Probabilistic vs deterministic blockchain consensus in finance

The Monetary Authority of Singapore has recently launched a report titled

" Project Guardian - Enabling Open and Interoperable Networks"

In it, and rightly so, the authors speak about probabilistic vs deterministic consensus. So I thought time for another explainer post, created with a little LLM help:

Probabilistic

In the world around us, many things are uncertain and unpredictable. Probabilistic refers to situations or events that involve uncertainty and can be described using probabilities. A probability is a way of measuring how likely something is to happen. It's like a way of predicting the chances of something occurring.

Let's take an example to understand it better. Imagine you have a bag of different coloured marbles—red, blue, and green. Suppose you close your eyes and pick a marble without looking. In that case, the probability of getting a red marble depends on the number of red marbles in the bag compared to the total number of marbles. If there are five red marbles out of 15, the probability of picking a red marble is 5/15.

In a probabilistic situation, we use probabilities to describe the chances of different outcomes happening. It helps us understand the likelihood of events occurring based on our information. However, it's important to remember that probabilities do not guarantee what will happen. They are just estimates based on the available information.

Probabilistic thinking is widely used in various fields like science, statistics, economics, and everyday life. It helps us make predictions, analyze risks, and make informed decisions. By understanding probabilities, we can assess the likelihood of different outcomes and make better choices.

Deterministic

Some things are predictable and follow a clear cause-and-effect pattern. Deterministic refers to situations or events that are entirely predictable and can be explained by known rules or laws. It means that we can accurately determine the outcome if we know the starting conditions and the rules governing the system.

Let's take a simple example to understand it better. Imagine you have a ball and roll it down a straight track. If you know the angle at which the track is tilted and the ball's initial speed, you can accurately predict where the ball will end up. The laws of physics determine the ball's path, and the outcome is certain.

In a deterministic situation, there is no randomness or uncertainty involved. Everything happens in a predictable and calculable manner. This concept is often used in fields like physics, engineering, and mathematics, where precise calculations and predictions are important. (for example, the settlement of financial / securities transactions?!)

However, it's important to note that not everything is deterministic. External factors or complex interactions can sometimes introduce unpredictability, and the outcome may no longer be entirely deterministic. For example, weather forecasting involves deterministic models based on known atmospheric physics and probabilistic models due to the inherent uncertainty of weather patterns.

Blockchain Consensus

When we discuss blockchains, consensus refers to the process of reaching an agreement among multiple participants or computers, called nodes, on the state of the blockchain. Since blockchains are decentralized systems, consensus is essential to ensure that all nodes have a duplicate copy of the blockchain and agree on the validity of transactions.

Imagine a group of friends playing a game together. They must agree on the rules and the game's outcome to make it fair. Consensus in blockchain works similarly. When a transaction is made on the blockchain, it needs to be validated and added to a block. However, instead of relying on a single person or authority to validate the transaction, blockchain achieves consensus by having multiple nodes verify and agree on its validity.

To reach a consensus, different consensus algorithms are used. They can include Proof of Work (PoW) or Proof of Stake (PoS).?

Consensus is crucial for maintaining the integrity and security of the blockchain. It ensures that no single entity can tamper with the data or control the system. Having multiple nodes agree on the state of the blockchain makes it a trustworthy and transparent record of transactions.

Probabilistic vs deterministic consensus

Probabilistic Consensus Algorithm:

• Probabilistic consensus algorithms rely on probabilistic mechanisms or economic incentives to reach an agreement in a blockchain network. They often involve elements like voting, probability-based selection, or economic rewards.
• Example: Proof of Stake (PoS). Proof of Stake is a probabilistic consensus algorithm that various blockchains like Ethereum 2.0 use. In PoS, participants are selected to validate transactions and add blocks based on the number of coins they hold and are willing to "stake" as collateral. The probability of being chosen as a validator is proportional to the stake held.

Advantages of Probabilistic Consensus:

1. Sybil Attack Resistance: Probabilistic consensus mechanisms often incorporate economic incentives or reputation systems that make it costly or difficult for malicious actors to control the network through Sybil attacks. This helps maintain network integrity and security.

• Scalability: They can offer better scalability by allowing more validators or participants to reach a consensus.

Disadvantages of Probabilistic Consensus:

• Centralization Risk: Certain probabilistic consensus algorithms may concentrate power among participants with a higher stake, potentially leading to centralization.
• Nothing-at-Stake Problem: Some probabilistic algorithms face the "nothing-at-stake" problem, where validators can potentially support multiple competing chains, reducing security and network stability.

Deterministic Consensus Algorithm:

• Deterministic consensus algorithms use fixed rules or protocols to achieve agreement in a blockchain network. They aim to provide deterministic finality and typically do not involve probabilistic elements.
• Example: Tendermint. Tendermint is a deterministic consensus algorithm used in various blockchain networks, including the Cosmos network. It relies on a set of trusted validators who take turns proposing and voting on blocks to reach a consensus.

Advantages of Deterministic Consensus:

1. Finality: Deterministic consensus algorithms provide immediate finality for transactions, meaning that the transactions are considered irreversible once consensus is reached. This enables faster settlement times and enhances transaction certainty.
2. Security: Deterministic consensus mechanisms offer robust security by requiring a majority or supermajority of participants to agree on the validity of transactions. This provides a high level of resistance against attacks, making it more challenging for malicious actors to manipulate the system.
3. Byzantine Fault Tolerance: Deterministic consensus mechanisms, such as Practical Byzantine Fault Tolerance (PBFT), are designed to tolerate Byzantine faults, which refer to malicious behaviour in a network. This fault tolerance enables the system to continue operating correctly even if a subset of participants behaves maliciously.

Disadvantages of Deterministic Consensus:

• Scalability: Deterministic consensus algorithms may face scalability challenges as the number of participants in the consensus process increases.
• Dependency on Trusted Validators: Some deterministic consensus algorithms, including Tendermint, rely on a fixed set of trusted validators, introducing a degree of centralization and dependence on the validator set.

Probabilistic consensus algorithms like Proof of Stake (PoS) use probabilistic mechanisms and economic incentives. In contrast, deterministic consensus algorithms like Tendermint rely on fixed rules and protocols to achieve agreement. Tendermint in the Cosmos network is an example of a deterministic consensus algorithm.

Finality in Finance

The concept of finality holds significance in various financial transactions and processes, ensuring certainty, security, and the completion of obligations. Here are a few instances where finality plays a crucial role in finance:

1. Settlements: Finality is essential in the settlement of financial transactions, particularly in payment systems. When a payment is made, it is essential that the transaction is considered final and cannot be reversed or cancelled. Finality in settlements ensures that funds are securely transferred, and obligations are fulfilled.
2. Clearing and Confirmation: Finality is crucial in the financial transactions' clearing and confirmation process. It ensures that once a transaction is confirmed, it cannot be changed, revoked, or modified. This certainty is necessary for parties involved in the transaction to proceed confidently.
3. Legal and Regulatory Compliance: Finality is significant in ensuring compliance with legal and regulatory frameworks. Financial institutions and market participants rely on finality to ensure that transactions are conducted per applicable laws and regulations, providing a basis for contractual agreements and legal obligations.
4. Investor Protection: Finality protects investors by establishing clear boundaries and rights in financial transactions. It ensures that ownership and entitlements are firmly established and cannot be altered or disputed, safeguarding the interests of investors.

Finality is a crucial aspect of finance as it ensures the completion, security, and certainty of financial transactions. It underpins settlement processes, legal compliance, investor protection, and overall trust within financial systems. Finality in finance helps to minimize risks, establish clear rights and obligations, and enable the efficient functioning of financial markets.