In order for the cryptocurrency to be immutable, that is, its transactions cannot be changed or altered, there are technologies working together that allow the existence and functioning of many cryptocurrencies, such as consensus algorithms.
Proof of Work (PoW)
It is the consensus protocol introduced by bitcoin that makes it possible for thousands of nodes to agree on the state of the network. Ethereum uses another version of it, called Ghost, that works under the same premise.
The nodes that are part of the consensus building are called miners. In private networks where there are no rewards (block reward) for miners, they can be called validators. A miner or validator who is able to propose a new block and transmit it is called a proponent.
The Proof of Work is what the other nodes expect the proponent to present together with the new block. A PoW is a special number that shows that the proponent found the solution to a complex mathematical operation.
The effort focuses on how to add new transactions to the blockchain. Because transactions can arise from any node in the network, the challenge is to reach an agreement that defines which transactions are processed and in what order. In practice, the nodes take the initiative, collect some transactions in a block and propose it to other nodes.
This is how the PoW keeps all the nodes synchronized: the responsibility to stay aligned with the opinion of the majority rests with the node.
The algorithm of the PoW penalizes the wrong decisions, if a node clings to a certain notion of the state of the network and then it turns out that it was not aligned with the rest of the nodes, then all the mining work of the node has been in vain and he will not receive a reward.
The convention is that the longer or heavier chain always reflects the “truth” of the state of the network because it is likely that more work has been invested in it (computing capacity that consumes a lot of electrical energy) to solve complex mathematical operations. The shorter or lighter chains will be rejected.
There is only one way to generate a PoW: by allocating enormous energy and information resources to a particular block.
Proof of Stake (PoS)
A number of consensus algorithms have been proposed. Proof of Stake (PoS) is one of them.
Many crypto actives use their native cryptocurrency to participate in mining. This means that they will invest a certain amount of a native token to propose and validate the next block in the blockchain. If they fail in the validation, they lose their tokens; If they succeed, they receive a small commission.
Difference between PoW and PoS
The PoW invests a resource that is extrinsic to the blockchain: electricity. The PoS invests a resource that is intrinsic to the blockchain: native token. Electricity has a universal value since it costs to generate it.
Due to this simple reason, it turns out that PoW is also PoS, but PoS is not PoW. The PoW is expensive because it is generating value on a planetary scale and it also implies a great effort to solve the mathematical operation.
How do the PoW and PoS impact banking?
Jean Chalopin an investor and chairman of Deltec International said, “Consensus algorithms exist to provide the blockchain with security and immutability, and these are features of great value to any banking system.”
The blockchain with its consensus proof will provide the world banking system with numerous advantages in terms of transparency, which will necessarily result in better user experience. But, in addition, the incorporation of this technology will cause significant cost savings for financial companies.
Disclaimer: The author of this text, Robin Trehan, has an Undergraduate degree in economics, Masters in international business and finance and MBA in electronic business. Trehan is Senior VP at Deltec International www.deltecbank.com. The views, thoughts, and opinions expressed in this text are solely the views of the author, and not necessarily reflecting the views of Deltec International Group, its subsidiaries and/or employees.