Most digital currencies have a central entity keeping track of every user and the amount of money they have. But there’s no such leader in charge of cryptocurrencies. This is possible thanks to Proof of work.
Proof of work solves the “double-spending problem” that is generally trickier to solve without a leader in charge. If users can double-spend their coins, the supply may get inflated and make the currency unpredictable and worthless. This is an issue for online transactions because digital actions are straightforward to replicate. Proof of work makes doubling digital money very, very hard.
What exactly is Proof of work, and how does it work? Here are all the essentials of this breakthrough technology underlying cryptocurrencies.
Proof of work (PoW) is the first cryptocurrency consensus mechanism that requires nodes in a network to perform a large but possible amount of work to deter malicious use of computing power, such as sending spam emails or launching denial of service attacks.
PoW was first used in the creation of Bitcoin and has since been adopted by many other cryptocurrencies. It’s based on the concept of “reusable proof of work” using the SHA-256 hashing algorithm, developed by Hal Finney in 2004.
When discussing Proof of work, the question of transaction fees arises as well. Transaction fees were initially used as an anti-spam tool, but eventually turned into one of the essential attributes of blockchain technology. They’re used to compensate the miners who contribute to the network’s growth.
Blockchain consists of a chain of blocks. In the case of Bitcoin, each block contains the most recent Bitcoin transactions stored in it. How do you add new blocks to the blockchain? This is where Proof of work comes in.
Blocks are brought to life by miners – players in the ecosystem who execute Proof of work. A new block is accepted by the network every time a miner comes up with a new winning Proof of work, which happens roughly every 10 minutes.
Finding the winning Proof of work is so difficult that miners need to use expensive, specialized computers that have high mining power. In addition to mining Bitcoins, miners can earn them if they guess a matching computation. The more computations they land, the more Bitcoin they are likely to earn.
To create new blocks in Bitcoin, miners solve complex math problems. These problems are made up of algorithms that get more challenging over time. A miner’s goal is to find a number that creates a hash with a certain number of zeroes at the beginning when paired with the current target.
It’s improbable that miners will find this number on their first try. In fact, if they did, the algorithms would be made more difficult, making it even harder to win a batch of Bitcoin. Whoever wins the race receives bitcoins as a reward.
We referred to Bitcoin in our explanation, but the truth is that most cryptocurrencies use Proof of work. Some are experimenting with other methods and resolve to move away from it (for example, Ethereum).
The most popular cryptocurrencies that tap into the power of this consensus mechanism include:
Proof of work aims to prevent users from creating new money they haven’t earned. If users were able to spend their money more than once, it would effectively make the currency worthless.
In most digital currencies, this problem is easy to solve. The entity in charge of the system keeps track of how much money each person has. If John sends Bob $1, then the bank deducts $1 from John and gives $1 to Bob.
But in cryptocurrency, such an entity doesn’t exist. Proof of work provides a solution. What’s in it for miners? Miners earn Bitcoin rewards for every block they find the solution for. This is what drives them to mine in the first place. This monetary reward also motivates them to follow the rules – for example, not double-spending their money.
Imagine a miner who finds a winning hash for a block. If they submit the solution with the block but break the rules within the block – for instance, spends coins more than once – other members of the Bitcoin network will reject their block. The miner will lose all the Bitcoin they should have won. This threat is what keeps miners honest.
There are a few issues with Proof of work that the crypto community is trying to solve at the moment:
Ethereum uses 113 terawatt-hours per year – as much power as the Netherlands uses in a year. A single Ethereum transaction can easily consume as much power as an average American household uses a week or more. Bitcoin’s energy consumption is even more extreme.
There’s no denying that Proof of work is an energy-consuming solution. That’s why currencies like Ethereum are moving to Proof of stake.
If one person or entity gains control over 51% of a coin’s mining hash rate, it can temporarily defy the rules. For example, they could allow double-spending coins or block transactions.
Proof of work is supposed to create a currency without one central entity in charge. In practice, however, the system is somewhat centralized, with just three mining pools controlling almost 50% of Bitcoin hashing power. The crypto community is trying to alleviate this issue as much as possible.
Decentralization comes at a hefty cost for cryptocurrencies. In Proof of work, that cost translates into computing power. Proof of work poses miners against each other to compete to solve a complex math problem. This calls for a massive amount of computing power.
Today, the world is facing a power crunch. This is partly why China banned crypto mining, and countries like Kosovo or Kazakhstan (where the miners scattered off) are pushing miners out and cutting off their electricity.
Proposed on the BitcoinTalk forum on July 11, 2011, Proof of stake has been one of the most popular alternatives to this consensus mechanism. It was going to be the mechanism securing Ethereum from the beginning. But as Buterin noted in 2014, building such a system was “so non-trivial that some even consider it impossible.”
So, Ethereum launched with a Proof of work model and set to work developing a Proof of stake algorithm. This model does away with miners and replaces them with “validators.” Instead of investing in energy-intensive computer farms as they did back in 2014, validators can invest in the native coins of the system – the “stakes” – and win block rewards when they’re selected to seal blocks.
How do you become a validator? You need to lock 32 ether. If you don’t have that kind of money at hand, you can join a staking pool where participants serve as validators together. An algorithm selects from a pool of validators using the amount of funds they have locked up. The more you stake, the greater your chance of winning this lottery.
If a committee selects you, and your block is accepted by random “attestors” – a group of validators designated by an algorithm – you are awarded newly minted ether. You also have an economic incentive to play by the rules: If you validate bad Bitcoin transactions or blocks (called slashing), all your ether are “burned” or taken away from you.
The efficiency of Proof of stake will certainly put the Proof of work algorithm to the test. But the question of whether other cryptocurrencies adopt it is open.
As cryptocurrencies gain popularity, they need to find a way to process transactions quickly and efficiently. One way of doing so is through Proof of work, a mechanism that allows transactions to be verified on the blockchain in a trustless manner, with miners incentivized by the reward they receive once they solve a cryptographic puzzle.
Because of this inherent security, it has become hard for someone to gain control over the chain. By spreading out the computational power over many computers and users, the decentralized ledger becomes more difficult for any single entity to take control of, ensuring its authenticity and decentralization.
Proof of work plays a vital role in the current crypto landscape, but only the future will tell how many crypto coins stick to it once Proof of stake enters the scene.
