With the rise of cryptocurrency in 2021, the legacy of Bitcoin grows stronger and stronger. As institutions continue to invest in Bitcoin and as decentralized applications continue to make their way into public hands, an increasing amount of people want to know how these new technologies function. Eventually, if a curious crypto user comes across mining, it is likely the user will encounter the term Proof-of-Work (PoW) and Proof-of-Stake (PoS).
Let’s look into how this consensus mechanism first came about in order to get an overall better picture of cryptocurrency.
A Brief History of Proof-of-Work
Proof-of-Work has its roots in email technology. Spam messaging was common in the early 1990s, and a paper by two academics, Cynthia Dwork and Moni Naor, was released during this time on how to halt this spam messaging. In 1992, cryptography was already used for chains of blocks in documents. However, only in 2004, seminal work was done through developed tokens that allowed users to consistently validate each token in a legitimate server.
Spurred by the financial crash of 2008, Satoshi Nakamoto, the anonymous Bitcoin founder, used several technologies to create the consensus mechanism we now know in crypto as Proof-of-Work. Today, Proof-of-Work has been implemented on networks like Bitcoin, Litecoin, Ethereum and Dogecoin. It is still considered to be the most secure and time-tested consensus algorithm today, despite the fact that newer protocols for decentralized applications are experimenting with alternative consensus mechanisms such as Proof-of-Stake (PoS), delegated Proof-of-Stake (dPoS), and other experimental algorithms that use a fusion of both Proof-of-Work and Proof-of-Stake.
What is Proof-of-Work?
Bitcoin and other networks operate on what is called Proof-of-Work (PoW) consensus mechanism. Consensus mechanisms are what allows an entire system to agree on the current state of the network and requires participation from both miners who act as transaction validators, as well as individual nodes that enforce the consensus rules. It’s vital that every single node has the exact same copy of the ledger and enforces the same consensus rules in order to be ‘in consensus.’
If one computer node has one version of Bitcoin protocol while another is running a slightly different version of Bitcoin, then the network isn’t compatible . Since Bitcoin and other blockchain protocols function to have every transaction permanently recorded on a digital ledger, having a different ‘consensus’ as to how the digital ledger functions would make the functionality moot. Simply put, each computer has to be ‘in consensus’ for the blockchain to be valid.
One of the main factors of decentralization is to not be subject to a central authority, for the laws that govern any blockchain project to adhere to math and code. The alternative is a centralized authority that dictates how a protocol runs. The drawbacks, of course, are entities that can abuse their power over a system. As such, consensus algorithms are one of the key elements to achieve a functionally viable yet trust-minimized system.
As a mechanism of security, PoW also uses energy and computation to protect the network against attacks. Using cryptography, hashes, and complicated puzzles, PoW works to ensure that the digital ledger remains unalterable for good. To alter the blockchain, one would have to have vast computational power and hardware that can solve algorithms of otherworldly difficulty. This is what makes Proof-of-Work blockchain networks so secure.
Mining and Proof-of-Work
Genesis Mining center. Source: Marco Krohn / Wikimedia Commons.
In crypto-speak, mining and Proof-of-Work have become synonymous. It is easy to see why: PoW refers to the proving work that was done via spending energy. In turn, miners share a Bitcoin block reward, which is often referred to as “mining bitcoin.”
In the early days, it was a lot easier to mine coins because there weren’t a lot of people mining Bitcoin, Litecoin, Ethereum, etc. It wasn’t as competitive because not as many blocks were created. Blocks are where the transaction data is permanently recorded on the blockchain. Mining a block refers to finding a solution to the math problem, and miners reap block rewards and transaction fees for mining. Every 2,016 blocks, Bitcoin mining difficulty adjusts either to the upside or downside, based on the number of available miners. As such, each block’s average time is always approximately 10 minutes.
Back in the days, you could run just any old PC to mine Bitcoin. Over the years, the mining difficulty increased to where you needed GPUs or specialized machines called ASICs to mine. Now you have a situation in which entire mining farms are built just to be competitive in mining Bitcoin. Unless you have vast resources and cheap energy, mining Bitcoin is not necessarily profitable.
Long story short, mining works like this. Let’s say that I want you to guess between a number 1-20. Easy, right? We all played this game as children. But let’s say I want you to guess a number between 1 – 1 billion. A bit harder. Now, I want you to guess a 64 digit string of 16 symbols, from 1-10 and letters A-G. You might need to have 3000 IQ or an immensely powerful machine to guess that I was thinking of the data string 1eF32a0a026bb49… and so on.
If you guessed right with your ultra giga-brain, congrats. You’ve ‘proven the work’. This is why Proof-of-Work was reliable for so long and still has valid proof to support it. You would need vast computational power in order to even remotely control or hack the network because of all the cryptographic work done on it. The task would need herculean effort.
Proof-of-Work vs. Proof-of-Stake
Although the electrical output needed to generate Proof-of-Work is overblown by mainstream media, Bitcoin mining still requires significant amounts of energy. Bitcoin uses up 0.5% of the world’s energy output, as much as one megacity like Las Vegas, although its proponents claim that much of the hashrate comes from renewable energy sources or stranded energy.
Another popular criticism of Proof-of-Work coins states that the consensus algorithm favors miners who have more resources since those with a bunch of cash can buy whole buildings filled with mining tools and mine cryptos. In contrast, Proof-of-Stake, the protocol chance to validate blocks is proportional to the amount of currency you owe. So there is a baseline level of resources you need, which is how much crypto you need to ‘stake’ to ‘prove’ or validate the network, plus the hardware requirements. Instead of mining, Proof-of-Stake functions on validator nodes, which are run by users who validate the network.
However, Proof-of-Stake lends to other issues like a blockchain being overtaken. In PoS, if suddenly a bunch of people come together to take over 51% of the network, or even a single powerful individual buys more than half the protocol’s stake, then the network is compromised. In theory, this might be possible, but in practice it has been impractical to execute. Still, because of this and other issues, some protocols in the future might opt to use a mix of Proof-of-Work ideas alongside Proof-of-Stake.