Proof of Work is a consensus protocol used by cryptocurrencies, including Bitcoin, to validate the transactions that occur in their networks. These networks are usually built on blockchain technology. A blockchain is a decentralised, trusted ledger of transactions which occur within a network.
Transactions are validated by a network of separately-owned computers using a cryptographic protocol to assess the accuracy of the data contained on the ledger. The real innovation behind Bitcoin and some other cryptocurrencies lies in the integration of three separate technologies: a decentralised ledger, cryptographic keys, and the Proof of Work.
Proof of Work explained
The Proof of Work protocol is used during the mining process. During this process, nodes compete among themselves to make sure that the information contained in each block of transactions is accurate. For these efforts, they receive a reward.
If you are paid $10 for a product, you recognise the value of that currency, and you trust it because it’s backed by the US Federal Reserve. These institutions act as guarantors of the value of the currencies they print. The Proof of Work protocol does the same for cryptocurrencies. It ensures the data contained in the blockchain is trustworthy by giving the network nodes an incentive to validate accurate data and reject false information.
All of this happens in spite of the fact there is no central institution backing it. When used in the context of a blockchain, it allows for trust between unknown parties because they share a confidence in the veracity of the consensus protocol.
How does Proof of Work actually work?
If I send you one Bitcoin, that transaction is registered on a block with other transactions with a timestamp and communicated to the decentralised network where different machines, or miners, employ their computing power to validate it (along with the rest of the block).
The network nodes validate the information by competing among themselves to find the solution to increasingly more complex mathematical riddles. They present solutions on a trial-and-error basis until one finds the correct number and communicates it to the remaining machines. When a majority of nodes agree that one miner has solved the problem, a consensus is achieved.
For this work, the miner receives a reward in the form of transaction fees and the block of transactions is added to the decentralised, shared ledger where it becomes an immutable part of the blockchain. When these different nodes compete until they reach a solution on which the whole network agrees, they use up a lot of computational power, energy, and time.
As the problems increase in complexity, so do these costs, which provides a further incentive not to cheat the system. Why would you go through all the effort and cost of investing in powerful computers to then miss out on the rewards?
The proof of work protocol that allows for this validation is brilliant in its inception because it relies on human self-interest to guarantee the integrity of the blockchain. Proof of Work exists so that transactions can’t be falsified.
Why does Proof of Work matter?
Proof of Work is essential because it allows for trust in a trustless environment. When miners agree to compete for the reward for getting the next block right, they implicitly agree to abide by the rules of that community of nodes, instead manipulating the blockchain for their own purposes.
By increasing the difficulty of verifying each block, this protocol ensures excessive mining doesn’t take place. It preserves the supply of cryptocurrency while incentivising miners to keep the network running.
Since it uses limited resources like time, computational strength and energy, Proof of Work isn’t infinitely scalable. This often causes controversy.
An alternative to tackle the resource inefficiencies inherent to this protocol is the Proof of Stake (PoS) consensus mechanism. In this mechanism, the network values seniority and investment in the cryptocurrency over computational power. Since every time a new block is created the miner has to trade in old units of that crypto for new ones, that miner will be in a weaker position to create the next block.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.