How Consensus Algorithms Shape Web3 Infrastructure.
Private and public blockchains enable vastly different forms of financial engineering. Consensus algorithms lie at the core of this distinction.
Decentralization is the core principle at the heart of blockchain technology. The promise of its benefits has become a recurrent theme in discussions about Web3. But how does it really work?
A blockchain is powered by nodes (independent computer systems that form a network). These nodes broadcast transactions and simultaneously perform checks on transactions distributed to the network.
This mechanism is called a “consensus algorithm.” It ensures that no single node operator can cheat the system. A public blockchain is permissionless: nobody needs authorization to join the network. In essence, it is a truly decentralized network. But what about private blockchains?
Permissioned (or private) blockchains work just like the name implies. Node operators are subject to the approval of a central authority that calls the shots. If you’re not one of the cool kids, sorry, you can’t play in this type of sandbox.
You’re probably thinking, “If private blockchains are not completely decentralized, why bother using them?” Great question!
Permissioned blockchains are good for testing systems within a controlled environment. Imagine watching your favorite TV show while someone sits behind the screen and messes with the settings. Similarly, engineers have the freedom to run wild on a private blockchain without ruining anybody’s Sunday dinner. Plus, it's cheaper!
But things start to get weird when private blockchains are deployed to service public infrastructure. So far, most corporations in the industry have stuck to public blockchains and stacks when launching their products. It’s the sensible way to go, given how decentralization is a core value of Web3 technology.
It is possible that government authorities may see things differently, though. The Central Bank Digital Currency (CBDC) wave is sweeping across the world. It is estimated that over 95% of the global GDP is represented by countries exploring the system.
More likely than not, CBDCs will not be launched on public blockchains. Central banks would rather retain the power to choose who participates in their networks. For example, a rule could require node operators to be lawfully registered financial institutions such as banks.
Private blockchains that power CBDCs may even be treated as a matter of national security. This is a gateway for governments to justify a decision to run all the nodes, or shut them down arbitrarily.
If you’re not cringing already, you have nerves of steel. Satoshi Nakamoto’s vision of a transparent global financial ecosystem would be in shambles. Opaque, government-operated blockchains are not only unethical; they’re straight up dangerous.
Let’s paint a few pictures:
The government syncs your tax data and public records to a private blockchain that tracks every penny you spend. They see EVERYTHING.
OK, let’s assume you’re not making any red herring transactions on your bank account. Let’s assume you just happen to be a political opponent of an undemocratic regime. One click of a button, and you’re locked out of the financial system.
Isn’t it weird how often governments have had their official websites hacked? Imagine now if an entire nation’s financial (and presumably, personal) information was tied to a centralized blockchain.
Some private blockchains have a peculiar Achilles’ heel to which public blockchains are immune. They can be compromised from the inside. The rules of engagement are determined by a central authority. Whoever holds the master key becomes the king of the hill.
Think about the losses suffered when DeFi protocols are exploited. Now imagine that on a national scale, with sensitive information falling into the wrong hands.
Now, you know the merits and demerits of private blockchains. Let’s take a quick look at the types of consensus algorithms used by private blockchains.
- Proof of Authority (PoA): The right of a node to participate is determined by proving its identity.
- Proof of Elapsed Time: A randomly determined window of time is set. The first node to complete a task within that time wins the new block.
- Proof of Importance: Nodes with a higher “score” have better odds of winning a new block. Basically, a rigged blockchain.
- Practical Byzantine Fault Tolerance: This assumes that at least 2/3 of amount of the overall nodes in the system cannot simultaneously be malicious. One node is chosen as the leader, and others are designated as backups.
There are other types of consensus algorithms that work in conditions that can be described as "private blockchains." However, sometimes the context is unique enough to not fall strictly under that category. If you’d like to learn more about this, here’s a great article on the topic.
It’s important to understand the subtle differences that affect how blockchains work. Knowing when to sign up for a product or service and where to draw the line, could go a long way.