What is the blockchain consensus mechanism and why does it matter to all of us?

In December I published an article on what distributed ledger and blockchain technology is (only in Polish). A few days ago the International Monetary Fund presented a very interesting study on the consensus mechanism, which is the heart of all solutions relevant to decentralized finance. Today, based on this report, I will try to explain what is the confirmation of transactions (understood in a broad sense) in the framework of this consensus and why the choice of the right mechanism is so important. And it does not matter whether we use new technologies in the public or private sector.

To begin with, let's remind ourselves what blockchain technology is. In very simple terms, we can say that it is a way in which we "arrange" various transactions, which we understand as sending data (e.g. confirming ownership) and registering them in a specific database. This data - in the case of blockchain - are arranged in consecutive blocks of data, which are connected by "nodes", or so-called nodes (let's assume that this is a way of communication by relevant units). In the report we are discussing, blockchain is defined as a subset of distributed ledger technology (DLT), which has specific properties and a way of organizing data. I would add here that it is also important that in the case of blockchain, we use advanced cryptographic techniques to ensure the security and integrity of the transmitted data.

Since in the case of DLT and blockchain we are talking primarily about data transfer in the Peer-2-Peer model, i.e. between users, it is necessary to have a mechanism that ensures "non-repudiation" of transactions that are carried out within a specific register (and protocol used, e.g. Ethereum). In this particular case, we use a mechanism called consensus, which is the confirmation that a particular action or situation is correct. For this, we use - rule-specific entities (units) that are part of a given network. Most often in the context of the consensus mechanism, we talk about achieving a 51% majority (democratic process), but the question remains what this "majority" is. More on that in a moment.

In this context, we also need to understand that blockchain can take diverse forms. For example, only certain entities or individuals (or holders of a certain feature) may be authorized to confirm transactions (correctness of operations) - permissioned network, but the most common seems to be the permissionless model, where anyone can add new records to the register or confirm a transaction. Arrangements can be created for specific needs. It will look different for public and private applications.

So let's go back for a moment to the issue of transaction confirmation. This is the element that makes blockchain and DLT unique because it gives a sense of "fairness" in a (seemingly) decentralized world. However, it is necessary to determine what constitutes the "strength" of a given user (or individual) within the network. This can be for example the value of work done to solve the puzzle (I wrote about this in an earlier article - only in Polish) - Proof of Work, the number of tokens in the wallet of a given user - Proof of Stake (those units with more tokens have a greater chance of being rewarded), but also other variants, which for now are less common. Also interesting is Delegated Proof of Stake, which allows delegating "value" to specific units that are responsible for solving tasks. The above consensus mechanisms are the most popular within public blockchain networks.

In the case of private solutions, the matter gets a bit more complicated for us, because here we have more sophisticated mechanisms, about which I will write on another occasion, but already today we can point to the so-called Byzantine Fault Tolerance or Proof-of-Elapsed-Time. The choice of the right direction depends on specific needs, which is especially important in the case of private solutions.

Why is this important? Well, besides the fact that the choice of consensus mechanism determines the level of "democratization" of the network and/or its centralized or decentralized nature, as well as - which is sometimes overlooked - the security of the transactions and the registry, it is an important choice from an environmental point of view. The most common PoW generates a lot of carbon footprint because it requires a significant commitment of energy used by units (computers) to solve mathematical puzzles. This is often argued in favor of networks based on PoW, e.g. bitcoin or ethereum (version 1.0, because 2.0 could potentially use PoS). From the point of view of regulators and policymakers, it is also very important as it determines whether the transactions (data transfer) described in a given network can be trusted. Lack of control mechanism - however, we define it - is undoubtedly a big challenge in this area.

There are of course many more risks, as there is the issue of user protection or cyber security. There is also the issue of "fairness" within the registry or the ability to scale a given network - especially if the majority is "undemocratic" in nature.

That's it for today. If you have questions, feel free to ask them in the comments. The next article is already being written.