Understanding BitCoin: Consensus without Identity and the Power of Proof-of-Work

Consensus algorithms are integral to the functioning of blockchain networks, typically relying on the notion of node identities. However, BitCoin, the pioneering cryptocurrency, challenges this convention by operating without the need for node identities. In this article, we will delve into why BitCoin nodes forgo identities, explore the concept of implicit consensus, and examine the critical role of proof-of-work in the BitCoin ecosystem.

Why Don’t BitCoin Nodes Have Identities?

Unlike traditional consensus algorithms, decentralized nodes in a peer-to-peer network like BitCoin lack the authority to create new node identities. Moreover, there is no way to verify that nodes are not creating multiple identities at will—a vulnerability commonly known as a Sybil attack. Avoiding identities in BitCoin also aligns with the cryptocurrency’s focus on privacy and pseudonymity, as the network allows users to transact without revealing their true identities.

Implicit Consensus: Reaching Consensus Without Identities

In the absence of identities, BitCoin employs an alternative approach to achieve consensus. Randomly selected nodes take turns proposing transaction blocks to the network, determining the order in which transactions should be recorded in the blockchain. Other nodes in the network then validate and either approve or disapprove of the proposed block by adding it to their own blockchains or omitting it in favor of the next proposed block.

The structure of the blockchain plays a crucial role in this consensus process. Each block contains a hash of the previous block, enabling nodes to reference and extend the blockchain while maintaining a chronological sequence of transactions.

The BitCoin Consensus Algorithm

Let’s explore the step-by-step process of the BitCoin consensus algorithm:

  1. New transactions are broadcasted to all nodes in the network.
  2. Each node continuously listens to the network and collects new transactions into a block.
  3. In each round of proposal, a randomly chosen node broadcasts its block containing all outstanding transactions it has received.
  4. Other nodes only accept the block if all transactions within it are valid, including valid digital signatures and unspent coins.
  5. If accepted, nodes include a hash of this newest block in their next block.
  6. If rejected, nodes omit the block and instead use the hash of the most recent valid block.

As a transaction receives more confirmations (each time it is recorded in the blockchain), the likelihood of a double-spending attack decreases exponentially. To have a high degree of confidence in a transaction’s validity, it is commonly recommended to wait for six confirmations.

Incentives and Proof of Work

Assuming the honesty of nodes in their transactions is problematic, as individuals can exploit the system for personal gain. BitCoin addresses this issue by employing incentives to promote honest behavior. There are two primary mechanisms for incentivizing participants:

  1. Block reward: The creator of a block includes a special transaction within the block, known as a coin-creation transaction. This transaction rewards the node for proposing the block. The block reward started at 50 BitCoins per successful transaction and is halved approximately every four years. Eventually, the total number of BitCoins in circulation will reach a cap of 21 million. The reward is only certified if the block containing the transaction becomes part of the consensus chain, ensuring the incentive system rewards genuine transactions.
  2. Transaction fee: Any transaction creator has the option to include a transaction fee, which is an additional payment made to the block creator for confirming the transaction. This fee is voluntary and operates akin to a tip. As the block reward diminishes over time, transaction fees will become increasingly important and eventually mandatory.

Proof of Work: Ensuring Security and Preventing Monopolies

To address concerns related to selecting random nodes and preventing node monopolies, BitCoin utilizes a concept called proof of work. Rather than selecting nodes randomly, BitCoin approximates randomness by selecting nodes based on resources that cannot be easily monopolized. Two commonly used resources are:

  1. Computing Power: BitCoin uses a proof-of-work algorithm where nodes are selected in proportion to their computing power.
  2. Ownership: Another approach, called proof-of-stake, selects nodes based on their ownership of the currency. However, this mechanism is not employed in BitCoin but is utilized by various alternative coins.

Proof of work enables nodes to compete based on their computing power to earn the right to create blocks. This also makes it moderately difficult to create new identities within the network.

In BitCoin, the proof-of-work system takes the form of hash puzzles. When a node proposes a block, it includes a nonce (a random number) along with the block’s payload, which consists of a pointer to the previous block and a list of transactions. The nonce, previous block link, and transaction list are combined into a long string, which is then hashed. To be considered valid, the hash output must be an extremely small number that fits within a predefined target space—a tiny fraction of the total output space of the hash.

Finding a valid nonce is computationally challenging and requires substantial processing power. Nodes constantly compete to solve these hash puzzles, with the lucky miner who finds the nonce gaining the right to propose the next block of transactions.

Properties of Proof of Work and Mining Economics

Proof of work in BitCoin exhibits several important properties:

  1. The hash puzzle must be difficult to compute, with the target space being a small fraction of the hash’s output space. This computational difficulty limits participation to nodes with significant computing power, such as dedicated mining rigs, as the cost is too high for smaller processors like laptops or Raspberry Pis.
  2. The difficulty of the hash puzzle is recalculated approximately every two weeks, aiming to maintain an average block discovery time of 10 minutes. As competition increases and more blocks are found, the system automatically adjusts the difficulty to make finding blocks more challenging, thus increasing the overall network difficulty.
  3. The probability of completing a hash puzzle is directly related to the fraction of global hash power controlled by an individual miner. More powerful hardware provides an advantage in solving puzzles.
  4. The 10-minute block latency is invariant. Proposing blocks at a faster pace would lead to mistakes and smaller block sizes, reducing the number of transactions per block. Reducing the latency beyond an acceptable threshold could introduce various issues.
  5. Attacks on the network are infeasible as long as the majority of miners, weighted by hash power, follow the protocols and act as good actors. With a majority of hash power dedicated to honest participants, there is a greater than 50% chance that any new block will contain valid transactions.
  6. Solving hash puzzles is probabilistic, and there is no deterministic method to find a nonce. Miners must attempt various combinations until they find a successful solution. On average, the time it takes for an individual miner to find a block is equal to 10 minutes divided by the fraction of hash power they control.
  7. It is trivial to verify that a node has correctly solved the hash puzzle. Once a nonce is published within a block, it is simple to verify that the supplied nonce satisfies the requirements. This verification process is crucial, as it allows miners to quickly and easily validate each other’s work. While finding the nonce may take considerable time, verifying its correctness is straightforward.

Mining Economics: Is It Profitable?

Considering the computational requirements of mining BitCoins, the question arises: is it profitable? Mining involves computing a vast number of hashes, with approximately 10²⁰ hashes needed to find a single block. This computational cost can be significant,and unless an individual has access to substantial hash power and advantageous electricity providers, mining BitCoins is generally not profitable. The diminishing block rewards, coupled with the rising difficulty of mining, further contribute to the challenging economics of mining BitCoins. It’s worth noting that profitability can change if the value of BitCoin appreciates dramatically, but as of now, entering the mining industry should be approached with caution.

In conclusion, BitCoin has revolutionized the concept of consensus in the realm of cryptocurrencies by eliminating the need for node identities. Through implicit consensus and the utilization of proof of work, BitCoin ensures the integrity and security of its blockchain network. By incentivizing participants with block rewards and transaction fees, the system promotes honesty and authenticates genuine transactions. As the cryptocurrency landscape continues to evolve, comprehending the underlying principles of consensus algorithms and their impact on network security remains pivotal to shaping the future of decentralized finance.