Satoshi Nakamoto published the 2008 Bitcoin White Paper, mining the first bitcoin block in 2009. Since the Bitcoin protocol is an open-source project, anyone can take the protocol, fork it (change code) and start their own P2P money version. This open-source quality of the Bitcoin blockchain has contributed to faster or more anonymous alternative cryptocurrencies like Zcash and Litecoin.
The underlying blockchain protocol allows groups of people who don’t know or trust each other to organize themselves around specific goals without a central authority or middleman. Although the Bitcoin’s Proof-of-Work consensus mechanism is groundbreaking as it solves the “Byzantine Generals Problem,” it’s an untrusted, slow, energy-intensive network that favors anyone with the most computational power. As a result, many researchers and developers explore alternative consensus mechanisms, building on Proof-of-Work, while trying to solve the many challenges of Bitcoin.
Alternative Consensus Mechanisms to PoW
Shortly after the launch of bitcoin, the idea emerged to move away from single-purpose blockchains, instead of creating a protocol where you can build any P2P transaction on the same blockchain. Examples of early projects are Colored Coins and Mastercoin. Their main idea was to use Bitcoin as a token for other transaction types or legal contracts. Vitalik Buterin realized that the Bitcoin blockchain adaptations were not sufficiently efficient and flexible. He introduced smart contract functionality decoupling from blockchain functionality and launched the Ethereum project.
The Ethereum network provides a more flexible development environment than blockchain Bitcoin and special-purpose blockchains. It’s a P2P network that executes smart contracts with a few lines of code. With Ethereum, you don’t need your own unique purpose blockchain infrastructure. Unlike Bitcoin and other single-purpose blockchains, Ethereum decoupled this smart contract layer that now runs on top of the Ethereum blockchain underlying, making it easy to create smart contracts with just a few lines of code.
Ethereum has inspired many new blockchain projects to build similar smart contract networks. Examples include Cardano, Neo, EOS, Hyperledger Fabric, and many others. There are many factors to assess their feasibility — technical, economic, and legal. Which alternatives to Ethereum will become popular, whether there will be a winner takes all scenario, or whether we will continue to develop blockchains on multiple platforms. Even though Ethereum has the most traction and first-mover advantage, this can change.
Private institutions like insurance companies, banks, and many supply chain industries realize that collecting data storage and managing the spreadsheet has many advantages. Although, unlike public and unauthorized blockchains, many industries design private blockchains where validators are consortium members or at least separate legal entities of the same organization.
The use of the term “Blockchain” for private distributed ledgers is controversial. Critics question whether private ledger should classify as a blockchain. Private blockchain defenders argue that blockchain applies to any data structure that batches data into hashed blocks of transactions. While public managers create trust by math, with a consensus mechanism that encourages individuals to achieve a collective goal, authorized directors don’t utilize trust by math. They use the confidence of the course of a legal agreement or trust by notoriety. However, the common denominator, whether public or private, is the data storage and data verification principle. Thus, the term distributed ledger technology (DLT) emerged as a more general term to describe Bitcoin-derived technologies. Therefore, some blockchains are private and licensed, others are public and unauthorized, and others may not even use blockchain-like IOTA.
Alternative distributed ledger technologies are emerging with different consensus mechanisms, such as, for example, directed acyclic graphs (DAGs), not requiring a blockchain, but using alternative mechanisms to reach consensus. Projects like IOTA, Byteball, or Nano. Some projects use blockchain technology for other types of P2P value transfer, such as decentralized file storage in the Sia Network or incentivized social networks such as Steemit.
While Proof-of-Work and Proof-of-Stake are the most common consensus mechanisms, different blockchains using the same consensus mechanism may use different specifications.
Proof-of-stake is a consensus model where only network participants with a network financial stake could add blocks to the blockchain. Instead of sacrificing energy to confirm a block, users must show a stake in the network. Their stake is the tokens in one’s wallets.
Peercoin was the first blockchain project to introduce Proof-of-Stake. Other implementations include Tendermint (or Cosmos), Ouroboros (or Cardano), Tezos, Dfinity, Nxt, BlackCoin, NuShares/NuBits, Qora, all with different properties. Some, such as Decred, combine Proof-of-Work and Proof-of-Stake elements.
PoS assumes that those more involved in the network have a natural incentive to promote network integrity. If stakeholders aren’t interested in network success, their tokens may lose value. We assume the higher the stakeholder’s tokens, the greater the risk involved. Voting rights are proportionate to stakeholder value. But the original proof-of-stake mechanism is problematic. In Proof-of-Work, validators need stronger computations to create the next block. As a result, it is not economically wise to waste your energy on malicious attempts to make false transactions not accepted by the network; the same is not true in Proof-of-Stake. There’s nothing wrong with a malicious validator to lose.
