Proof-of-Work: Bitcoin Consensus Algorithm – The Cryptonomist

Proof-of-Work (PoW) is a consensus algorithm used by many blockchains to confirm validity of transactions made on the network, which are grouped into blocks and then recorded in the ledger in a way that is accessible to everyone. Some of the most popular blockchains that use PoW are Bitcoin, Dogecoin and Monero.

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

Certificate of employment: Purpose and function

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 whitepaper, PoW is a consensus algorithm that aims to secure correct function of a decentralized network of anonymous participants without them needing to trust each other.

Since blockchains by design do not have one centralized authority (like 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 – financially – to take the action that benefits the network itself the most.

In fact, miners are motivated to correctly validate transactions and ensure the security of the network through block rewards, i.e. the issuance of new cryptocurrencies that are rewarded to miners after they have done their job correctly.

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

The mechanism for work permit agreement

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

Each block contains information about date, wallet addresses and transaction amounts, which are recorded in block the header, a hexadecimal number (ie base 16) generated by the blockchain’s hash function. Each block that makes up the blockchain also contains the hash of the previous block, so it is impossible to change a single block without necessarily changing all the previous ones as well, making the operation incredibly complex and expensive.

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

Since mining is a competitive process, miners compete with each other 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

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 almost impossible to receive rewards without being part of a mining pool.

Criticism of Proof-of-Work

Over time, there has been no shortage of criticism of PoW and mining, mainly focusing on two key issues: environmental impact and centralization.

When it comes to environmental impact, the criticism is based on the high energy consumption associated with a highly intensive activity such as mining.

Although it is undeniable that cryptocurrency mining consumes a lot of energy, several initiatives have emerged in recent years that aim to use renewable and/or green energy for mining, thereby significantly reducing emissions from the networks.

In terms of centralization, critics claim that there is currently an imbalance in the composition of the miner pools, with the largest pools controlling a large proportion of the network’s hashrate.

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

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

Conclusion

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

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


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