What is a consensus mechanism?

A consensus mechanism is an inherent part of blockchain infrastructure. In a permissionless state, that is when a blockchain network is open for all to participate in, there is no responsible singular person or entity for taking important decisions on various levels – and still, consensus must be achieved somehow.

Why is the consensus mechanism important?

Just imagine a network full of nodes, geographically distributed, with no connection to each other and the need to decide on the true state of the blockchain network. Some type of mechanism must be employed to avoid malicious behavior and the risk of individual nodes cheating the system to their own monetary advantage. It should be kept in mind that we are talking about a young industry here, so there is no golden standard for which consensus mechanism works best. What usually happens is that projects take the “basics” and adjust them to their individual needs.

The most well-known consensus mechanism – Proof of Work (PoW)

The first and probably most well-known consensus mechanism in the blockchain is Bitcoin’s Proof of Work (PoW). We will, therefore, start with some basic knowledge about Proof of Work and then proceed to Proof of Stake to highlight the differences between the two and provide the reader with a holistic overview. Proof of Work is heavily relying on a miner’s capacity to solve a complex mathematical puzzle which allows him to add new blocks to the blockchain and be rewarded in cryptocurrencies such as Bitcoin. Miners with greater computing power do also have a greater chance of being the next block producer. Since the difficulty to solve the mathematical puzzle is automatically adjusted to make sure that only one block is mined every 10 minutes, competition between the miners can get fierce. As a result, electricity consumption spikes, which ultimately led to critics arguing that PoW is hurting the environment and therefore, should be considered unsustainable.

Proof of Stake consensus mechanism

Proof of Stake came about to solve this exact issue. Instead of investing in computing power, users invest in the network in the form of a financial contribution. They lock-up an amount of their tokens in a deposit – the tokens cannot be spent or traded – to participate in the block building process of the blockchain. The assumption is that users with a financial stake in the network will behave in an honest manner and process blocks truthfully, or risk losing their contribution. The higher a user’s stake, the greater is his chance to be chosen as the next block producer.

Specific forms of Proof of Stake

Several projects took this basic version of PoS and adapted it to their needs. We are going to dive deeper into two specific forms of PoS: Delegated Proof of Stake (DPoS) and Leased Proof of Stake (LPoS).

Delegated Proof of Stake

Delegated Proof of Stake works in a slightly different manner. Users do not stake their tokens in order to produce blocks themselves but rather, to have the right to vote for other block producers, the so-called delegates. Imagine a digital democracy which grants voting rights to participants proportionate to their stake in the system. As citizens in a traditional system vote for governments, so do users in a DPoS system vote for their specific representative as well, and in the same manner, delegates can choose to campaign for votes and prove their trustworthiness. The voting process is continuously developing which means that block producers must behave in an honest manner or face the risk of being voted out and losing all participation rights. 

Leased Proof of Stake

Leased Proof of Stake puts another spin on the basic version of PoS. Here, users basically support a full node that wants to act as a block producer. By leasing their tokens to a specific node, they increase its chances of being selected for adding the new block. As we already know from the basic version of Proof of Stake, the higher a user’s contribution the greater the probability that he will be the lucky one to produce a new block. Users that wouldn’t be otherwise eligible to participate in the process, have now the chance to contribute as well – given that they are able to collect a high enough stake. During the leasing period, the tokens do not change ownership but remain locked-up in the holder’s account. The holder has also the right to cancel a lease at any time.

Proof of Stake maintains a safe network

It should be obvious by now that all these mechanisms work to maintain a safe network that stores the actual state of the current transactions. Since distributed systems lack a single point of control, trust needs to be established in another way. In Proof of Stake, it is in the participants’ interest to act in an honest manner and boot out malicious actors because the damage to their finances could be devastating otherwise. Regarding rewards, the process of adding a block in PoS is called minting and block producers are usually compensated in transaction fees. There are basically two ways in which a user can be rewarded for his stake in the network – directly, if he is actually the one adding the block and indirectly, through his delegate or lessee.

Conclusion

It will be exciting to see if a specific mechanism can and will prevail. For now, projects are still in an experimental phase and attempting to improve on the standards that have been set so far. As previously mentioned, existing solutions still have their disadvantages, with Proof of Work suffering from its enormous electricity consumption and costly hardware requirements and Proof of Stake suffering from the heightened risk of wealthy individuals hijacking the system. It is, therefore, safe to assume that we will encounter many more variations of consensus mechanisms we already know and also, entirely new concepts that seek to establish consensus in their own manner.

Julia Krieger

Julia Krieger

Julia holds a Master’s Degree in Management Information Systems and a Bachelor’s Degree in International Business Studies from the University of Paderborn, Germany. Her strong interest in capital markets, investments, and innovation led her away from traditional finance and towards the blockchain industry. As an Analyst, she had the opportunity to work on numerous projects in the space and put her extensive knowledge of economics and technologies to use.