Consensus Methods

Today’s Agenda

• Consensus Methods
  • It’s All Behind the Scenes
• Proof of Work
  • Hashrate
  • Proof of Stake
  • Proof of History
  • Transaction Speed & Throughput

Consensus Methods

Consensus methods enable networks to decentralize. These methods are algorithms embedded into the code that allows verified networks of computers to participate in blockchain transactions. They are the absolute cornerstone of every blockchain, and they incentivize miners or validators to verify transactions while at the same time making it too expensive to take control of the entire network. If one miner or validator overtakes the network, they could re-write history and front-run any transaction.

Generally, the more computers there are mining or validating blocks of transactions, the more secure the network is. 

There are dozens of consensus methods with which blockchains verify and settle transactions, each with its own tradeoffs. Blockchains have attributes that, when addressed, make other attributes problematic. Ethereum’s co-founder, Vitalik Buterin, has clarified this concept with the idea of the Blockchain Trilemma. It is a set of three issues – decentralization, security, and scalability – which require sacrifices of one for the sake of the others.

There are plenty of arguments over which is the most secure consensus method. Still, it’s important to remember that crypto is a hyper-evolving technology that, in many cases, can be considered unproven. There are proven aspects of the technology, but that doesn’t mean another technology can’t come in and make it all obsolete.

Some skeptics even think quantum computing will make the cryptography behind cryptocurrency obsolete, but that is entirely hypothetical. The alternate take is that the security measures behind it evolve alongside advances in technologies like quantum computing.

It’s all Behind the Scenes

By far, the most important and widespread consensus methods are Proof of Work (Bitcoin, Hathor), Proof of Stake (Ethereum, Avalanche, Near, IBC chains), and Proof of History (Solana). We’ll break down each of these below. Most chains utilize Proof of Stake to some capacity, although many operate with variations or hybrids of the above. To make it even more confusing, Ethereum is switching from Proof of Work (PoW) to Proof of Stake (PoS), and Solana is a hybrid of PoS and PoW. 

Ultimately, the vision is for blockchains to operate as an enhanced version of the internet. You won’t need to understand what consensus method is going on behind the scenes of your favorite NFT or DeFi protocol in the same way that you don’t need to understand the TCP/IP and HTTP protocols behind the scenes of every website on the internet. 

Proof of Work (PoW)

When using a Proof of Work consensus method, the computers that verify transactions must compute highly complex math problems. These computers are called Miners. 

Transactions are recorded in a sequential series of blocks that are constantly updated as more transactions are mined. This method prevents users from double spending the same cryptocurrency as every miner can see every transaction made up to the present moment. Mining is an energy-intensive process that requires more energy the more miners are involved. The math problems these miners have to solve become more complex as more miners join the network – thus requiring more energy to be expended. The same is true in the opposite direction.

When a Miner has mined a block of transactions (verified them as being true and distributed that truth across the entire miner network), they are rewarded with a token. In the case of the Bitcoin blockchain, miners are rewarded with Bitcoin. The reward size decreases over time, thus introducing more scarcity into the network.

An entire overhaul of Bitcoin’s source code would need to be implemented for the total number of Bitcoins to change. Many checks and balances are intended to make changing the code a challenging and arduous process, which would require thousands of developers to agree on issues that have caused previous developers to go out and start their own blockchains. It’s unlikely, but it is possible. The culture surrounding Bitcoin is another roadblock, as Bitcoiners are typically against implementing changes to the protocol. 

The last of the 21 million Bitcoin is projected to be mined around 2140. It’s up to speculators to estimate how the network will work after all the coins have been excavated – some claim it will be done solely with transaction fees being rewarded to miners. We’ll see (or our grandkids will).

Hashrate

The difficulty of the math problems is calculated by Bitcoin’s hashrate. The hashrate measures the combined computational power being used to mine Bitcoin. In 2019, China accounted for over 75% of the global hashrate. This meant roughly 75% of Bitcoin mining was taking place in China. In 2021, China banned the holding and mining of cryptocurrencies, and all the Chinese miners were forced to shut down or move operations to a different country. Because of this dramatic event, the hashrate declined.

