What is Proof-of-Work? The definition, features, and benefits
Proof-of-Work (PoW) is a consensus mechanism that requires network members to validate transactions in order to keep the system safe.
Table of contents:
Suppose you are trying to understand how blockchain technology works at some point. In that case, you were probably wondering who makes sure that transactions will be safe since there are no central bodies.
The short explanation would be - blockchain networks such as Bitcoin or Ethereum have mechanisms that make sure every transaction is safely processed, confirmed, and stored.
There are two main mechanisms that blockchain networks use to do that:
- Proof-of-Work (PoW)
- Proof-of-Stake (PoS)
A beginner would struggle to understand how blockchain operates without intermediaries, especially since many explanations on the internet are still filled with technical jargon.
If you opened an article that says: “blockchain networks use Proof-of-Work or Proof-of-Stake as a mechanism to verify transactions,” you would probably be confused.
This is why we will break down in detail how blockchain networks make sure that transactions are verified and safely stored without needing a bank, accountant, or any other third party.
In this article, we will focus solely on the Proof-of-Work concept.
In order to understand the mechanism better, we have to explain the consensus mechanism. This mechanism is the core concept that Proof-of-Work and Proof-of-Stake utilize in order to replace intermediaries.
What is consensus mechanism?
The term “consensus” is the agreement of a group of people on some topic or matter. For example, if you are going out with your friends, you need to reach a consensus about where to go (movies, dinner, etc.).
When it comes to blockchain technology, there are several ways or models in which a group of people can reach a consensus.
What should people in a blockchain network agree on? In short, people who use the blockchain network must agree that every transaction has correct details and that there are no fraud attempts.
How can every user of the blockchain network know that the transaction is valid?
As we explained in our previous blog on blockchain technology and how it works, every user has a digital copy of the list of every transaction in blockchain history (the ledger) which makes the entire process transparent.
Why do blockchain networks use consensus mechanisms in the first place?
Decentralization is one of the key features of blockchain technology. Technology promises a more transparent way of doing everyday things without the need for intermediaries.
The consensus mechanism concept is based on the idea that the consensus of every user of the blockchain network is the only fair, transparent, and safe way to conduct transactions without third parties (like banks, notaries, or other institutions).
Let’s compare the transaction flow in a bank and the blockchain network to explain how users maintain network operations through a consensus mechanism.
Transaction through a bank as an intermediary usually looks like this:
On the other hand, transaction through a blockchain network usually looks something like this:
Many people will ask what stops a random user of the blockchain network from doing something against the rules and for personal gain.
The consensus mechanism is designed to automatically detect fraud attempts and exclude that type of user from participating in the blockchain network.
How is that possible? As we mentioned earlier, blockchain and other Web 3 projects use two models to maintain safety and transparency, Proof-of-Work and Proof-of-Stake.
What is Proof-of-Work?
Proof-of-Work is an algorithm developed in 1993. Its purpose was the protection of potential spam on the servers and DoS (Denial of service) attacks (a cyber-attack deployed to make a computer or network unavailable to its user).
The concept appeared again in 2009. thanks to Bitcoin. This time Proof-of-Work had a new purpose. It was designed as a consensus mechanism that will:
- help confirm every transaction in the Bitcoin network
- add new blocks of transactions on the blockchain
- prevent “double spending” (sending the same number of coins multiple times to several different people)
Bitcoin network still uses the Proof-of-Work mechanism. Besides Bitcoin, there are other Proof-of-Work cryptocurrencies such as Dogecoin and Litecoin.
How Proof-of-Work works?
The reason why the mechanism is called “Proof-of-Work” is that the blockchain users (nodes) have to invest some work in order to verify transactions. We will use visual examples to break it down.
Let’s say Person A sends 100€ to Person B via a blockchain network.
Once the amount is sent, every user in the blockchain network (node) will examine the transaction. Using the distributed ledger, they will notice that it is a new transaction with the amount of 100€.
Once that is established, the users will make sure that Person A hasn’t sent simultaneously the same 100€ to Person C, Person D, and Person E (in a situation where Person A has only 100€ left on his/her account, and he/she tries to send it to others).
If the transaction ticks all the boxes, it will be confirmed and stored in a block.
This is the part where Proof-of-Work gets in. Every block has a unique cryptographic puzzle. Once the block storage reaches its limit (one block in Bitcoin can store 100 transactions), it must connect to the previous block on the blockchain.
Every node will use the power of its computers to solve the cryptographic puzzle.
The user who solved the cryptographic puzzle will share the solution with other users. They will all agree that the block of the transaction can be stored on the blockchain (after which it can never be altered or changed). Also, the user will receive a reward for solving the cryptographic puzzle.
The reward for solving the cryptographic puzzle and storing the block of transactions in the Bitcoin network is 6.25 BTC (per block).
In the next Bitcoin halving process, the reward will be halved to 3,125 Bitcoins per block.
The users who invest their computing power to solve cryptographic puzzles are also known as miners (the whole process is called mining).
The mining process might be tempting, but it has become practically impossible for the everyday user to participate in the last several years.
Solving a cryptographic puzzle requires a large amount of computing power since you are competing simultaneously with tens of thousands of other users for a single solution.
3 key benefits of the Proof-of-Work mechanism
Proof-of-Work consensus mechanism enables an efficient system that will be fully transparent and safe.
It eliminates any possibility of network manipulation, such as double spending (spending the money you don’t have).
Users can try adding fake transactions to the blockchain, but other nodes will easily detect fraudulent attempts. As a consequence, nodes will automatically prevent the user and exclude him from the network.
Adding a large number of fake transactions to the blockchain is practically impossible. This means you have to strongarm the majority of the nods in the network (have control of 51%), which would require a large amount of money and computing power.
According to multiple calculations, trying to take control of the blockchain network would cost hundreds of billions of dollars.
Even if there is an entity that would gain 51% control of the blockchain network, it’s less likely it would succeed in network manipulation.
2. Decentralized system
Besides security, Proof-of-Work promises a high level of decentralization.
It offers the opportunity to every user to be a part of the network. Every user can update the changes and records and have access to the public ledger. That is practically impossible in traditional finance, where institutions keep the records and information to themselves.
3. Reward incentives
Blockchain allows everyone to participate in the network and receive rewards for it. As we mentioned earlier, every node that solves the cryptographic puzzle and confirms the new block in the blockchain can receive compensation in a form of a transaction fee.
This feature motivates many users to join the network and become a node. Having plenty of nodes means the network will be stronger, and more stable which makes the transactions much faster.
Features that make Proof-of-Work a safe and reliable mechanism also have some negative impacts, primarily on everyday users.
The possibility of earning “free coins” by mining attracted many people in this space. As time passed and cryptocurrency became more popular, many invested more money to upgrade their mining equipment and have a better starting position when solving a cryptographic puzzle.
Today, miners are on an entirely different level. We have mining companies with mining farms that contain hundreds of computers. This is something everyday users can’t compete with, which led to the creation of a “mining monopoly.”
Furthermore, having extensive mining facilities led to another problem, and that is higher energy consumption. The consequence of high energy consumption is a negative effect on the environment.
Even though many companies are trying to find solutions for sustainable mining, the public perception of the Proof-of-Work concept is mostly negative, which is why they prefer the Proof-of-Stake mechanism more.