Blockchain protocols

Blockchain Protocols: Learn Them All

Author: 
Michael R.
Date: 
September 28, 2018
Read time: 
10 minutes
PoW
PoS
consensus

Most people think they understand how the blockchain works, but they are mistaken. These blockchain protocols can be quite complicated. A majority of online sources explain it in ways that are far too technical. In this post, I will explain different blockchain protocols and the common consensus algorithms in a digestible manner. 

While a project’s roadmap and business efforts are important, understanding the blockchain on a more technical level will also help you in determining which coins to invest in. Different coins utilize different consensus algorithms as part of their protocol. These algorithms have important effects on security, inflation rates, and the overall value of each coin. Towards the end of this article, you will find a list of blockchain protocols explained.

Let’s dive in! 

Most people think they understand how the blockchain works, but they are mistaken. These blockchain protocols can be quite complicated. A majority of online sources explain it in ways that are far too technical. In this post, I will explain different blockchain protocols and the common consensus algorithms in a digestible manner. 

While a project’s roadmap and business efforts are important, understanding the blockchain on a more technical level will also help you in determining which coins to invest in. Different coins utilize different consensus algorithms as part of their protocol. These algorithms have important effects on security, inflation rates, and the overall value of each coin. Towards the end of this article, you will find a list of blockchain protocols explained.

Let’s dive in! 

 

What exactly is the blockchain?

To understand the purpose of different consensus algorithms, let’s back up a bit. We will begin by defining the main purpose of what a blockchain is responsible for. 

The blockchain adds trust to peer to peer networks. Instead of relying on banks and 3rd parties to hold, manage, and settle our money, we now have a trustless environment. The keyword there is trustless, meaning that no one entity needs to be trusted entirely. These peer to peer networks are decentralized by design, made up of nodes who are individuals that must agree on the most current state of transactions. Put simply, the blockchain represents a transaction ledger that is agreed upon by a majority of nodes on the network. It is a trusted ledger.
 

To break this down into simple pieces, the blockchain is responsible for three main functions:

  • Validating the order of transactions by achieving consensus
  • Ensuring no double spend attacks can occur
  • Adding security to the network by keeping it decentralized

And that’s it! There are many more details that go into HOW the blockchain works. From a functional, end-user perspective, though, the blockchain is effectively managing the order of transactions properly, ensuring that the same coins cannot be spent more than once at the same time (double spend), and ensuring the integrity of the economy on the blockchain. 

 

What are the blocks?

You can’t understand a blockchain if you don’t know what a block is. Each block in the blockchain contains recent transaction information. Each block also contains a reference to the block before it. This cryptographic linking makes it increasingly difficult to tamper with old blocks as new blocks are added to the chain. Every crypto protocol relies on valid blocks in its blockchain.

Miners are constantly taking in new transactions and trying to add them to the next block. Then, miners are rewarded for their efforts of facilitating transactions on the network. Without miners, transactions would not move. All miners and nodes in the network must agree on the latest transactions. This agreement is referred to as achieving consensus. 

Source: BitcoinMiningCom Youtube Channel
 

Miners take part in the system by being part of the consensus protocol. This is what mining really is. Let’s dive into what these consensus protocols are all about. 

 

Why are consensus algorithms necessary?

Consensus algorithms keep the network secure and alive. They validate transactions, add trust to the peer-to-peer network, and reward miners for contributing to the network. Without these consensus models there would be no incentive or trust in the network. 

To be more clear on consensus, let’s explain mining with an example.

 

What is mining?

As mentioned, miners are the ones keeping the network alive and are rewarded with the network’s native currency for their efforts. For example, if you are mining Bitcoin’s blockchain, then miners will be rewarded with Bitcoin, whereas if they are mining Ethereum’s chain, then they will be rewarded in Ethereum. They validate transactions by proving the correctness of a block through complex algorithms. It is like a game, and we will explain it here. 

Miners are the first participants in a network - before traders and users - and are an integral part of the economy. If there are no miners, then no coins will be mined, which means there is no inflation occurring. Additionally, no miners mean no activity, so no transactions will ever move. If you try to send coins on a network with no contributing miners, then your coins will never be received by your recipient. It is like trying to send money to a bank with no employees. 

Economic activity and inflation rates are defining forces in any economy. Without economic activity - people transacting - there is no value. 

