Cryptocurrencies are decentralized, meaning they don’t use third parties to validate transactions happening on their blockchain network. Instead, cryptocurrencies use consensus algorithms to confirm transactions.
Consensus algorithms are a set of agreed rules that decide how a transaction is validated on a blockchain network. The two most common consensus algorithms in use are proof-of-work and proof-of-stake.
In this article, we are going to explain both of these algorithms.
In proof-of-work, nodes on the blockchain network solve a cryptographic mathematical equation to find a transaction’s hash value. Each equation is unique, meaning that once it is solved, the network knows that the transaction is authentic and creates a new block on the blockchain.
The nodes that solve these cryptographic equations are called miners. Miners compete to solve the equation, and whoever solves it first gets rewarded. The miners having powerful hardware, therefore, stand a greater chance of winning a reward.
The first blockchain project to use proof-of-work was Bitcoin, but now it is also employed by Ethereum, Litecoin, Bitcoin Cash, and others.
How transactions are verified in proof-of-work:
- A new transaction is broadcasted on the blockchain network.
- Miners compete to find the hash value that matches that of the transaction.
- The first one to find the hash receives the reward.
- A new “block” is created, which includes the recently concluded transaction and the address of the previous transaction.
In proof-of-stake, an algorithm randomly selects a node to validate the transaction. A node’s ability to validate a transaction depends on the number of blockchain tokens in its wallet.
In proof-of-stake, the modes are called validators or forgers because they don’t get any reward for solving the equation. Validators earn a transaction fee to validate the transaction.
The first blockchain project to use Proof-of-stake was Peercoin. But now, it is also employed by Dash, Neo. Ethereum is also working on shifting from Proof-of-work to Proof-of-stake with Eth2.0.
How transactions are verified in proof of stake
Instead of miners competing to be the first validator, in proof-of-stake, its algorithm randomly selects a validator based on their stake in the network. To do this, the network creates a staking pool that anyone can join. The algorithm randomly chooses nodes from this pool based on their stake in the network.
For example, let’s say a blockchain has 1000 tokens, and you own 10% tokens of that blockchain in your wallet. Then the proof-of-stake algorithm will give you the ability to validate 10% of the transaction happening on the network.
Proof-of-work vs Proof-of-stake
- Proof-of-work: Proof-of-work requires massive amounts of computational proof-of-worker and electricity to solve the equation. Most of the proof-of-work done is wasted as only one miner is rewarded for each block while thousands compete for it.
- Proof-of-stake: Proof-of-stake uses tokens to validate a transaction, so it does not require a massive amount of computation proof-of-worker to validate a transaction.
A 51% attack is a condition where a group or a single person gains 50% of the total mining proof-of-worker of a network.
- Proof-of-work: If a miner or a group of miners somehow gains control over the blockchain, they’ll be able to manipulate the blocks for their advantage.
- Proof-of-stake: In proof-of-stake, to gain control over the blockchain, the bad actor(s) would need to purchase 50% of the total amount of crypto of that blockchain in circulation, which is financially not feasible.
- Proof-of-work: In proof-of-work blockchains, miners who have powerful hardware stand a better chance of winning the reward resulting in people creating mining pools to combine their computing proof-of-worker to stand a better chance of winning the reward.
- Proof-of-stake: In proof-of-stake, the algorithm randomly picks a validator, which prevents validators from forming groups. Instead, those who contribute to the network are awarded.
Both consensus algorithms penalize network disruptors and punish bad actors for not following the algorithm. In proof-of-work, the algorithm penalizes bad actors by reducing the reward, while in proof-of-stake, the algorithm slashes a percentage of funds staked by the node for accepting bad blocks.
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