The blockchain technology that powers Bitcoin and a slew of other cryptocurrencies is essentially a database, but it is unlike any other centralized ledger. It’s decentralized, with no central authority to call the shots or set the rules, and it’s powered by peer-operated nodes all over the world.
Check out the BitDAO guide for detailed information on where to find the right cryptocurrencies to invest in.
So how do you secure a decentralized network and ensure that everyone agrees on the contents of the ledger? That’s where Bitcoin’s proof of work consensus algorithm comes in.
What is Proof of Work?
Proof-of-work is the blockchain-based algorithm that secures many cryptocurrencies, including Bitcoin and Ethereum.
In combination with public-key cryptography, the proof of work consensus algorithm secures the distributed ledger and protects the network from “double spend” attacks, all while adding new blocks of transactions to the chain and generating BTC rewards.
If users can double-spend their coins, this inflates the overall supply, debasing everyone else’s coins and making the currency unpredictable and worthless.
The proof of work mechanism requires Bitcoin miners to compete to solve complex mathematical equations using their computers—a very energy-intensive process. It’s difficult on purpose, but the resulting Bitcoin rewards can be incredibly valuable indeed.
Proof of work is essential to Bitcoin’s continued operation, but its energy consumption has received considerable scrutiny and some other cryptocurrencies have embraced the proof of stake model.
Moving on, let’s define what a consensus mechanism is, how proof of work functions, why it is necessary for Bitcoin, and what the drawbacks are.
What is a Consensus Mechanism?
A consensus mechanism is a process by which the network reliably and automatically determines which participant’s submitted block—which is a record of recent transactions—will be added to the chain, thus minting and rewarding them with new cryptocurrency in the process.
How Proof-of-Work Works
Proof of work is the consensus mechanism designed for Bitcoin by its creator, Satoshi Nakamoto. A similar model has been employed by Ethereum, Litecoin, Dogecoin, and other cryptocurrencies since then.
A PoW algorithm works in such a way that miners within a network need to solve a mathematical problem so that they can create the next block. Whoever is the first one to get the solution to the mathematical problem gets the consensus permission to choose the block that should be added next to the platform.
As a result, this successful miner gets currency as a reward. In a bitcoin network, the reward is a bitcoin token. Therefore, there is the incentive to continue solving the mathematical problems so that one can get permission to choose the next block.
Ultimately, the math is arbitrary: miners are doing work for the sake of it, to spend precious computing resources in exchange for a potential reward. It’s an intentionally difficult process to prevent potential attacks on the network, but that means that more powerful computers have an advantage.
This is to say that those miners that have the highest computational power are the most likely to find the solution to the mathematical problem.
Bitcoin users broadcast transactions to the blockchain, and miners collect them up in a block and compete in proof of work to be the first to solve the equation via a process called hashing. The miner or mining pool whose block is accepted earns Bitcoin as a reward. The reward is currently set at 6.25 BTC; it was originally 50 BTC and halves every four years. This process repeats every 10 minutes or so, as new blocks are written and new Bitcoin is effectively minted and awarded.
Why is Proof-of-Work Important?
The goal of proof-of-work is to prevent users from printing extra coins they didn’t earn, or double-spending. If users were able to spend their coins more than once, it would effectively make the currency worthless.
In most digital currencies, this problem is easy to solve. The bank that is in charge of the system keeps track of how much money each person has.
But in cryptocurrency, there isn’t such an entity. Proof-of-work provides a solution.
Which Cryptocurrencies Use Proof of Work?
Proof of work is the dominant consensus model among cryptocurrencies, with the two largest coins—Bitcoin and Ethereum—both using it, along with other coins like Litecoin, Dogecoin, Bitcoin Cash, and Monero.
What are the Problems with Proof-of-Work?
There are at least a few problems with proof-of-work:
High energy use: Bitcoin uses as much energy as all of Switzerland because of proof-of-work. And its energy use is increasing as more miners join the hunt for bitcoins, though some of this is powered by renewable energy.
51% attacks: If one mining entity can accumulate 51% of Bitcoin’s mining hash rate, it can then flout the rules temporarily, double-spending coins and blocking transactions.
Mining centralization: Proof-of-work is all about creating a currency without one single entity in charge. That said, in practice, the system is somewhat centralized, with just three mining pools controlling almost 50% of Bitcoin’s computational power. Developers are attempting to at least alleviate this issue, however.