- Automated Market Maker
- Blockchain Explained
- Blockchain: Private vs Public
- Blockchain Oracle
- Cryptocurrency Trading
- Digital Assets
- Digital Banking
- Digital Currency
- Digital Securities
- Digital Wallet
- Directed Acyclic Graph
- Equity Crowdfunding
- Equity Tokens
- Hard Fork
- NFTs (Non Fungible Tokens)
- Proof of Work vs Proof of Stake
- Security Tokens
- Stablecoins Explained
- Stablecoins – How They Work
- Smart Contracts
- Token Burning
- Tokenized Securities
- Utility Tokens
- Web 3.0
Digital Assets 101
What is a Directed Acyclic Graph and How Does it Work?
Table Of Contents
After the cryptocurrency industry emerged and traders and investors started entering the sector, it quickly became clear that digital coins are like no other asset out there. With no real-world assets to match them and give them value, they were highly volatile. However, they also offered extremely fast, cheap transactions anywhere in the world.
For a time, they even offered anonymity, until block explorers were invented and centralized exchanges started conducting the KYC procedure in order to identify users for their own protection. But, with all the good and bad mixed, the good — representing potential to earn and solve a number of real-life problems with crypto and blockchain — winning, people started coming into the industry.
With a growing number of users, the crypto sector started developing trading and investing strategies, which eventually led to the need for trading, investing, and payment tools, as well. Of course, some products needed to be created to solve some of the problems that persist in the crypto sector to this day. This led to the creation of a number of solutions, not all of which were good enough to succeed or stick around. However, some did, and are still being used to this day. Some were imported from traditional finance, while others were freshly developed for crypto.
Among them is Directed Acyclic Graph (DAG), which is actually what we are interested in discussing today, and helping new crypto industry members understand what this is, how does it work, and what does it do.
What is Directed Acyclic Graph?
A directed acyclic graph is a data modeling or structuring tool that is typically used in the cryptocurrency sector. It is different from the blockchain itself, as blockchain consists of blocks, while DAG has vertices and edges.
As such, crypto payments conducted on it are recorded as vertices, and then they get recorded atop one another. However, it does still share some similarities with blockchain technology, such as the fact that transactions are also submitted through nodes, and the process requires Proof-of-Work (PoW) tasks to be conducted, meaning that software still needs to solve tasks in order for the processing to take place. However, it is different from what you can see on the blockchain, as we will discuss soon.
In the end, the blockchain looks like an actual chain consisting of blocks, while DAG, due to the way transactions are recorded and stored, reminds more of a graph.
Not only that, but there are some who prefer things to be handled in this way, and they believe that DAG and its graph model may end up being a substitute for blockchain technology at some point in the future. This might be a sensible way to go, considering that DAG has proven to be more efficient when it comes to things like data storage or online transaction processing, whereas many blockchains still struggle with scalability.
DAG might even end up being a solution for the problem of decentralization in today’s crypto industry. Plus, it would eliminate the miners’ need to compete for new blocks and add them to the chain.
DAG can even make transaction processing itself faster, since the nodes are developed simultaneously in its ecosystem. At this point, it simply seems like a better, more secure solution that can allow users to improve the usability of the network once it becomes more scalable and capable.
How do Directed Acyclic Graphs work?
Previously, we have explained that DAG has a tree-like structure, meaning that it has transactions stored one on top of the other, with interconnected nodes acting as its branches. Each node can have multiple parent roots, so the model allows for a greater number of transactions to be validated at one time. This is possible since it is not necessary to wait for one transaction to be over before the next starts being processed.
Of course, there are still certain rules to the way a DAG operates. For example, each new transaction must reference previous transactions before it gets to become a part of the network, which is the same principle that is used in blockchain. Each block must reference previous blocks, in the way blockchain is now.
This was seen as a good practice that only allows a transaction to be confirmed successfully when referenced by another transaction. In DAG, every vertex is a transaction, and there are no blocks involved, so there is no real need for mining to be conducted. Instead of grouping transactions and storing them into separate blocks, they are simply recorded on top of one another.
This is where PoW comes into play, as its tasks are done when a node submits a transaction in order to validate prior transactions.
What can a Directed Acyclic Graph be used for?
The DAG model was created for processing transactions in the cryptocurrency industry, and the reason why it was invented is the fact that the blockchain itself is imperfect. In fact, DAG users have spotted two major weaknesses of the blockchain that DAG was invented to address. One of them is decentralization, while the other is scalability. Meanwhile, even though blockchain’s security and usability are considered to be rather good, DAG has improved upon them further, so we can say that this is another area in which a DAG model beats blockchain.
DAG speeds things up by not requiring one transaction’s verification to be completed before the next one can start, which is a necessary procedure when it comes to transaction processing when it comes to the traditional blockchain system. Along the way, DAG also doesn’t rely on blocks, and no blocks means no mining, which means that less power is needed for the network to function, making DAGs more eco-friendly, on top of everything else mentioned so far.
This leads to other, smaller advantages as well. For example, since there is no mining, that means that there are no miners, and without miners, there is no need for transaction fees.
All the benefits that DAG has to offer are certainly encouraging for the future of this model. However, for the time being, DAGs are still very new in the world of crypto, meaning that their technology — as advanced as it is — is still only in its early stages. As a result, they have yet to reach full decentralization, so their main use case for now is to get networks started.
Their role as a system for transaction processing that can compete with the blockchain, or even eliminate it in the future, was not yet reached, although there is little doubt that DAGs will someday be a dominant technology.
So far, there are only a handful of cryptocurrency projects that rely on DAG. However, those that do — including IOTA, Nano, and Obyte — have all caught the eye of developers and crypto users alike.
DAG vs Blockchain: Pros and Cons
With all that said, let’s summarize how DAG and blockchain compare to one another by listing the pros and cons of each model.
- DAG eliminates the need for mining and expensive mining equipment
- With no mining, there are no miners, which also means that mining fees are eliminated
- No mining also means that DAG-based projects do not require as high amounts of energy as blockchains
- All of these benefits make DAG well suited for microtransactions and high volumes of transactions
- Low volume of transactions makes it more vulnerable to attacks
- Currently still in very early stages
- It has yet to reach full decentralization
- With over 13 years of development and growth, blockchain is now a well-established technology
- It is widely used throughout the crypto industry
- Blockchain is highly secure, immutable, and transparent
- Even the least scalable blockchains are cost-effective when it comes to high-value transactions
- Some of the biggest and most used chains have extremely high transaction fees
- Most blockchains struggle with scalability and transaction processing speed
- PoW blockchains require mining and large amounts of energy
- Requires a lot of storage space and network bandwidth
While blockchain technology revealed that there are other, more modern ways of processing transactions, it may have only been the first step towards achieving the ultimate solution, and not the ultimate solution itself. DAGs might be the second step on that road, or they might be the solution that will stick around for years, decades, or longer.
At this point, it is still too early to try and assume the full spectre of benefits that DAGs may end up offering, as they are simply still too young. However, given everything that they already can do better than blockchain itself, it might not be a stretch to say that further development might result in DAGs being a preferable model to the blockchain that we know today.
It is possible that they will dominate the DLT sector in the future, or they might be a parallel solution to the blockchain. For now, it is important to note that they have huge potential, and that it is worth keeping an eye on their development.
Ali is a freelance writer covering the cryptocurrency markets and the blockchain industry. He has 8 years of experience writing about cryptocurrencies, technology, and trading. His work can be found in various high-profile investment sites including CCN, Capital.com, Bitcoinist, and NewsBTC.
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