Steps of crypto mining

So, here are the basic steps involved in mining:

  • New transactions are broadcasted to the network
  • Miners grab each transaction and put it into a block. Note that each block is basically cryptographically linked to the block before it. 
  • Miners play a guessing game to find the ‘answer’ to the next block, trying to solve the answer which links properly to the prior block. 
  • The ‘guessing’ is more literally your computer solving extremely complex math problems. The answer a long string of characters, and the race to be the first to answer make mining like a game. The first one to properly figure out the ‘answer’ to the next block is rewarded in coin. 
  • Next, miners independently turn their backs and begin hashing away (mining/guessing) for the answer to this new block
  • Once a miner thinks they have solved the answer to the next block, they propose this block to the network
  • If all other nodes agree that this block is correct, then the consensus is achieved. The block is added to the global blockchain ledger, and the miners begin racing to solve the next block  

 

Keep in mind the following:

  • Miners take in new transactions, add them to a block, then propose the block to the network
  • If all nodes in the network agree that the proposed block is valid, then it is added to the blockchain and the cycle starts over

The winning miner(s) are rewarded with coins for their efforts. 

Please note that this mining logic applies to virtually all consensus models. While it is not always referred to as mining, adding blocks to the blockchain is the integral function of a blockchain and is needed despite the differences between different models. 

 Proof of Stake (PoS) is a different consensus model, which has been gaining an increasing amount of enthusiasm over PoW as of late. A PoS-based blockchain does not require the same types of miners as PoW.

Crypto Inflation! Block Times and Reward

A cryptocurrency’s rate of inflation can have a significant impact on its price and overall economic activity. 

Blockchain Protocols

The rate at which coins are mined is more technically referred to as a block time. In these protocols, blocks are set to be found at predicted intervals in time based on hash rate. So, if a coin has a block time of 5 minutes, then every 5 minutes a new block is found and a block reward is given to miner(s). 

The block reward time and amount are relative. If a block time is 5 minute, and a normal block reward is 100 coins, then every 5 minutes 100 coins are introduced to the ecosystem. This is where you need to consider the total coin supply of a cryptocurrency. If the total supply of a coin is 1,000,000, then 100 coins every 5 minutes holds a pretty high inflation rate. If there are 10,000,000,000 coins, then this is quite low. 

Understanding inflation helps in judging the forces of supply and demand when valuing a coin. 

Now, let’s dive right into different variations of blockchain protocols to explore how different models work and how they affect the economy of a coin - which affects your investment decision. 

List of Blockchain Protocols

Now that you understand the purpose and network effects associated with these consensus algorithms, let’s dive into different the different blockchain protocols. Below is a list of some well-known consensus algorithms that you should be familiar with. Most of the coins that you currently hold most likely utilize one of these. 

 

What is PoW?

Bitcoin and many other coins use Proof of Work (PoW) as their consensus algorithm. This means Bitcoin (and other PoW coins) miners are taking part in a PoW scheme. 

In PoW schemes, miners participate in the network by contributing large amounts of computing power. This means miners create physical mining rigs, commonly consisting of several graphics cards, which allows them to make more ‘guesses’ per second. More powerful rigs give miners a better chance of winning the next block and receiving the coins of the next block reward. Senders also include fees with their transactions, which are rewarded to the miners. 

Mining ring

Without getting into more detail, you simply need to understand that a PoW-based blockchain protocols rely on miners who actually have physical rigs. This means there is an upfront cost on the miner. The miner has to spend real money (usually more than a few thousands dollars) to have any chance of winning a block reward. In the case of Bitcoin, miners can pool their power together. When miners pool their power to add blocks, the reward is distributed proportionately to each miner depending how much computing power they contributed. 

Now let’s talk economics of PoW.

Users have to spend thousands of dollars to build mining rigs to be part of PoW networks. Without these invested miners, no coins would exist.

Many argue that the prices of the mining rigs in addition to electrical cost (your electricity bill will increase significantly from mining) sets a nice base value for a coin. Miners will not want to sell their coins for less than the ‘wholesale’ cost they paid for a coin via mining. 

If a coin utilizes a PoW protocol, then it may be beneficial to have a rough idea for:

  • The cost for miners to mine new coins
  • The block time and reward

If a PoW scheme has fast block times and high block reward, but a low total supply, then the supply will be nearing its max quickly. In this case, as long as the demand is there to fulfill this fast supply rate, it may be a good buy.

