Blockchain is a generic term for the way most cryptocurrencies record and share their transactions. It’s a type of distributed ledger that parcels up those transactions into chunks called “blocks” and then chains them together cryptographically in a way that makes it incredibly difficult to go back and edit older blocks. How often a new block is made and how much data it contains depends on the implementation. For Bitcoin, that time frame is 10 minutes; for some cryptocurrencies it’s less than a minute.
Unlike most ledgers, which rely on a central authority to update records, blockchains are maintained by a decentralized network of volunteers. The ledger is shared publicly, and the responsibility for validating transactions and updating records is shared by the users. That means blockchains need a simple way for users to reach agreement on changes to the ledger, to ensure everyone’s copy of the ledger looks the same and to prevent fraudulent activity. These are known as consensus mechanisms, and they vary between blockchains.
Blockchain consensus mechanisms decide which user gets to create the next block in the chain, prescribe how other users can verify the block is valid, and ensure users add only genuine transactions through incentives, deterrents, or both. Here we’ll discuss four primary consensus mechanisms.
The granddaddy of all consensus mechanisms—behind Bitcoin, Litecoin, Monero, and (for the time being at least) Ethereum—is called proof of work. Essentially, PoW makes adding transactions to the blockchain computationally—and therefore financially—very expensive, so as to discourage fraudulent activity. At the same time, users who go to the trouble of creating valid blocks, known as mining, are rewarded with cryptocurrency.
The only way miners can game a PoW system is if they control over 51 percent of the blockchain’s mining power, which is almost impossible for a large network like Bitcoin. The downside to PoW is that it requires huge amounts of electricity to power all these computations, which is both inefficient compared with other financial systems and bad for the environment.
Three alternatives to proof of work are being used in other cryptocurrencies and could offer real competition for Bitcoin’s PoW (the industry gold standard) in the years ahead.
Each alternative, of course, has its own upsides and downsides. The three consensus mechanisms outlined here—proof of stake, proof of burn, and proof of capacity—each consume far less energy than PoW. But proof of stake (PoS) and proof of burn (PoB), for instance, could lead to a “rich getting richer” scenario because they both reward users who hold lots of their coins. PoS could also encourage hoarding among its holders.
As an upside, proof of capacity has a lower cost and less of an environmental impact compared with PoW because memory uses much less energy than processing. On the other side of the coin, PoC invokes the fear that if it becomes popular, it could also lead to massive price inflation of memory chips and nonvolatile storage. That may already be playing out, after the launch of the PoC currency Chia, in March, led memory prices to spike with shortages in some markets. Most important, none of these alternatives have had their security tested at scales comparable with those of Bitcoin.