Proof-of-Work: Bitcoin consensus algorithm – The Cryptonomist

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 way that can be accessed by anyone. Some of the most popular blockchains using PoW are Bitcoin, Dogecoin and Monero.

In todays article, we will explain how the consensus algorithm works and analyse its strengths and weaknesses.

First theorised 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, the PoW is a consensus algorithm that aims to ensure the proper functioning of a decentralised network of anonymous participants without them having to trust each other.

Since blockchains by design do not have a centralised 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 incentivised economically to perform the action that most benefits the network itself.

In fact, miners are incentivised 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.

Let us now look at the specific case of Bitcoin to understand how the PoW ensures the security of the worlds most famous blockchain.

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 transaction amount, which are recorded in the block header, a hexadecimal (i.e. base 16) number generated by the blockchains 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, its hash has to 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 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.

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

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

In terms of environmental impact, the criticism is based on the high energy consumption associated with a high-intensity activity such as mining.

While 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, thus significantly reducing the emissions of the networks.

In terms of centralisation, critics argue that there is currently an imbalance in the composition of miners pools, with the largest pools controlling a large proportion of the networks hash rate.

As the graph shows, the top four mining pools controlled approximately 77.2% of the networks hash rate over the last 24 hours.

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 Merge, which sanctioned the transition of the network from PoW to PoS, Proof-of-Work is still used by many large cap protocols because of 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 widely used by blockchains to guarantee their security?