January 17, 2022
March 2, 2022
BackgroundA “consensus mechanism” is the way a distributed network of nodes come to the agreement of the state of the blockchain.
In this article, we will be discussing Bitcoin’s consensus mechanism, Proof of Work (POW).
POW ExplainedOn average, every ten minutes a new block is added to the blockchain. This block is added by a successful Bitcoin miner which usually utilises specialised computer hardware, known as an ASIC, to run multiple guesses in an attempt to find a number, that when hashed meets a certain target.
At any given time, many miners around the world compete by incurring operational costs, mostly energy bills, all with the goal of earning a block reward, which is currently 6.25 bitcoin.
The successful miner (who guesses correctly the answer to the cryptographic problem described above) adds the new block to their copy of the blockchain, as well as chosen transactions within it, at which point (presuming other nodes across the Bitcoin network validate and add the new block to their copies of the blockchain) become confirmed.
The miner may add it to their own chain, but they do not add it to anyone else chain, that is up to the receiving node, to determine if it is valid and hence add it, to it’s own chain, and so forth.
This process is the essence of POW, albeit somewhat simplified.
Proof-of-Work (POW)When it comes to a digital asset such as Bitcoin, POW is the only known viable consensus mechanism as it optimises for fairness, decentralisation and security.
POW is innately fair since there are no intricate governance algorithms controlling who “solves” the block. It is therefore irrelevant whether a miner has 1% or 50% of hash power, or whether the miner holds a lot, some or no bitcoin at all. It also does not matter if the miner just began operations or if it was operating for years. There is absolutely no special treatment or privilege afforded to anyone.
Since Bitcoin miners necessarily incur electricity costs to participate in the network, they are naturally incentivised to be honest and go where energy is abundant and low cost. This promotes greater decentralisation, from a geographical and organisational perspective.
Finally, given that POW requires energy to be spent in order to add blocks and transactions, the more energy the network uses, known as its “hash power”, the more secure it becomes. This makes it more difficult and expensive for bad actors to coordinate a “51% attack”, a situation where an individual or group collectively controls at least 51% of the hash power and uses it to outpace other miners in producing blocks, which allows transactions manipulations i.e. double spend. Earlier this year, Bitcoin hash power reached an all-time high, making it more secure than ever.
But what about Proof-of-Stake (POS)?POS, by contrast, is a consensus mechanism where holders of a crypto token “stake” them in order to become a validator. Through staking, or posting tokens as collateral, they then have the chance to validate blocks, which is done through random selection. Additional tokens are then given to the successful miner as a reward.
POS is innately more complex since the creation of new blocks is costless – it has no connection to real-world resources. It also needs to establish a way to punish stakers who improperly vote on the “wrong” chain. Confusingly, it also needs a mechanism to prevent the stakers from voting on all possible chains.
While proponents herald POS as being more “environmentally friendly”, its biggest weakness is that it is prone to centralisation. The more tokens you own, the more you can stake, which necessarily leads to you acquiring more tokens available to be staked, thus gaining even more tokens and so the cycle continues.
Ultimately, it’s not dissimilar to an election where your vote is weighted by your net worth. Inevitably, the ultra rich get to determine the outcome. In the blockchain context, by using POS, those with the biggest stake get to determine the rules of the game. POS has no cost associated with the creation of new blocks and rewards holders in proportion to their ownership. This makes it innately prone towards centralisation and concentration of power. The best use case for it is therefore in the context of companies where votes can be weighted by shareholding.
Final ThoughtsThe energy required in POW is a feature, not a bug. In order to have a truly decentralised, global monetary asset, it must be tied to real-world resources, otherwise it is no different to fiat currency.
Bitcoin was created with a view to creating a sound, fair and transparent monetary system, and POW provide the foundation for its operation. POW is not only necessary for security, but it is also an ingenious mechanism for ensuring that the Bitcoin network is honest and decentralised.