What is Proof-of-Work?
In the world of crypto assets, Proof-of-Work (PoW) is a consensus mechanism that is used in Bitcoin and other blockchains. Through a process called mining, PoW is used to create new blocks, thereby establishing an ongoing transaction history that prevents double-spending. Its primary purpose is to uphold the cryptocurrency’s network integrity and security.
Technically speaking, Proof-of-Work is a “cryptographic proof” whereby a node (prover) proves to the other network participants (verifiers) that a level of computational work has been expended.
Contrary to popular belief, Bitcoin did not create Proof-of-Work. It only brought the concept into the spotlight and innovatively turned it into a competitive task (mining), backed by a financial incentive in the form of a coin reward. However, we can’t fully understand Proof-of-Work without knowing its origin.
A brief history of Proof-of-Work
The concept of Proof-of-Work dates back to 1992 when Moni Naor and Cynthia Dwork embarked on a quest to tackle the problem of email spamming. They published an academic journal titled “Pricing via Processing or Combatting Junk Mail.” The concept aimed to discourage spamming by mandating mail senders to perform some computational exercises before sending out an email.
In 1997, Adam Back developed a protocol called Hashcash, a more advanced concept to prevent email spamming. Hashcash itself already included a type of double-spending (peculiar to blockchain technology) by including what is called the “double-spending protection” concept. Interestingly enough, these initial concepts were not referred to as Proof-of-Work themselves.
Hal Finney, Proof-of-Work, and Bitcoin
In 1999, two years after the creation of Adam Back’s concept of Hashcash, an academic essay by Ari Juels and Markus Jakobsson was published entitled “Proofs of Work and Bread Pudding Protocols.” This was the first time the term Proof-of-Work actually appeared. In the essay, the Proof-of-Work concept is described as “a protocol in which a prover demonstrates to a verifier that she has expended a certain level of computational effort in a specified interval of time.” This version is already similar to the Proof-of-Work concept used in Bitcoin. However, the major difference is that this prior version was not based on any economic incentive.
So, innovation with Proof-of-Work did not stop there. In 2004, Hal Finney developed the concept of “reusable Proof-of-Work (RPOW),” which was built on Adam Back’s Hashcash concept. As such, to this day, this concept is considered to have been an important puzzle piece in the development of digital cash, and it was an essential precursor to Bitcoin.
On October 13, 2008, Satoshi Nakamoto published Bitcoin’s whitepaper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System.” In the paper, Satoshi made it clear that Proof-of-Work plays a prominent role in the success of Bitcoin. Proof-of-Work is used to process and timestamp transactions, thereby creating a chronological transaction history, commonly referred to as the blockchain.
He directly referenced Adam Back’s Hashcash concept, comparing it to Proof-of-Work in Bitcoin’s whitepaper:
The above excerpt shows how the concept of Proof-of-Work evolved over the years. It turned out to be the first consensus mechanism in crypto; that’s why some people believe by creating Bitcoin, Satoshi indeed created Proof-of-Work. However, Proof-of-Work existed long before the creation of the first cryptocurrency (Bitcoin) and was integrated by Satoshi as one of the essential aspects that make Bitcoin work.
How does Proof-of-Work work?
As explained above, Proof-of-Work became popular due to the success of Bitcoin and the blockchain technology behind it. Hence, nowadays it is almost impossible to intellectually separate Proof-of-Work from Bitcoin and its blockchain technology. Ultimately, Proof-of-Work is a consensus mechanism to secure a blockchain like that of Bitcoin, making it possible to create a decentralized transaction history that every network participant agrees on.
What’s a blockchain again? Blockchain is a digital ledger that keeps data records without a central server or single storage point. Data is stored in blocks on every node connected to the network, and nodes are spread around the globe.
In order to maintain the decentralized transaction history, transactions need to be added to the blockchain. This task is carried out by miners following the Proof-of-Work algorithm. They will compete to solve a cryptographic problem by finding a valid hash (nonce) that meets the system’s protocol criteria. Any miner that solves the problem first is given the power to append the new data (block full of transactions) to the existing blockchain.
Before new blocks can be added to the blockchain by providing the necessary Proof-of-Work, there are three important things miners need to hash:
- The batches of transactions to be added to the block
- A hash of the previous block
- A nonce, which represents a random number that is generated for the specific purpose of making mining computationally expensive
The failure to include any of the three will result in an invalid hash.
