprise blockchains and private networks.

7. Proof of Participation (PoP) - Proof of Participation

Active participants in the network who support nodes, vote or provide liquidity are rewarded. This mechanism is used in some decentralized autonomous organizations (DAOs) and next-generation blockchains.

The impact of new algorithms on the future of blockchain and cryptocurrencies:

• Scalability and fast transactions

Innovative algorithms will reduce network load and speed up transaction processing. Already Solana, Near and Algorand have demonstrated speeds of up to 100,000 transactions per second.

• Green and sustainable

Moving from PoW to more energy-efficient models (PoS, PoST, PoA) will significantly reduce power consumption.

• Increased decentralization

The use of random validator selection (VRF) and enhanced delegation (NPoS) will reduce centralization and increase fairness in the distribution of authority.

• Automation and integration with artificial intelligence and IoT

Consensus algorithms can integrate with artificial intelligence for optimal resource allocation. IoT devices will be able to apply consensus with minimal computational cost, providing new opportunities for smart contracts and decentralized systems.

• New consensus mechanisms for Web3 and meta-universe

     - Decentralized Proof-of-Presence - an algorithm that confirms a user's physical presence in the meta-universe.

     - Proof of Contribution - a system that rewards users who actively participate in blockchain development (e.g., by creating content).

Conclusion

Cryptocurrency consensus algorithms are the backbone of cryptocurrencies and blockchain technology. Despite current limitations, the development of new consensus mechanisms holds promise for improving the efficiency and adapting the blockchain to new challenges.

FAQ

1. What is a consensus algorithm and why is it important for cryptocurrencies?

A consensus algorithm is a mechanism that allows nodes in a network to agree on the state of the blockchain. It ensures security, data validity, and prevents fraud.

2. What are the main types of consensus algorithms and how do they differ?

There are several key types of consensus mechanisms, among which Proof of Work (PoW) and Proof of Stake (PoS) stand out. While PoW relies on the need for significant computational resources to verify transactions, PoS, on the other hand, relies on participants having a certain amount of coins.

3. Why does Bitcoin use the Proof of Work (PoW) algorithm and what are its features?

Bitcoin uses PoW to provide a high level of security. Its features include the need to solve complex problems, rewards for block creation, and automatic complexity adjustments.

4. How is distributed consensus achieved in cryptocurrencies?

Distributed consensus is achieved by verifying and validating transactions using algorithms such as PoW or PoS without the involvement of a central authority.

5. What are the future prospects for consensus algorithms?

The future of consensus algorithms is based on finding more energy efficient, secure and scalable solutions such as PoS, PoA and hybrid models.