Proof-of-Work (PoW) is a blockchain consensus mechanism that is used to validate blocks of information that are attached to each other. This data structure creates ledgers of transactions utilizing distributed ledger technology.
Here algorithm is used to solve a computationally challenging puzzle in order to create new blocks within the network. This blocks contains a list of the of the transactions that took place during a certain period of time.
Those who are able to solve the puzzle are able to add the block, receiving a block reward in the process. This is the incentivization that block producers have to run the hardware and maintain the network. Under PoW, these producers are called miners.
Cryptocurrency mining has come under attack due to the energy usage required to power these systems.
Proof-of-Work was appealing for a couple reasons:
- Solving the mathematical problem is hard
- Verifying the correctness of the solution is easy
Proof-of-Work found its way into the Bitcoin White Paper, released in 2008 by the pseudo-nonymous Satoshi Nakamoto. This was the first major digital currency network to employ this mechanism.
The idea for digital currencies that utilized decentralized systems came from the Cypherpunk movement in the 1980s/1990s. People such as Nick Szabo and David Chaum were some of the early innovators when it came to digital monetary systems.
Many of these early attempts were met with failure. ECash was a concept by Chaum that was ahead of its time. That ran into challenges due to computational speeds. Bit Gold was put forth by Szabo but that could not overcome the centralization of the validation process.
The idea for Proof of Work was first published in 1993 by Cynthia Dwork and Moni Naor. We see the term “proof of work” first used by Markus Jakobsson and Ari Juels in a publication in 1999.
By the time Satoshi Nakamoto released the Bitcoin White Paper, computational networks were significantly more advanced. Another major change was the fact the Proof-of-Work consensus mechanism was able to solve the double spend problem in a decentralized manner. This is what Szabo was not able to overcome.
This is a vital component for money as a system that allows for random changes to account balances or coins to be spent more than once will not garner a great deal of trust.
As the Bitcoin software was released, other innovators forked it. This created other chains such as Litecoin which used the same basic code yet did change some features. For example, the block time on Litecoin is much faster than Bitcoin.
How PoW Consensus Works
PoW is a race to solve a cryptographic puzzle. Once this is accomplished, they won the chance to add the block to the chain and collect the block reward.
The miners collect all pending transactions from the decentralized network and compete with each other to solve the puzzle. Whoever does this will generate a block and push it into the network for verification from other nodes.
Once a block is verified, the other nodes can add it to their own copy of the blockchain. Even though each node is running their own version of the software, all copies have to match. If one does not, it is rejected as it is no in line with consensus.
Under PoW, the miners race to identify the value of the nonce. A nonce is an attribute in the block header structure. To start, each miner guesses a number, checking whether the resulting hash value is less than the blockchain specific target. Every number between 0 to 232 has the same opportunity. For this reason, many opt to loop through from 0 to 232 until a number can meet the criteria.
The algorithm used by Bitcoin is the SHA-256 algorithm which outputs a fixed-length number.
Once the nonce is found, the information is broadcast to the network for verification.
- the previous block's hash value
- the collection of transactions
- the Merkle root of all transactions in the block
The other nodes then check whether the results are valid. If they are, the block to their copies of the blockchain. This is the alert to stop mining that block and move onto the next one.
Disadvantages To Proof-of-Work
There are a number of disadvantages that cropped up to this consensus mechanism. For this reason, newer projects tend to opt for other avenues. Proponents of PoW maintain the security and the enormous energy required to take over a chain like Bitcoin is actually worth the disadvantages.
Critics often point to the following:
Energy consumption - miners use a great deal of energy powering their nodes. This led for calls to ban cryptocurrency mining in many places due to concerns about the environment.
51% attack - this is a vulnerability that can be exploited by garnering enough power to simply take over the hash. Bitcoin is probably out of the range of threat since the network is so large. Smaller blockchains did suffer this.
Centralization - mining equipment is very expensive. There are now publicly traded corporations on major stock markets who are nothing more than cryptocurrency mining companies. These entities keep exerting greater control although a number have recently had to file for bankruptcy.
In recent years, miners have sought to counter the energy impact upon their operations by turning to renewable energy where possible. Mining companies receive their revenues from the block rewards. Their costs, outside the hardware, mostly comes from the energy bill. They actually have an incentive to turn to less expensive forms of energy in an effort to help their profits.
In spite of this, many governments still used the energy usage to justify to ban cryptocurrency mining.
Scalability - the ability to scale to a level that puts PoW networks on par with others within the financial or social media realm is still lacking. This was one of the reasons why Ethereum moved to a Proof-of-Stake (Pos) consensus system. Many point to the traffic of a Visa network as compared to Bitcoin's 8 transactions/second as evidence that this approach will not work.
Transaction Fees - in times when the network gets busy, the cost of a transaction skyrockets. One of the selling points of cryptocurrency versus the traditional financial system is the idea that it would be less costly to operate. Fees during peak usage on a PoW chain can exceed that of the banks.
Lack of smart contract - these were introduced in the 1980s but incorporated into blockchain by Ethereum. This is a fundamental piece of decentralized finance (DeFi) since it allows for the creation of tokens using a protocol such as ERC-20. Smart contracts also enable the formation for decentralized financial services such as liquidity pools and the construction of decentralized exchanges (DEX) to interact with them.
Settlement time - since PoW chains are slow, the time before a transaction is fully settled is delayed. On Bitcoin, this can often take hours if not days. Even still, the transaction might fail after that duration. This obviously is a hindrance to acceptance for commerce and trade.
Taproot: A Reason For Optimism
Bitcoin had an upgrade to the network called Taproot. This was designed to, ultimately, address some of the issues cited above. In addition to that, one thing it provided was the ability to access the network for storing non-fungible tokens (NFTs) on-chain. This capability was always present on Bitcoin yet it was not an easy process. This changed with Taproot.
The Ordinal Protocol allowed digital artifacts called inscriptions to be placed in a Bitcoin transaction. This set off a wave of people using Bitcoin for NFT storage.
Shortly after the introduction on that chain, a developer on Litecoin added the feature that that network.
Taproot offers developers the opportunity to address the speed and cost of the Bitcoin network. Proponents believe this will open the door to PoW chains being able to rival others in terms of the features they eventually offer.
CPU versus GPU
One of the keys in the discussion of cryptocurrency mining is the processor that is used. Originally, Central Processing Units (CPUs) was the norm. However, that changed as GPUs started to take over.
There is debate regarding how this should be approached. Ultimately, since GPUs tend to be specialized, they work better at a task such as hashing. CPUs tend to have more responsibilities which means there is less power available for the mining process. This can make it effective.
Most of the mining hash these days come from GPUs although Bitcoin relies upon ASIC.