As shown in the diagram above, the hashrate has since improved and reached all-time highs. Many miners moved to the US, which has positioned the US as one of the top locations for Bitcoin miners in the world. It needs to be clarified if this was anticipated by the Chinese government or was an unintended consequence.

This hashrate rally occurred during a multi-month drawdown on Bitcoin’s price, so it is clearly not a representation of pricing but rather a representation of the network’s security. 

Proof of Stake (PoS)

Ethereum and Solana utilize Proof of Stake, although Solana is technically a hybrid Proof of Stake and Proof of History (PoH) network. The computers verifying transactions on a Proof of Stake network are called validators. These validators are not performing the complicated math to earn rewards but instead proving themselves as network participants with large stakes in the network. Individual stakers choose to delegate tokens to a validator on the network of that token and are rewarded with a share of the validator’s rewards. Stakers delegate to validators based on criteria like their reward share, uptime, and reputation. If you’re staking SOL, you’re doing so through a SOL validator and helping secure the Solana network.

💡 The more validators or miners involved in a blockchain, the better.

If a validator has too much sway on the network, they can change the ledger’s history and cause mayhem. To help prevent that from happening on Solana, Solflare has implemented Marinade Finance’s liquid staking product, which delegates SOL to a network of over 450 validators, effectively securing the decentralization of the Solana network. Given that Solflare has facilitated over 25% of SOL staking (roughly $30 billion worth at its peak), this partnership with Marinade is rather significant.

Bitcoin is the primary blockchain that utilizes PoW and is somewhat its own. Most of the other top blockchains use PoS or variations of it. 

Proof of History

Solana has introduced several novel innovations, namely Proof of History. Proof of History is a mechanism that enables Solana validators to measure time in a new way, allowing them to process transactions at unprecedented speeds. The speed and efficiency of Solana can not be overstated. 

Proof of History implements a clock that allows validators and the network to tell time without relying on any trusted source. The clock does not measure absolute time frames as a regular atomic clock but rather the relative distance between events and transactions. This enables a standardization that is impossible elsewhere and allows the network to validate information exceptionally quickly.

For a more thorough understanding of the potential of PoH and how it works, read this article written by Solana’s CEO on Solana.com and in Solflare’s Knowledge Base. 

Transaction Speed & Throughput

Throughput refers to how many actions are completed in a window of time. 

Different blockchains form for different reasons and have vastly different speeds and throughputs. Bitcoin was formed to be a peer-to-peer method of exchange but has since become digital gold. Ethereum was formed to be an infinite machine. Solana was developed to be the fastest and most scalable medium to record state changes. 

Bitcoin can handle anywhere from 5-10 transactions per second (tps). Ethereum can handle about 10-30 depending on network congestion, but as many of you know – it can be pretty costly. Solana, on the other hand, can handle roughly 65,000 tps, which will theoretically increase as computing power increases. It regularly handles between 2,000-6,000 tps at the time of writing.

Fees are also a fraction of a penny on Solana, while Ethereum fees can range from $5-200 for simple transactions. For some perspective, Visa and Mastercard – centralized entities with closed ecosystems – can handle about 50,000 transactions per second at their peak volumes and charge vendors anywhere from 1-4% per transaction. This isn’t even accounting for exchange fees when a charge is being made outside the country from which the card came.

That is all well and good for Visa and Mastercard, but Solana can do the same while being an Interoperable and Immutable open system with far lower fees. It’s an upgrade to traditional payment rails.

Conclusion

Blockchains are like operating systems. Some are built for modularity, and some are made to be monolithic. As mentioned in the first few paragraphs of this chapter, blockchains and cryptocurrencies are hyper-evolving experiments. The goals and vision of blockchains differ as much as the technology does, and there are endless arguments on the validity and security of different consensus methods. As a result, new blockchains are popping up every year.

Much of this course includes topics that could be a course in itself. Consensus methods could be many courses. It’s a vast topic relevant to developers, entrepreneurs, and investors alike. If you want to invest in or build something on a blockchain, you need to know what’s possible – and consensus methods make it all possible.