Only the second one is correct.
If $a=b$, then $\sqrt{a}=\sqrt{b}$. Note that $x\to\sqrt{x}$ is a function from $[0,+\infty)$ to $[0,+\infty)$: you can only take the square root of a nonnegative number, and the result is always a nonnegative number.
Your process 1 is referring to something else. You write $a=\pm b$ as a shortcut for $a=b$ or $a=-b$, and both are supposed to be valid [1]. And it doesn't really appear because of the square root.
For example, say, $x^2=4$. Then, taking square root,
$$\sqrt{x^2}=2$$
$$|x|=2$$
And only then,
$x=2$ or $x=-2$, that is $x=\pm2$.
You could also write:
$$x^2-4=(x-2)(x+2)=0$$
Hence $x=2$ or $x=-2$, that is $x=\pm2$.
You have to remember that $\sqrt{x^2}$ is not $x$, but $|x|$.
[1] One might want to say that because "$2=2$ or $2=-2$" is true, one could write $2=\pm2$, but I don't think it's ever used that way.