The concept of the nonce can be further explained by mentioning the so-called “difficulty level.” This feature, which is part of Bitcoin’s design, describes how easy or hard it is for miners to find a valid hash. The protocol sets the difficulty level and automatically adjusts to the speed it takes to find a nonce. In other words: The higher the difficulty, the more difficult it is to find a valid hash and vice-versa. This also means that if more miners are joining a Proof-of-Work blockchain, creating the proof of work will become more difficult. If miners leave the network instead, mining becomes easier. Thus, through the difficulty-level adjustment, it is assured that mining does not get easier, the more computational power is used by all the miners in the network.
One last question is: Why would miners be exerting a computational effort to add blocks to the blockchain? It’s because they are getting rewarded. Whatever miners find a nonce and are thus able to add their block of transactions to the blockchain are rewarded with new coins from the Proof-of-Work blockchain system. This way, miners are incentivized to do mining.
To sum things up: Proof-of-Work operates through guesswork. Miners gather a pile of transactions into a block. In order to add this block to the blockchain, they need to expend computational effort by searching for a valid nonce. Once such a hash is found, the solution is presented to the network and if valid indeed, the block of transaction is added to the blockchain and the guessing work begins anew.
Where is Proof-of-Work used?
The most popular use case of Proof-of-Work as a blockchain consensus mechanism is in the context of Bitcoin. The total percentage of all the cryptocurrencies operating on the Proof-of-Work protocol is estimated to be 64% of the global crypto market.
Numbers don’t lie. Proof-of-Work still dominates the crypto space, even with the recent announcement of Ethereum’s migration from the Proof-of-Work to the Proof-of-Stake consensus mechanism. Ethereum Classics, Monero, Dash, Zcash, Bitcoin Cash, Dogecoin, and other crypto projects are still actively operating on Proof-of-Work.
Why is Proof-of-Work important?
Proof-of-Work is the backbone behind Bitcoin. It helps the cryptocurrency maintain and secure its distributed ledger of transactions in a decentralized way. As such, the consensus mechanism has a good track record in securing a distributed ledger and Bitcoin is living proof of this. After all, the mother of all cryptocurrencies has never been hacked, nor has any counterfeit currency been issued or spent on its blockchain.
Because Bitcoin is based on Proof-of-Work, its security is dependent on how much computing power is used to secure the Bitcoin network. This number can be expressed using the concept of a hash rate. The higher the hash rate, the more computing power and thus energy is securing Bitcoin. While it can be said that a Proof-of-Work network like Bitcoin becomes securer, the more hash rate it compiles, it is also essential that the hash rate is distributed and not controlled by only a few players.
One of the advantages of Proof-of-Work is that it gets better over time. The more it grows, the more secure and expensive the system becomes for hackers to attack. The puzzle being solved during the mining process becomes more difficult to solve as miners increase in numbers. And the more miners there are, the more computing power is needed to successfully participate in mining, which is why the security level of Proof-of-Work blockchains increases.
On the flip side, Proof-of-Work is especially vulnerable in its infancy, because when the hash rate is low, the network can easily be attacked. Bitcoin, however, profited from an immaculate conception. Due to Bitcoin’s low popularity in the early days, the network was successfully bootstrapping without falling prey to any major attacks. In Bitcoin’s beginning, no bad actors considered launching an attack on Bitcoin worthwhile.
The Pros and Cons of Proof-of-Work
Proof-of-Work is important to the blockchain world as it has successfully secured blockchains like that of Bitcoin for many years. However, the consensus mechanism is not perfected and has its pros and cons:
- Proof-of-Work offers blockchain networks a high level of security with its unique way of reaching consensus through mining.
- It upholds the principles of blockchain technology by providing a truly decentralized process of appending transactions to a distributed ledger.
- Economic incentives back it; miners are paid for mining.
- Proof-of-Work mining processes consume more electricity than most alternative consensus mechanisms like, for example, Proof-of-Stake. Also, it requires mining equipment.
- Compared to Proof-of-Stake, the PoW algorithm is less scalable and its transaction throughput lower.
- Proof-of-Work can fall prey to centralization among miners.