On the other hand, if a PoW scheme has slow block time and low block rewards, and there is high demand, then the price should increase quickly since fewer coins are being introduced to the ecosystem.

 

What is PoS?

Proof of Stake (PoS) is a different consensus model, which has been gaining an increasing amount of enthusiasm over PoW as of late. A PoS-based blockchain does not require the same types of miners as PoW.

what's Pos

Source: beagency.com
 

PoS does not require its users to buy physical mining rigs or spend huge amounts of computing power to participate. Instead, PoS allows all coin holders to easily contribute to the network. As long as you hold coins in your wallet, activate staking, and leave your computer on (contributing a relatively minimal amount of computing power), then you receive staking rewards by acting as a miner.

Generally, the more coins you hold, the more you contribute to a network and the better chances you have of solving the next block. 

 

The Pros and Cons to PoS

PoS and PoW actually have the same problem, but in different ways. In PoS, a very rich person can buy a majority of coins and reap most of the benefits. This does NOT provide for a safe or fair economic environment. That person can potentially sell their stash and crash the price. 

Similarly, in PoW, a wealthy person can build many mining rigs, controlling the hash power of the network, reaping most of the block rewards. This introduces the same threat as someone buying all of the coins in a PoS environment. 

In PoS, unlike PoW, you have no baseline of physical cost to create a coin. The only metrics you have are total supply, current supply, inflation rate, and current market price. This makes it a bit riskier, but the upside is that you can gain staking rewards as a node much easier than in a PoW protocol. This is the main reason the community has been siding with PoS.

 

What is DPoS?

DPoS is a proposed iteration introduced to the scene after PoS. DPoS stands for delegated proof of stake. The reason for this name is because there are delegates; a person elected by votes to represent others. So, instead of anyone being able to stake and verify blocks, users in the network can actually vote on delegates, who they hope are trusted nodes.

DPos

Bitshares is a big proponent of DPoS. Delegates on Bitshares have the ability to tune network parameters such as block intervals, transaction times, and fee schedules. Different networks provide delegates with different power.

The ultimate notion here is to understand that users vote on trusted nodes (delegates) to validate blocks. This is meant to democratize PoS environments by creating an agreed upon trusted group of delegates responsible for validating the network.

 

The Downside to DPoS

The main downside here is that crypto enthusiasts can join a network early, buy lots of coins and vote for each other, essentially centralizing the network. It is still difficult to perform this type of attack, but it is certainly possible, and a major downside for most people. Additionally, people don’t trust to vote for other nodes who may not have good uptime or understand what it is they stand for. The delegates are often referred to as witnesses. 

If the delegate does not have sufficient uptime and fails to contribute to consensus, then their reputation score will go down. Generally, in these networks, delegates have a reputation which will affect whether or not they are voted again by the community stakeholders. 

 

Proof of Weight

Proof of Weight is another blockchain protocol gaining interest with projects that have more literal applications. For example, a file storage type of project would most likely use Proof of Weight. In PoS, stakers’ effectiveness is judged by the relative amount of coins they hold, while in Proof of Weight they take into account the number of coins, as well as the amount of files (or any other measurable metric) you hold for the network. 

This means that there is an incentive to not just hold coins, but actually be a meaningful contributor to the network. If you actually help store files, then you have a better chance at gaining staking rewards. Proof of Weight’s use-case is a bit more specific than general PoS, PoW or DPoS. For example, Bitcoin would not use Proof of Weight. 

Proof of weight

 

Which is the best blockchain protocol?

Overall, PoS is favored by the crypto community. 

The reality is that it is generally much more expensive to buy all of the coins in an economy than it is to have enough mining rigs to dominate a new blockchain in terms of hashing power. Explained in a different way, PoW requires only dominating hash power on a network, while dominating PoS requires owning a majority of the coins. This means PoS is seen as a better alternative from a technical point of view (much harder to manipulate; better protects against 51% attacks) and provides virtually no barrier of entry to act as a contributing node in the network and gain rewards. 

 

Want to learn more?

And that sums things up! Let the information in this article soak in and you should understand the basics of the more popular blockchain protocols. If you want to learn more deeply about how the blockchain works, the mining process, and how different coins use these protocols, check out our blog!

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