As the first blockchain consensus deployed in Bitcoin (BTC), Nakamoto Consensus ensures that blockchain's data blocks - transactions - are verified as true across all the nodes on the blockchain network.
There is no shortage of speculation on who created Bitcoin. Whether it is a group or an individual, the creator has been dubbed as Satoshi Nakamoto. You may have noticed that satoshi is also the smallest Bitcoin fraction. It is equivalent to 100 millionth of 1 BTC, just like a cent is the smallest fraction of a US dollar, equivalent to 1 hundredth of 1 USD.
Pseudonymous Satoshi Nakamoto published his Nakamoto Consensus in the iconic whitepaper titled "Bitcoin: A Peer-to-Peer Electronic Cash System." Nothing in finance has remained the same after this revolutionary proposal to create digital money based on computer networks and cryptographic math. Since Bitcoin's launch in 2009, it has surpassed the market capitalization of one trillion dollars several times.
Tested over a decade, Nakamoto Consensus gave Bitcoin its value by giving it decentralized security.
Simply put, Nakamoto Consensus gives Bitcoin this enormous value. After all, what good is digital money if transactions can be falsified? Nakamoto Consensus ensures that doesn't happen. If you recall, blockchain is based on data blocks across a network of computers. Each computer (also called a miner or a node) holds the entire record (ledger) of all transactions ever created on the network.
Hence, this is why another name for blockchain is distributed ledger. The question then is, how is this ledger secured from tampering?
This is where one must first understand the concept of Byzantine Fault Tolerance (BFT). For a network to be secure, it must have an in-built tolerance for flaws. In other words, even if there is imperfect data generated by the network or a malicious actor, it must produce valid consensus of the ledger.
Such agents would then have to be removed by a voting consensus. However, as the network scales up, it would take time to make it happen, congesting the network in the process.
Nakamoto Consensus solves the BFT problem through four critical blockchain cogs:
- Proof-of-Work (PoW) - Network nodes (miners) verify data blocks by solving complex mathematical equations. The computing power necessary to solve them requires electricity, which is the "work." Needless to say, the more computing power (hash rate) there is, the more difficult it is to tamper with the network or commit a 51% attack. For their service, miners receive BTC as reward. More importantly, PoW prevents the problem of double-spending because each block is time-stamped, making them immutable. The blockchain that is the longest on the network will always be the one that is valid because most miners verified it with their computing power.
- Block Selection - To become the ones to verify transactions, miners have to compete based on a lottery system - the first to solve a puzzle wins the reward. Because this process is random, it eliminates the potential exploit abuse.
- Scarcity - Hard-coded coin limit of 21 million Bitcoin that can ever be released (mined) into circulation. Moreover, the reward is halved for every 210,000 mined blocks, which happens approximately every four years (usually followed by a bull run). This is because the value of something rises when it becomes both scarce and more difficult to obtain.
- Incentives - The foundation to form a trustless network like Bitcoin blockchain. All parties (miner nodes) on the network have an incentive to validate blocks due to Bitcoin's deflationary design.
Combined with BFT, Nakamoto Consensus makes all four cogs work together to create a decentralized, trustless network that facilitates secure digital money, without having any banking or governmental oversight to instil trust.