DEFINITION of Consensus Mechanism (Cryptocurrency)
A consensus mechanism is a fault-tolerant mechanism that is used in computer and blockchain systems to achieve the necessary agreement on a single data value or a single state of the network among distributed processes or multi-agent systems. It is useful in record-keeping, among other things.
BREAKING DOWN Consensus Mechanism (Cryptocurrency)
In any centralized system, like a database holding key information about driving licenses in a country, a central administrator has the authority to maintain and update the database. The task of making any updates - like adding/deleting/updating names of people who qualified for certain licenses - is performed by a central authority who remains the sole in-charge of maintaining genuine records.
Public blockchains that operate as decentralized, self-regulating systems work on a global scale without any single authority. They involve contributions from hundreds of thousands of participants who work on verification and authentication of transactions occurring on the blockchain, and on the block mining activities.
In such a dynamically changing status of the blockchain, these publicly shared ledgers need an efficient, fair, real-time, functional, reliable, and secure mechanism to ensure that all the transactions occurring on the network are genuine and all participants agree on a consensus on the status of the ledger. This all important task is performed by the consensus mechanism, which is a set of rules that decides on the contributions by the various participants of the blockchain.
There are different kinds of consensus mechanism algorithms which work on different principles.
The proof of work (POW) is a common consensus algorithm used by the most popular cryptocurrency networks like Bitcoin and Litecoin. It requires a participant node to prove that the work done and submitted by them qualifies them to receive the right to add new transactions to the blockchain. However, this whole mining mechanism of Bitcoin needs high energy consumption and longer processing time.
The proof of stake (POS) is another common consensus algorithm that evolved as a low-cost, low-energy consuming alternative to POW algorithm. It involves allocation of responsibility in maintaining the public ledger to a participant node in proportion to the number of virtual currency tokens held by it. However, this comes with a drawback that it promotes cryptocoin saving, instead of spending. (For more, see Ethereum To Adopt Proof-of-Stake.)
Similarly, there are other consensus algorithms like Proof of Capacity (POC) which allow sharing of memory space of the contributing nodes on the blockchain network. The more memory or hard disk space a node has, the more rights it is granted for maintaining the public ledger.