Blockchain Consensus Mechanisms and Scalability Solutions – Their Impact on Crypto Transactions

Blockchain and cryptocurrencies are no strangers to attacks and fraud and that’s where consensus plays a crucial role. Without a reliable consensus mechanism, the blockchain network becomes susceptible to security breaches. This opens the possibility of forks, causing the network to divide into multiple independent networks, which in turn could lead to a decline in trust within the system. 

In terms of scalability, cryptocurrencies lag far behind traditional banking systems since Bitcoin can only process 7 transactions/second as opposed to Visa whose rate goes up to 2,400 transactions/second. Thus, it remains a fundamental challenge to mainstream adoption, with developers continually seeking solutions for it. 

Understanding these two elements is essential in getting a clearer picture of how cryptocurrencies work and how to apply fundamental analysis. 

Take a deep dive into the realm of consensus mechanisms and scalability solutions used by cryptocurrencies.

Blockchain Consensus Mechanisms – How They Relate to Cryptocurrencies

A consensus mechanism is a program used in blockchain systems to achieve distributed agreement about the ledger's state. Generally, it’s implemented in a network with many processes and users. Cryptocurrencies, blockchains, and distributed ledgers benefit from their use because the consensus mechanism replaces much slower human verifiers and auditing.

A consensus mechanism ensures that:

• all nodes on the network have the same copy of the ledger
• only valid transactions are added to the ledger
• the ledger is resistant to tampering and malicious attacks

There are many types of consensus mechanisms available, each with its advantages and disadvantages. 

The most common consensus mechanisms are:

Proof of Work (PoW)

Used by: Bitcoin (BTC), Litecoin (LTC), Bitcoin Cash (BCH), Zcash (ZEC)

Proof of Work (PoW) stands as one of the most widely recognized consensus mechanisms. Popularized by Bitcoin, PoW requires miners to solve complex mathematical problems to validate transactions and add blocks to the blockchain. By dedicating computational power to solving these puzzles, miners provide the necessary validation for transactions, ultimately leading to the creation of new blocks in the blockchain.

Although PoW is secure and decentralized, it has garnered attention due to its substantial energy consumption and scalability challenges. The computational work involved in the mining process demands significant electricity, leading to concerns about the environmental impact of PoW-based cryptocurrencies. 

Moreover, as the network grows, the scalability of PoW-based systems becomes a point of contention, as the computational demands increase with the expanding user base.

Proof of Stake (PoS)

Used by: Cardano (ADA), Binance Coin (BNB), Solana (SOL), Avalanche (AVAX), Bitcoin Minetrix (BTCMTX)

Proof of Stake (PoS) offers a different approach to achieving consensus within cryptocurrency networks. Within a Proof of Stake (PoS) system, validators are selected to generate new blocks and authenticate transactions according to the quantity of coins they possess and are willing to "stake" as collateral. This approach not only promotes energy efficiency by eliminating the need for extensive computational work but also contributes to enhanced network security through the economic disincentives for fraudulent behavior.

The differences between PoW and PoS are stark. While PoW relies on computational power and external resources, PoS leverages internal resources in the form of staked coins to facilitate network participation and transaction validation.

PoS addresses some of the environmental concerns associated with PoW but introduces new considerations for network security, like:

• Nothing at Stake Problem: validators could vote for multiple blockchain histories without any consequence, leading to potential security issues.
• Long Range Attacks: an attacker could start creating blocks in private; if this private chain becomes longer than the main chain, it can cause a disruption.
• Stake Grinding: a validator manipulates the source of randomness to influence which validators are chosen to create the next block, thereby gaining an unfair advantage.

Delegated Proof of Stake (DPoS)

Used by: Tron (TRX), Tezos (XTZ), Lisk (LSK), EOS

This is a variation of PoS that introduces a voting system to elect a group of delegates or validators who are responsible for creating new blocks and maintaining the network. The delegates are chosen by the stakeholders based on their reputation and performance. 

Voted delegates vary between 10 and 100, depending on the system, and are subject to periodic changes. Delegates who underperform or pose a threat to the system face removal through a vote by token holders, with replacements taking their positions.

This mechanism aims to enhance scalability and transaction speed. DPoS is also faster and more democratic than PoS, but it also requires more trust and coordination among the participants.

Proof of Burn (PoB)

Used by: Slimcoin, Ethereum Classic

PoB follows the principle of “burning” the coins held by the miners that grant them mining rights. Burning coins means sending them to an inaccessible address, effectively removing them from circulation. By doing so, the miners prove their long-term commitment to the network and their willingness to sacrifice short-term profits. The more coins a miner burns, the higher the chance that they will score the right to mine the blocks.

PoB reduces energy consumption and lowers the entry barrier for new miners, thus increasing decentralization. However, Proof-of-Burn is still an experimental concept and lacks transparency since it’s difficult to prove that the coins sent to a burner address are truly inaccessible. 

