Blockchain

Understanding Proof Of Work – Forbes Advisor

Proof of work is a technique used by cryptocurrencies to verify the accuracy of new transactions that are added to a blockchain. The decentralized networks used by cryptocurrencies and other defi applications lack any central governing authority, so they employ proof of work to ensure the integrity of new data.

What Is Proof of Work?

Cryptocurrencies do not have centralized gatekeepers to verify the accuracy of new transactions and data that are added to the blockchain. Instead, they rely on a distributed network of participants to validate incoming transactions and add them as new blocks on the chain.

Proof of work is a consensus mechanism to choose which of these network participants—called miners—are allowed to handle the lucrative task of verifying new data. It’s lucrative because the miners are rewarded with new crypto when they accurately validate the new data and don’t cheat the system.

“Proof of work is a software algorithm used by Bitcoin and other blockchains to ensure blocks are only regarded as valid if they require a certain amount of computational power to produce,” says Amaury Sechet, founder of the cryptocurrency eCash. “It’s a consensus mechanism that allows anonymous entities in decentralized networks to trust one another.”

The “work” in proof of work is key: The system requires miners to compete with each other to be the first to solve arbitrary mathematical puzzles to prevent anybody from gaming the system. The winner of this race is selected to add the newest batch of data or transactions to the blockchain.

Winning miners only receive their reward of new cryptocurrency after other participants in the network verify that the data being added to the chain is correct and valid.

Why Is Proof of Work Important?

The first cryptocurrency, Bitcoin, was created by Satoshi Nakamoto in 2008. Nakamoto published a famous white paper describing a digital currency based on proof of work protocols that would allow secure, peer-to-peer transactions without the involvement of a centralized authority.

One of the issues that had prevented the development of an effective digital currency in the past was called the double-spend problem. Cryptocurrency is just data, so there needs to be a mechanism to prevent users from spending the same units in different places before the system can record the transactions.

While you’d have a hard time spending the same dollar bill on two separate purchases, anyone who’s duplicated a computer file by copying and pasting can probably imagine how you could spend digital money twice—even ten times or more.

Nakamoto’s consensus mechanism solved the double-spend problem. By incentivizing miners to verify the integrity of new crypto transactions before adding them to the distributed ledger that is blockchain, proof of work helps prevent double spending.

Proof of Work and Mining

Consider a conventional bank account. If you deposit a check in your savings account, how do you know that you’ll be credited for the accurate amount? How does the writer of the check trust that they’ll only be debited for the amount they wrote on the check? The value of a bank is that all the parties to a transaction trust the bank to accurately move money around.

With cryptocurrencies, there are no bankers or financial institutions to ensure trust. Instead, miners and proof of work guarantee transparent, accurate transactions. For blockchains that use proof of work, miners are the guardians and facilitators that make the system run smoothly and accurately.

A proof of work mechanism requires miners to use computing resources for the privilege. Here’s how it works:

  • New transactions are grouped together. Users buy and sell cryptocurrency, and the data from these transactions are pooled into a block.
  • Miners compete to process the new block. Crypto miners compete to be the first to solve a complex math problem. By showing proof that they’ve undertaken the computational work—referred to as a hash—earns the miner the right to process the block of transactions.
  • One miner is chosen to add the new block. There is a degree of randomness in deciding which miner wins the right to process the block. The winner is awarded new cryptocurrency coins, and adds a new block to the blockchain.

“Miners work to solve complex math problems to earn a reward,” says Dan Schwenk, chief executive officer of Digital Asset Research. These are laborious problems that require significant computer power and energy to solve. Since miners have invested significant resources in the computer equipment and energy costs required, they’re motivated to accurately validate transactions.

Criticism of Proof of Work

Proof of work systems have attracted a fair amount of criticism, mostly surrounding their massive appetite for electric power:

  • Energy requirements. According to the New York Times, in 2009 you could mine one Bitcoin using a regular desktop computer and a negligible amount of electricity. But in 2021, you would have needed to consume an amount of electricity equal to what a standard American home would use in nine years to mine one Bitcoin.
  • Centralization. One of the most attractive features to cryptocurrency investors is decentralization. Thanks to the intense computational and energy demands of proof of work, however, mining operations have become centralized in a small number of major outfits. This could potentially lead to a few entities controlling the majority of cryptocurrency operations.

Cryptocurrencies That Use Proof of Work

Approximately 64% of the total market capitalization of the universe of cryptocurrencies use proof of work for validation. Some of the most popular cryptocurrencies include:

  • Bitcoin
  • Dogecoin
  • Bitcoin Cash
  • Litecoin
  • Monero

Proof of Work vs Proof of Stake

Proof of work and proof of stake are two different consensus mechanisms for cryptocurrency, but there are important differences between them.

Both methods validate incoming transactions and add them to a blockchain. With proof of stake, network participants are referred to as “validators” rather than miners. One important difference is that instead of solving math problems, validators lock up set amounts of cryptocurrency—their stake—in a smart contract on the blockchain.

In exchange for “staking” cryptocurrency, they get a chance to validate new transactions and earn a reward. But if they improperly validate bad or fraudulent data, they may lose some or all of their stake as a penalty.

Proof of stake makes it easier for more people to participate in blockchain systems as validators. There’s no need to buy expensive computing systems and consume massive amounts of electricity to stake crypto. All you need are coins.

The Final Word

Proof of work is the most popular of the two main consensus mechanisms for validating transactions on blockchains. While it’s not without limitation, miners using proof of work help ensure that only legitimate transactions are recorded on the blockchain.

By doing so, miners also help protect the security of the blockchain from potential attacks that could cause those transacting blockchain-based businesses to suffer losses.

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