The Ethereum project plans to move from Proof-of-Work to Proof-of-Stake with a hard fork, referred to as Casper, and is developing solutions to the aforementioned problem:
- Casper FFG (Friendly Finality Gadget), a hybrid version of Proof of Stake and PoW, where validators create checkpoints every 50 blocks, creating a new genesis block;
- Casper TFG (The Friendly Ghost) would require. Any malicious validator attempt would invoke a smart contract to destroy deposited ETH. They base this on the assumption that fear of penalty will keep validators in check to remain honest and solve the problem of nothing at stake.
Delegated Stake Proof (DPoS) & Other PoS
Delegated Stake Proof (DPoS) variants, as first implemented by BitShares is a more radical PoS variation. Validators don’t compete to create transaction blocks. It is a representative democracy where stakeholders can vote to validate the transactions. Token holders do not vote on block validity; they vote to select delegates to validate blocks on their behalf. This means setting up a panel of trusted parties where members can create blocks and prevent untrusted parties from creating blocks. Instead of competing on validating blocks, they assign each delegate time slots to publish their blocks. Token holders may withdraw their delegate vote if they miss a block or publish an invalid transaction.
By centralizing block creation, DPoS can run larger orders, much faster than most other consensus algorithms. Delegates cannot change transactions but can veto the inclusion of specific transactions in the next block. Different networks use DPoS variations, examples of which include Steemit, EOS, and Lisk.
There are even more Proof-of-Stake variations, most of which are only concepts or were implemented by a single network, including Leased Proof-of-Stake, Proof-of-Stake, Proof-of-Importance, Proof-of-Capacity, Proof-of-Weight, Proof-of-Stake, Proof-of-Time. Other consensus mechanisms group are Byzantine variations. Examples include Federated Byzantine Agreements (e.g.’ Stellar’ and’ Ripple’), Byzantine Fault Tolerance Practice (e.g.’ Hyperledger Fabric’) and dBFT (Delegated Byzantine Fault Tolerance) as’ NEO.’ Other alternative protocols combine mechanisms such as Hashgraph (Byzantine Fault Tolerance Protocol, Gossip Protocol, Virtual Voting).
Many protocols use Directed Acyclic Graphs (DAGs), such as IoT Chain, Byteball, Block Lattice (e.g., Nano), and IOTA (e.g., Tangle). DAGs consensus mechanism differs from blockchains. Instead of pooling data into blocks that are then confirmed, Directed Acyclic Graphs requires adding data for reference and validating past data. Each new transaction must confirm two previous transactions. The network will form a transaction convergence and validation graph. If one confirms a false transaction, the other participants will recognize it and deny it.
Private Vs. Public Blockchains
We design public and unauthorized blockchain protocols on the assumption that the least common denominator is money. These mechanisms allow us to create new global governance tools, guided by economic incentives to create new tokens. Native tokens encourage disparate groups of people who don’t know or trust each other to organize around a specific blockchain or similar public ledger without a centralized authority. The token is part of the incentive scheme.
In a public blockchain, anyone can:
- Run a full node on their local machine to write and validate blockchain transactions, thus taking part in the consensus process and earning network tokens.
- Download a wallet and send network transactions and expect to see them included in the blockchain is valid.
- Use the browser to view all transactions that have ever occurred on the blockchain.
While tokenized incentives secure untrusted networks, they make them very slow. Public networks can handle only a few transactions per second, making them unfeasible for high-volume large-scale applications. For example, Bitcoin and Ethereum can handle only less than a dozen transactions per second, while Visa can handle hundreds of thousands of transactions. However, several technological solutions aim to address these scalability problems.
Another question is how to determine network trust. Public networks, because of the lack of existing legal relationships, require algorithmic trust guaranteed by consensus mechanisms like Proof-of-Work. As we don’t know the participants, we consider all nodes taking part in the Consensus Protocol untrusted. The consensus mechanism must be responsible for maliciousness. The token is a key mechanism to resist this network of untrusted actors.
Some private blockchains federate bilateral contractual agreements. It’s an invitation-only club member. Arbitrary parties can not access the network. Parties trust each other because they have bilateral agreements and know who to sue if something goes wrong. Therefore, private ledgers do not need a token to encourage coordinated action, whereas it is part of unauthorized networks. Because they know participants ‘ identity, it provides natural protection against Sybil attacks. As a result, private managers can settle many more transactions per second as they don’t have to deal with an unknown number of anonymous nodes. They also provide more privacy than current state-of-the-art blockchains.
Most private blockchains pre-select a set of transaction verification participants and pre-set consensus rules. For example, there are 60 financial institutions, each operating a node, and forty of which must sign each block to be valid. Private blockchains may be useful in some regulated industries that want to build on a distributed ledger as they offer traditional financial institutions higher levels of efficiency, security, and fraud protection.
Private blockchains won’t revolutionize the global financial system, but replace legacy systems, making industries much more efficient. This could also be a step towards broader adoption of more public blockchains once the underlying technology becomes more scalable and mature, regulators understand it better, and people develop more know-how and trust.
Nobody knows how medium-to-long-term technology will develop. Some predict that private ledgers may suffer the same as Intranets did in the early 1990s when private firms built their own private networks because they feared to connect to the public internet. This fear has since vanished. Today, we only use intranets in minimal cases where we need high security.