Consensus Algorithms: How to Balance Efficiency with Decentralization?

Consensus algorithms general features

Proof of Work (PoW)

PoW pros:

  • The algorithm was time-tested on many of the large cryptocurrencies with millions of users.
  • The structure of incentives ensures that the bigger the network, the more secure it is.

PoW cons:

  • A lot of electricity is consumed, which is harmful to the environment.
  • In many PoW networks, only the biggest players can afford full-fledged solo mining.
  • This creates the risk of centralization: the one with more money has more control over the blockchain.

Proof of Work cryptocurrencies:

  • Bitcoin (BTC) and its forks: Bitcoin Cash (BCH), Litecoin (LTC), Dogecoin (DOGE)
  • Ethereum (ETH) until 2022
  • Monero (XMR)
  • Zcash (ZEC)

Proof of Stake (PoS)

PoS pros:

  • No huge computational resources are needed to validate blocks.
  • If a protocol is implemented favorably for small stakers, the coin can be very decentralized and resistant to attacks.

PoS cons:

  • If the algorithm is implemented in a way that the richest stakers win, the risk of centralization and hence lack of security is high.
  • If there’s a disagreement regarding which block is valid, the coin risks getting split in two (which is called a hard fork). In Proof of Work, it’s profitable for miners to work only for one chain not to divide their resources, whereas in PoS, validators don’t care. That’s why, theoretically, the risk of hard forks in PoS coins is higher.

Proof of Stake cryptocurrencies:

  • Ethereum 2.0
  • Cardano (ADA)
  • Tezos (XTZ)

Delegated Proof of Stake (DPoS)

  • Proof of Authority. There are only a handful of approved accounts authorized to validate blocks, and their reputation (‘authority’) is at stake. VeChain (VET), Binance Smart Chain leverage PoA with a limited number of nodes. This is a deliberate “no” to true decentralization in favor of efficiency.
  • Proof of Importance. This one is similar to PoS, but nodes are ranked by their “importance” level before getting the right to validate blocks: it depends on how long they’ve been holding the coin for and how actively they were using it. NEM (XEM) uses PoI consensus.
  • Combined PoW and PoS in Decred (DCR). Miners validate blocks and get 60% of a block reward, and then these blocks are additionally confirmed by stakers who get 30%. The remaining 10% goes to the dev fund. Such a combination makes an attack on DCR even more expensive than on Bitcoin: you’d have to control not only mining but also staking.

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