What is Cardano and how does it work? A guide to ADA

With a market capitalization over $10 billion, Cardano ADA +0.81% is one of the biggest blockchains utilizing the proof-of-stake mechanism to serve as the infrastructure for decentralized applications.

Cardano was founded in 2015 by Charles Hoskinson and Jeremy Wood. Hoskinson was previously a co-founder of Ethereum. It is the first blockchain to implement the Ouroboros proof-of-stake consensus algorithm, which is often described as more energy-efficient than the proof-of-work consensus used by Bitcoin.

Cardano's initial mainnet went live in September 2017. This marked the launch of the Cardano blockchain, enabling ADA transactions over a federated network using the Ouroboros consensus mechanism. The network employs a smart contract framework called Plutus, which allows the use of the Haskell programming language to write applications. 

The ADA cryptocurrency

The ADA cryptocurrency is the native asset of the Cardano blockchain, and it plays a critical role in maintaining and operating the network. Unlike cryptocurrencies like Bitcoin, which primarily serve as a digital store of value, ADA is designed to enable a broader set of functionalities, ranging from facilitating transactions to being staked to secure the network.

Cardano’s consensus mechanism, known as Ouroboros, is a proof-of-stake system, which is fundamentally different from the proof-of-work systems found in cryptocurrencies like Bitcoin. In proof of stake, the creation of new blocks is performed by validators who are chosen based on the number of coins they are willing to “stake” as collateral. Essentially, ADA holders can participate in staking to help validate transactions, add new blocks to the blockchain, and thereby keep the network secure. In return for staking their ADA, participants receive additional ADA as rewards, creating an incentive for users to hold and stake their coins rather than spending them.

In terms of its economic model, ADA has a capped supply, much like Bitcoin. The maximum supply of ADA is fixed at 45 billion tokens, with a current circulating supply of approximately 35 billion. Transaction fees in the Cardano network are also paid using ADA, and these fees are adjusted algorithmically based on network activity. Additionally, certain network upgrades and functionalities might require users to pay fees or make deposits in ADA, which further integrates the cryptocurrency into the Cardano ecosystem.

ADA can be stored in various types of wallets, including hardware wallets, mobile wallets, and desktop wallets. Cardano offers its official wallet, known as Daedalus, which provides a full copy of the Cardano blockchain and offers enhanced security features. Another option is the Yoroi wallet, which is a lightweight wallet for Cardano that runs as a browser extension.

Cardano development phases

Since its launch, the blockchain has evolved through several phases, each introducing key features. The Byron Era, the initial version of Cardano, began in September 2017. This phase launched the first mainnet, enabling ADA transactions over a federated network using the Ouroboros consensus mechanism.

The Shelley upgrade followed in mid-2020, decentralizing network consensus. This update transitioned the network to a state where most nodes were operated by the community rather than a centralized entity.

After Shelley, the Goguen era brought further blockchain capabilities through a series of hard forks. In March 2021, the platform added support for native assets through the Mary hard fork. Later, Cardano advanced to the Alonzo phase in 2022, enabling smart contracts for the first time. Concurrently, the project initiated the Plutus Pioneer Program to train over 1,000 interested developers in writing dapps on Cardano.

Cardano consensus and architecture

Cardano features a unique two-layer architecture. The Cardano Settlement Layer (CSL) handles all ADA transactions, while the Cardano Computation Layer (CCL) oversees computational functions, including smart contracts and dapps.

Time on the Cardano blockchain is divided into epochs, each consisting of a series of slots. In each slot, a slot leader is elected to validate transactions and add them to the blockchain. This election is not random but rather is based on the amount of ADA an account holds and has staked.

The election of slot leaders is a key aspect of the Ouroboros protocol. The more ADA an account has staked, the higher the chance that it will be chosen as a slot leader. This system of proportional election aims to ensure a more democratic and decentralized mechanism of transaction validation. Ouroboros also incorporates multi-party computation to ensure that the election of slot leaders is both random and secure, eliminating any predictable patterns that could be exploited.

Security is another focus of the Ouroboros design. The protocol claims to offer provable security, assuming that the majority of ADA staking is controlled by honest nodes.

The e-UTXO model

Cardano employs an Extended Unspent Transaction Output (e-UTXO) model for its ledger, which is a variation of the Unspent Transaction Output (UTXO) model used by Bitcoin. The traditional UTXO model keeps track of the ownership of tokens based on unspent outputs from previous transactions. In contrast to account-based models (like the one used by Ethereum), where the ledger resembles a state machine, the UTXO model treats each transaction as an atomic operation that consumes certain outputs and produces new ones without affecting other parts of the ledger.

The e-UTXO model extends this basic framework by incorporating some features commonly found in account-based models. Specifically, e-UTXOs can carry additional data fields and can also be subject to more complex conditions specified by smart contracts. In essence, e-UTXOs permit Cardano to integrate complex logic without compromising the benefits of the UTXO model, such as scalability and parallel transaction processing.

Cardano entities

The Cardano team is split across three independent Cardano-centric entities: the Cardano Foundation, Input Output, and Emurgo.

The non-profit Cardano Foundation, based in Zug, Switzerland, oversees and supervises the project. Input Output spearheads research and development as well as delivering protocol upgrades. Emurgo acts as the private investment side of Cardano funding, accelerating projects.

Research-driven approach

Cardano has quite a strong academic foundation. This methodology incorporates a peer-reviewed approach to the network's software architecture and functionalities.

Over the years, the project has been subject to rigorous academic scrutiny and has undergone peer review.  Due to this reason, the project has prioritized transparency in software development, using features substantiated by empirical evidence. Cardano's research team has generated over 100 scholarly papers, discussing topics from distributed systems and programming languages to game theory.

While the research-driven approach has its merits, it has also led to software upgrade delays during its progression.