Blockchain networks rely on a number of processes to function securely and effectively, one of which is a consensus algorithm. Although there are a variety of different consensus methods, each of which works a little differently, almost all of them are designed to achieve the same end goal, which is to ensure that all blockchain data is validated and accurate.
In this AAG Academy guide, we’ll explain consensus algorithms and their objectives in more detail, cover how they work, and look at the different types of consensus algorithms in use today.
A consensus algorithm allows users or machines to reach agreement on a blockchain’s transactions and the distributed ledger as a whole. There are a number of consensus methods that exist within the cryptocurrency industry today — which we’ll look at later on — but almost all of them are designed around the same objective, which is ensuring the validity of data.
To explain the importance of consensus algorithms and how they work, let’s use a simple analogy. Imagine a large team of people working together on the same database. If each of those people can add or modify data as they please, there is no way to guarantee that any of it is accurate. It would be easy for just one person to enter false data that corrupts the system.
An inaccurate database is no good, and that’s especially true when it comes to cryptocurrency transactions. So, a consensus algorithm is used to prevent one person, or even a group of people, from adding data before it is checked by everyone else on the network. Nothing can be locked into a blockchain database unless at least 51% of all participants agree it is valid.
In traditional financial systems, your bank or credit card company ensures you have the necessary funds available when you attempt to make a transaction. They also keep your account balance up to date. When you spend money, the transaction is recorded and the funds are debited. You cannot spend that money a second time.
The problem with this system is that it is centralized, and most cryptocurrencies were designed to avoid centralization of any kind. Instead, they rely on decentralized systems — like blockchain networks that have a large number of participants. As a result, a decentralized method of verifying and recording transactions is required.
Consensus algorithms are the solution. They were designed to ensure that data cannot be added to a blockchain unless it is valid and verified. This prevents double-spending — the ability for one person to spend the same cryptocurrency coins or tokens twice — and helps block bad actors and attackers from adding false data for their own gain.
Consensus mechanisms also ensure fairness and reliability. Because they are algorithms that are written into the blockchain, there can be no discrimination of any kind. Everyone has the same level of access. What’s more, since there is no single entity or small team in control, there is no need to worry about outages or instabilities when that person or team is out of action.
There are many different types of consensus algorithm, each of which operates in a different way. However, they are all designed to achieve the same end goal, which is to establish trust among peers — or those who decide whether data is valid. To understand how they do this, let’s break down the most common process from start to finish.
Firstly, a transaction is submitted to the network for approval and processing. Network nodes, which are essentially computers, analyze the details of the transaction to ensure they are valid. This includes checking the sender’s wallet balance to confirm they have the necessary funds, and verifying that they hold the private key that proves ownership of the assets they are using.
Once the transaction has been validated, it goes into a pool with other valid transactions, where it awaits confirmation. A group of transactions is eventually pulled from this pool and bundled into a block by a miner or validator. When it has been closed, the block is broadcast to the rest of the network so that other nodes can check its contents and confirm they are valid.
It is at this point that consensus is achieved. Only blocks that have been agreed upon by the majority — or at least 51% of all nodes in most cases — can be added to the chain. Those that are not agreed upon are essentially rejected, and the network moves on without them. A transaction is not complete until it has been entered into a block and added to the chain.
This process means that if you wanted to exploit a blockchain, perhaps to take advantage of double-spending, you would need to successfully execute a 51% attack — or gain control of the majority of the blockchain’s validation power. That is near impossible, particularly with larger blockchain networks that can have millions of contributors.
When we think about consensus algorithms within cryptocurrency, it is usually proof-of-work (PoW) and proof-of-stake (PoS) that come to mind. PoW is used by Bitcoin, which essentially gave birth to the entire cryptocurrency industry, as well as lots of other cryptocurrencies. It relies on powerful computers that solve complex cryptographic puzzles.
PoS is now used by Ethereum — since “The Merge” in 2022 — and all the cryptocurrencies that are built on top of it. It is much more efficient than PoW because it relies on staking, in which validators and other participants contribute their own tokens as collateral, rather than high-end and energy-hungry hardware.
We have in-depth guides on both proof-of-work and proof-of-stake for those who would like to learn more about how these consensus mechanisms work, but it is important to note that they’re not the only ones used within the cryptocurrency industry today. They are certainly the most popular, but there are actually a long list of alternatives that we should not ignore.
In addition to PoW and PoS, here are six other consensus mechanisms that are currently in use. Here’s a list of them, including a brief description of how they work. In-depth guides on each of these will be available from AAG Academy in the near future.
Consensus algorithms are used to reach agreement on a blockchain’s data, which ensures that all transactions are valid and genuine.
There are a wide range of different consensus mechanisms in use today, which we’ve listed above, and each have their pros and cons. Which is “best” often depends on how they are implemented and used. The best algorithm for one project may not be the best for another.
Consensus must be a difficult process to ensure the security of a blockchain network. If it was easy, there would be little to dissuade attackers and other bad actors from attempting to overwhelm the network with false or invalid transactions.
This article is intended to provide generalized information designed to educate a broad segment of the public; it does not give personalized investment, legal, or other business and professional advice. Before taking any action, you should always consult with your own financial, legal, tax, investment, or other professional for advice on matters that affect you and/or your business.
Be the first to get our newsletter full of company, product updates as well as market news.