Proof of Authority (PoA)

Used by: Palm Network, Xodex, and Bitgert

This is a mechanism that assigns a set of trusted nodes or authorities who have the right to create new blocks and validate transactions. The authorities are usually selected by a central entity or organization based on their identity and credentials. PoA selects nodes with high authority and credibility as outgoing nodes. Since the block has the node’s signature, if any malicious activity is registered in that node, it won’t be qualified to update the block.

PoA is suitable for private or permissioned blockchains that prioritize speed and efficiency over decentralization and security.

PoA prioritizes efficiency but raises concerns about centralization – since the parties are predetermined and trusted, it’s possible they already know each other.

Blockchain and Cryptocurrency Scalability Solutions

Scalability solution is a term that refers to any method or technique that aims to improve the performance and capacity of a blockchain system. Scalability is one of the main challenges that blockchain faces, as it limits its ability to compete with traditional payment methods like Visa or PayPal.

The ability to process a large number of transactions per second, while maintaining decentralization and security, is a pivotal goal for blockchain networks. 

Scalability can be measured by three main factors:

1. Throughput – the number of transactions that a system can process per second (TPS). For example, Visa can process up to 24,000 TPS, while Bitcoin can only handle 7 TPS.
2. Finality –  the time it takes for a transaction to be confirmed and irreversible. For example, Bitcoin requires an average of 10 minutes for a transaction to be finalized, while Visa can do it in seconds.
3. Confirmation time – the time it takes for a transaction to be included in a block. For example, Bitcoin has an average confirmation time of 10 minutes, while Ethereum has an average confirmation time of 15 seconds.

As the demand for cryptocurrency transactions continues to surge, innovative scalability solutions have emerged to enhance transaction throughput, reduce latency, and improve network scalability.

There are many scalability solutions proposed for blockchain systems, which can be classified as follows: 

Segregated Witness (SegWit)

An upgrade to the Bitcoin protocol, SegWit separates the witness data (the signatures that prove the ownership of bitcoins) from the transaction data (the information about who sends and receives bitcoins). By doing this, SegWit reduces the size of each transaction and allows more transactions to fit in a block. This increases the capacity of the Bitcoin network and makes transactions faster and cheaper.

SegWit also solves a problem called transaction malleability, which is a vulnerability that allows someone to change a small part of a transaction without invalidating it. This could cause delays in confirming transactions and enable attacks on the network. SegWit prevents this by moving the signatures to a separate structure at the end of the block, where they cannot be modified.

Layer 2 Scaling Solutions

Layer 2 scaling solutions, like the Lightning Network and Plasma, play a vital role in enabling off-chain transactions, thereby alleviating the burden on the main blockchain. By conducting transactions off-chain and later settling the results on the main blockchain, layer 2 solutions offer the potential to significantly increase transaction speed and reduce fees. 

However, the implementation of layer 2 solutions presents challenges, including complex routing protocols, liquidity management, and potential centralization risks.

Sharding

Sharding involves breaking the blockchain into smaller parts, or shards, each capable of processing its transactions, enhancing overall scalability.

Each shard processes its own set of transactions, effectively parallelizing the transaction processing and enhancing network efficiency. While sharding holds immense potential for increasing transaction processing speed and capacity, it introduces trade-offs in terms of reduced security due to the isolation of data. 

Ensuring the integrity of transactions across shards and coordinating consensus among shards are among the key security considerations in sharding implementations.

Sidechains

Sidechains are parallel chains that operate alongside the main blockchain, enabling specific functions without affecting the primary network.

They allow users to lock a certain amount of cryptocurrency on the main blockchain, effectively taking it out of circulation. This locked amount is then mirrored on the sidechain, where users can transact more efficiently due to faster block confirmation times or specialized features unique to the sidechain. This is particularly beneficial for popular cryptocurrencies facing network strain during peak usage periods.

State Channels

State channels offer a compelling approach to improving scalability and reducing transaction costs in cryptocurrency networks. Through state channels, participants can conduct off-chain interactions for multiple transactions while ensuring the same level of security as on-chain transactions. 

The benefits of state channels include enhanced privacy, reduced latency, and minimal on-chain congestion. However, managing the opening and closing of state channels, as well as ensuring dispute resolution mechanisms, presents notable challenges in their widespread adoption.

Conclusion

As cryptocurrencies strive for mainstream adoption, the exploration of consensus mechanisms and scalability solutions becomes paramount. Each mechanism and solution presents its own set of advantages and challenges, and ongoing research and development aim to strike a delicate balance between security, decentralization, and scalability. 

There is no one-size-fits-all solution for blockchain scalability or consensus, as different systems may have different goals and requirements. Therefore, you should carefully analyze which ones best suit the needs and preferences of the users and developers. 

Additionally, stay on the lookout for the ongoing development of innovative consensus mechanisms and scalability solutions that will address future challenges of scalability, security, and decentralization.