Bitcoin did something revolutionary: It provided a way to send a digital asset from Point A to Point B on the internet with absolute assurance that it was truly valuable, and unique. There was no need for the sender or the recipient to worry that the Bitcoin was a fake or a duplicate of another token living somewhere else on the blockchain, the software that facilitates and records cryptocurrency transactions. The key was an innovation called Proof of work, or PoW. Without it, the blockchain wouldn’t function, and Bitcoin would be worthless.
What is proof of work?
Proof of work, or PoW, is a program that prevents what’s known as double-spending. That’s a major concern in a digital world where it’s easy to replicate sent objects, including payments.
Imagine if Bitcoin tokens could be copied and pasted—they would have little value to investors or users because they could be created at will by anyone. That’s what PoW is—it’s a control mechanism that preserves the uniqueness of every single one of the 21 million Bitcoins that will eventually circulate in the marketplace. It enables the blockchain to show that every Bitcoin transaction and newly minted token is an original, and not a copy. That gives the system integrity.
PoW does more than prevent double-spending: It helps validate and record Bitcoin transactions on the blockchain, and manages the creation of new Bitcoins. The central idea, as laid out in a 2008 white paper by Satoshi Nakamoto, the pseudonym of a person or group, is that a system of digital money doesn’t need banks or governments to make it trustworthy. Instead, PoW can make digital tokens with self-evident value.
In the crypto community, this is why the system is considered “trustless” or “permissionless”—the asset speaks for itself and doesn’t need an institution, such as a central bank or government, to stand behind it.
Still, if you want to participate in this ecosystem as an investor, user, or miner, you have to abide by the rules established a dozen years ago, called the Nakamoto Consensus. Working in tandem with PoW, it authenticates Bitcoin and the blockchain.
How the PoW algorithm works
PoW functions by requiring Bitcoin miners—organizations devoted to minting new tokens—to solve complicated mathematical puzzles. To do this, miners harness overwhelming computing power and consume massive amounts of electricity. Miners want to be the first in the race to solve these equations and win the right to “hash” a block of Bitcoin transactions. Those miners who prove their work receive new Bitcoins for their labor.
The result is an ever-changing digital ledger that exists on every computer that holds the blockchain, instead of on a centralized supercomputer. The blockchain is also immutable, meaning no one can erase or alter its data.
That’s what the PoW protocol set up: decentralization and immutability. And it’s secure. While crypto exchanges and digital wallets that hold tokens get hacked all the time, the blockchain itself has proven resilient. It’s widely believed that the only way to take control of the ledger would be a so-called 51% attack, in which a perpetrator hacks a majority of the thousands of machines processing Bitcoin transactions. That’s a caper worthy of a James Bond villain, but in the real world it’s highly unlikely.
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Which cryptocurrencies use proof of work?
- Bitcoin accounts for about 43% of the total $1.9 trillion valuation for cryptocurrencies, and it’s the No. 1 user of PoW.
- Ethereum, the second-most valuable chain, also uses PoW, though that will likely change soon.
- Litecoin, another first-generation token, uses PoW.
- Dogecoin, a prank token created by developers to lampoon crypto mania, which became a hit with day traders in 2021, uses PoW.
Proof of work vs. proof of stake
With Ethereum preparing to shift from PoW to Proof of Stake (PoS), comparing and contrasting these two protocols is important. They both use consensus mechanisms to support their respective blockchains. The major difference is that unlike PoW blockchains, PoS chains don’t rely on the sheer scale and speed of miners to expand. Instead, PoS aligns the creation of new blocks with the number of tokens miners hold. As a result, miners don’t have to add ever-more computing power to win the mining race—they can just mine the tokens in proportion to their ownership stake in the currency.
There are variations of the PoS approach. Some stakeholders can lease their tokens to miners, and smaller players can pool their holdings to gain an advantage. The bottom line is that by holding those tokens, they have earned the right to mine. Proof of work miners, on the other hand, can sell their stakes without missing a beat. In fact, they often do to finance their operations.
There’s another difference: electricity consumption. In the PoW world, warehouses filled with power-sucking computers work around the clock to solve equations and win the right to mine and pocket more tokens. That’s the business. That’s also an alarming (and perhaps unsustainable) situation given global warming. Because PoS doesn’t require as much computing power to process and record transactions, it consumes less electricity and has a smaller carbon footprint.
The third issue is the coming split between Bitcoin and Ethereum. In August, the latter undertook a long-planned first step toward transitioning to PoS from PoW. Green-minded crypto entrepreneurs are hopeful this will make Ethereum more sustainable. But the move could have major implications for decentralized finance, or DeFi. Cardano, a leading Ethereum-inspired platform, uses PoS and its token is the fourth most valuable cryptocurrency in the world, with a $69 billion market capitalization.
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