Proof of Work: Bitcoin Consensus Algorithm – The Cryptonomist

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Proof of work (PoW) is a consensus algorithm used by many blockchains to verify the validity of transactions made on the network, which are grouped into blocks and then recorded on the public ledger in a manner accessible to everyone. Some of the most popular blockchains using PoW are Bitcoin, Dogecoin, and Monero.

In today’s article, we’ll explain how the consensus algorithm works and analyze its strengths and weaknesses.

Proof of Work: Purpose and Operation

First theorized by Hal Finney in 2004 as Reusable-Proof-of-Work (RPOW), a precursor to the model later presented by Satoshi Nakamoto in his famous white paper, PoW is a consensus algorithm that aims to ensure the proper functioning of a decentralized network. network of anonymous participants without them having to trust each other.

Since blockchains, by design, do not have a centralized authority (such as a bank) to act as an intermediary between network participants, this task falls to the consensus algorithm, which has the important task of ensuring that each actor is incentivized – economically – to perform the action that most benefits the network itself.

In fact, miners are incentivized to properly validate transactions and ensure network security through block rewards, i.e. issuing new cryptocurrencies that are rewarded to miners after making their work properly.

Let’s now look at the specific case of Bitcoin to understand how PoW ensures the security of the most famous blockchain in the world.

Proof of work agreement mechanism

When transactions are executed on the bitcoin blockchain, they are grouped together before being verified and waiting to be placed in a block.

Each block contains information about the date, wallet addresses and amount of the transaction, which is recorded in the block header, a hexadecimal (i.e. base 16) number generated by the blockchain hash function. Each block that makes up the blockchain also contains the hash of the previous block, so it is impossible to modify a single block without necessarily also modifying all the previous ones, which makes the operation incredibly complex and expensive.

Before a new block can be added, its hash must be verified by miners by solving a complex cryptographic puzzle that requires a lot of computing power.

As mining is a competitive process, miners compete to be the first to solve the puzzle, validate the block and receive the reward, which consists of $BTC from block rewards and transaction fees.

Visual representation of the bitcoin block validation process. Source: mcgrathnicol.com

In order to increase their competitiveness and chances of receiving rewards, miners form “mining pools” and share their computing power and rewards. Due to the extremely competitive nature of mining today, it is currently nearly impossible to receive rewards without being part of a mining pool.

Proof of work review

Over time, criticism of PoW and mining has not been lacking, focusing primarily on two key issues: environmental impact and centralization.

In terms of environmental impact, the criticism relates to the high energy consumption associated with high-intensity activity such as mining.

While it is undeniable that cryptocurrency mining is very energy-intensive, several initiatives have emerged in recent years that aim to use renewable and/or green energy for mining, thereby significantly reducing network emissions.

In terms of centralization, critics argue that there is currently an imbalance in the makeup of miner pools, with the largest pools controlling much of the network’s hash rate.

Distribution of bitcoin pools in the last 24 hours. Source: btc.com

As the chart shows, the top four mining pools controlled around 77.2% of the network’s hashrate over the past 24 hours.

Conclusion

Despite the fact that the adoption of Proof-of-Stake (the other dominant consensus algorithm in the crypto landscape) has grown significantly in recent years, especially after the Ethereum merger, which sanctioned the network’s transition from PoW to PoS, Proof-of-Work is still used by many large-cap protocols due to the high level of security it provides.

Is PoW likely to be completely replaced by PoS in the next few years, or will it remain one of the most used consensus algorithms by blockchains to guarantee their security?

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