This is an old revision of the document!
**What is Cryptocurrency?**
Crypto is a form of digital currency that operates without the need for banks or governments. First introduced as Bitcoin (BTC) in 2008 by the mysterious Satoshi Nakamoto, Bitcoin runs on a decentralized network and was launched as open-source software in 2009. Since then, the project has been forked and thousands of alternate Cryptocurrencies have been created and released, some using the same algorithm as Bitcoin, and others on completely different algorithms and networks.
What is a blockchain consensus mechanism?
A blockchain consensus mechanism is a type of automated system that aims to accomplish two main objectives.
- Ensure a distributed, leaderless community of network validators are able to efficiently and unanimously agree on new and existing data on the blockchain ledger.
- Ensure all network validators follow the rules of the protocol and perform their roles honestly.
Data validation refers to verifying new information is accurate and valid. This is incredibly important in a decentralized system, especially a decentralized monetary system. If invalid transaction information is allowed to be added to the blockchain such as a false balance or a double-spend transaction, it would completely undermine the integrity of that database.
Without an integral database, nobody would trust it and no one would use it.
There is also one other key problem that consensus mechanisms are used to solve: network security.
Satoshi Nakamoto, the creator of Bitcoin, was the first to recognize that consensus mechanisms could also double up as an efficient system for deterring bad actors from attempting to take over the network through a majority attack (gaining control of more than 50% of a network.) This was a revolutionary innovation and one that helped cement the Bitcoin protocol as the first globally viable decentralized cryptocurrency.
What are the main consensus mechanisms?
There are many different methods employed by various blockchains to achieve consensus in today’s crypto industry.
However, the two most popular are known as the proof-of-work (PoW) and the proof-of-stake (PoS) consensus mechanisms.
Proof-of-work (PoW) Proof-of-work is the consensus mechanism used by bitcoin and a wide range of other cryptocurrencies.
First developed in 1993 by computer scientists Cynthia Dwork and Moni Naor as a means of preventing email spam, Nakamoto took the concept and adapted it for use in a decentralized monetary system.
PoW works by requiring validators, dubbed “miners,” to purchase, rent or outsource computing equipment and direct that power towards winning a cryptography-based competition in exchange for rewards. This process is more commonly known as crypto mining.
By requiring validators to invest in computing equipment and cover the ongoing costs associated with running it, the idea behind PoW is that potential malicious agents would be put off going through all that effort. Similarly, the incentive structure of block rewards— the rewards earned from winning the mining competition— means honest participation can be well compensated.
In terms of providing security, as more miners join the network and the sophistication of equipment rises, the cost of attacking the Bitcoin blockchain rises exponentially. This is because a perpetrator would have to source an extremely large amount of computational power to gain a 51% majority over the rest of the network. Even then, there would be no guarantee they’d win the mining competition every ten minutes to successfully establish an invalid chain of new blocks.
Proof-of-stake (PoS) Proof-of-stake is a relatively new type of consensus mechanism pioneered by Sunny King and Scott Nadal in 2012. Like proof-of-work, PoS fulfills the same key objectives of a consensus mechanism but in a uniquely different way.
In order to become a validator on a PoS-based blockchain, participants are required to purchase and lock away an amount of the corresponding project’s native cryptocurrency in a smart contract. This is known as staking.
A staking smart contract essentially acts like an escrow account and locks up tokens for a fixed or variable duration depending on the specific conditions of each blockchain protocol.
Validators are chosen at random by the protocol to propose new blocks inside set time slots—often called epochs. Stakers can increase the likelihood of being selected to propose new blocks by increasing the amount of tokens or coins they dedicate to staking.
This system works similarly to a lottery system, whereby the more tickets you have the greater your odds of winning the jackpot. But again, there’s no guarantee you’ll win every time, just like a lottery. Someone with a single ticket can still beat someone with thousands of lottery tickets. The same applies to crypto staking.
Peercoin was the first cryptocurrency to feature this mechanism, though Ethereum is perhaps the most well known example of a PoS blockchain after it completed its transition from PoW in 2022.
In addition to locking up tokens, some PoS consensus mechanisms like the one Ethereum uses administer penalties for dishonest behavior through a process called “slashing.”
If the protocol suspects malicious activity, a person’s locked funds can be confiscated, or “slashed,” partially or fully without warning. This coercively dissuades bad behavior and helps to ensure all network participants follow the rules.
Other types of consensus mechanisms Beyond PoW and PoS, there have emerged dozens of different consensus mechanisms that represent novel or hybridized versions of the aforementioned mechanisms. Each attempt to solve the Byzantine Generals’ Problem in various ways. These include:
- Proof-of-Activity (PoA)
- Proof-of-History (PoH)
- Proof-of-Importance (PoI)
- Proof-of-Capacity (PoC)
- Proof-of-Burn (PoB)
- Proof-of-Authority (PoA)
- Delegated Proof-of-Stake (DPoS)
- Proof-of-Elapsed Time (PoET)
What is a Cryptocurrency Algorithm?
A cryptographic algorithm is a set of mathematical instructions or procedures used to encrypt and decrypt data, making it unreadable to unauthorized users. By using a cryptographic key, it transforms readable data (plaintext) into an unreadable format (ciphertext) and back again, and is fundamental to secure communication and data protection.
What is a Crypto Blockchain?
A crypto blockchain is a decentralized, digital ledger that securely and transparently records transactions, forming the technology that underpins cryptocurrencies. It consists of a growing chain of “blocks,” where each block contains a list of transactions and is linked to the previous one using cryptography. This chain is distributed across a network of computers, making it nearly impossible to alter or tamper with past records once they are verified and added.
Why is a Blockchain used for Crypto?
It provides a secure and transparent way to record transactions without a central authority like a bank. It allows for the creation of a digital currency that can be traded safely and is resistant to counterfeiting. The decentralized nature eliminates the need for intermediaries, which can lead to faster and cheaper transactions.