Blockchains are examples of distributed database technology, since they store transactional data across many computers rather than in a single, centralised system.
In traditional centralised systems, where services run or data is stored on a single server, there is no concern about data synchronisation: all the data is simply present on that one machine.
The distributed nature of blockchains improves data security, since the multiple copies of data make it extremely difficult and costly to tamper with or introduce forged transactions, while also increasing network reliability/uptime, since blockchains are resilient and continue to function if a manageable set of nodes become unavailable.
However, to achieve these benefits, there needs to be a way that everyone on the blockchain can decide together what block accurately represents recent transactions across the network. Blockchains therefore require that a network-wide agreement, or consensus1, be reached among validating (mining) nodes, regarding which transactions will be combined into the next, new block and added to the blockchain (eg, Block creation times: Bitcoin = 10 minutes, Ethereum = 12 seconds).
There are two major consensus mechanisms being used to confirm transactions that take place on a blockchain without the need for a third party: Proof of Work (PoW) and Proof of Stake (PoS). However, their approaches to achieving consensus are quite different.
The work of PoW is to make it expensive to create the next block, so that the fact that you have a chain of blocks, with work going into making each block, makes it hard to forge such a chain. The longer the chain, the harder it is to forge.
The stake of PoS, on the other hand, is a bond that the chain holds for every miner/validator, thereby making it possible to punish fraudulent behaviour by not returning the bond.
Proof of Work (PoW)2, is the consensus protocol introduced by Bitcoin that makes it possible for thousands of nodes to agree on the state of its blockchain without the need for reconciliation. PoW is also the current consensus algorithm used by the Ethereum blockchain.
In the PoW consensus model (also called mining), all participating nodes on the network compete to solve a computational puzzle3 derived from the pending transaction data, with the “winning” node permitted to extend the chain by adding a new block and thus receiving newly “minted” coins as a mining reward4.
These math puzzles are called cryptographic hashes5 and are one way in nature, namely “difficult to solve” but “easy to verify”. Having to invest in computing hardware and pay electricity costs help act as deterrents against spam attacks.
PoW consensus, however, has some significant drawbacks, starting with cost. Today, one BTC transaction consumes enough electricity to power 1.6 American households for one day – the Bitcoin network is currently the 47th largest energy consumer in the world.
In addition, given the monetary incentive, Bitcoin mining has evolved into large mining pools, using specialised (ASIC) microprocessors that are predominantly located in China. Such aggregation and “centralisation” is antithetical to blockchain and theoretically could lead to collusion among miners to take control of the network via a so called 51% attack.
Lastly, both Bitcoin (7 tps) and Ethereum (15 tps) blockchains suffer from scalability problems.
Proof of Stake (PoS)6
Ethereum7 plans to migrate away from Proof of Work and implement Proof of Stake in the 2019-2020 timeframe as part of their Casper 2.0 “hard fork”8.
PoS is a greener and cheaper alternative to PoW. PoS does away with traditional miners and creates virtual miners or validators instead. The PoS validator simply collects the fees for the transactions included in the block, since there are no mining rewards.
With PoS, the right to add a new block is NOT granted to the solver of a computational puzzle like PoW, but rather is the result of a fair, round robin, deterministic process. As a validator, you send (and freeze) your staked ETH to the address of the PoS Smart Contract and the PoS protocol will randomly assign you the right to create a block, based upon the proportional value of your stake against the value of all available ether. This approach eliminates the massive electricity consumption driven by the competitive calculations associated with PoW consensus.
So, while Proof of Work disincentivises bad actors due to the tremendous power/electricity that would be consumed (at their cost), Proof of Stake disincentives bad actors by making them stake their wealth, which is lost if the Ethereum network identifies fraudulent behaviour.
Furthermore, to achieve a 51% attack, a bad actor will have to own and stake more than 50% of all the coins in the network. Real world supply and demand will make this prohibitively expensive and therefore is highly unlikely to occur.
The future of blockchain technology adoption will be driven by its ability to scale and provide consistent transactional throughput.
To do so, blockchains must balance the “trilemma” (as per Vitalik Buterin, the creator of Ethereum) of Security, Scalability and Decentralisation.
As part of the scalability strategy, along with migrating to PoS consensus, Ethereum is concurrently working on splitting the network into smaller groups or shards.
While there are many details to be worked out, Ethereum’s move to a Proof of Stake consensus is both better for the environment and a key evolutionary step toward broad adoption of blockchain technologies.
1 General definition of Consensus:
1 a: general agreement : unanimity
1 b: the judgment arrived at by most of those concerned
2: group solidarity in sentiment and belief
2 Concept published in 1993, term “proof of work” coined by Markus Jakobsson and Ari Jules in 1999. Utilised by Nakamoto’s Bitcoin white paper in 2008, allowing for trustless (no third party) and distributed consensus
3 One-way cryptographic calculation or HASH algorithm. Finding a solution is basically a guessing game, but checking if a solution is correct is easy. Bitcoin uses SHA-256. Ethereum uses ETHash.
4 17 million BTC in circulation, with the total of 21.4 million coins being reached in 2140. Current Bitcoin mining award is 12.5 BTC, which will halve again in 2020 to 6.25 BTC; current Ether mining award is 5 ETH. The total supply of ether was 100 million as of June 2018. In 2017, mining generated 9.2 million new ether, corresponding to a 10% increase in its total supply. Casper FFG and CBC are expected to reduce the inflation rate to between 0.5% to 2%. There is no currently implemented hard cap on the total supply of ETH, but it is expected to end at a certain point and become deflationary.
5 A cryptographic hash function is a hash function which takes an input (or ‘message’) and returns a fixed-size alphanumeric string. The string is called the ‘hash value’, ‘message digest’, ‘digital fingerprint’, ‘digest’ or ‘checksum’.
The ideal hash function has three main properties:
1. It is extremely easy to calculate a hash for any given data.
2. It is extremely computationally difficult to calculate an alphanumeric text that has a given hash.
3. It is extremely unlikely that two slightly different messages will have the same hash.
6 Proof of Stake (PoS) is a greener and less costly consensus algorithm, currently being used by Waves, and on the Ethereum Roadmap (Casper 2.0) for delivery in 2019-2020. Also currently used by DASH and NEO blockchains.
7 Ethereum is a second generation Blockchain 2.0 ecosystem that provides a full application development environment and supports Smart Contracts.
8 A hard fork is a radical change to the protocol that makes previously invalid blocks/transactions valid (or vice-versa). This requires all nodes or users to upgrade to the latest version of the protocol software. Put differently, a hard fork is a permanent divergence from the previous version of the blockchain, and nodes running previous versions will no longer be accepted by the newest version. This essentially creates a fork in the blockchain: one path follows the new, upgraded blockchain, and the other path continues along the old path.