What is Proof of Work and how does it work?

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What is Proof of Work and how does it work?

Key takeaways

  • Proof-of-Work is a consensus mechanism used by cryptocurrency networks that ensures the integrity of transactions and balances data on the blockchain 
  • Cryptocurrency miners have to solve complex mathematical problems to keep Proof-of-Work networks secure, for which they are compensated with block rewards
  • Prominent examples of Proof-of-Work cryptocurrencies include Bitcoin, Ethereum, Litecoin, and Dogecoin

Proof-of-Work (PoW) is a decentralized consensus mechanism that ensures blockchain systems' security and transaction data integrity. The pseudonymous creator of Bitcoin, Satoshi Nakamoto, was the first to envision PoW being used in a blockchain system as a way to achieve consensus about the state of the distributed ledger, more commonly known as the blockchain.

The Proof-of-Work consensus algorithm involves mathematical problems that are simultaneously difficult to solve–meaning they require a lot of computational power–but easy to verify. Individuals or groups solving computational problems to produce new blockchain blocks and verify on-chain information are called cryptocurrency miners.

Achieving consensus on the state of the ledger is crucial for any blockchain - if network participants are not in full agreement on the state of the ledger's transactions and balances, such blockchain won't be used.

In order to achieve consensus among different participants in the network, various blockchains employ different types of consensus mechanisms. The two most widely used consensus algorithms are Proof-of-Work and Proof-of-Stake (PoS).

How does PoW consensus algorithm work and what is cryptocurrency mining?

When it comes to Proof-of-Work, cryptocurrency miners contend for the benefit of supplying the next block to the blockchain by utilizing computer hardware to solve resource-intensive mathematical problems. Whoever is the first to reach the correct answer gets to add the next block to the blockchain and receives a block reward (more on that later) as compensation. Blockchain network nodes then distribute the information until consensus is reached among all network participants.

The premise behind Proof-of-Work is simple – when someone has to put in resources like acquiring the mining hardware, paying for electricity, and maintenance, they probably won’t harm the blockchain system, as harming the system will result in losing their investment. 

Bitcoin mining facility

Cryptocurrency mining hardware is often housed in large dedicated mining facilities. Image source: American Banker

The speed at which the Proof-of-Work cryptocurrency network processes transactions and updates the ledger is directly correlated with the number, or better said, speed of computer hardware employed to achieve a consensus.

Before transaction data from a new block can be added to the blockchain and the successful miner receives a block reward, all previous transaction data must be reconfirmed, which means that the process gets gradually more resource intensive over time. 

What is the Hash Rate?

The total computational power being used by a Proof-of-Work cryptocurrency is called the hash rate. If the hash rate is high, this means that a large number of miners are participating in the Proof-of-Work process. Conversely, a low hash rate number is an indicator that not many miners are active, which could mean the network’s security and integrity of the distributed ledger is in jeopardy. 

Bitcoin hash rate chart between May 2019 and May 2022

Bitcoin 3-year hash rate chart. Image source: Blockchain.com

Hash rate is measured in the number of calculations the combined computational power backing Proof-of-Work networks can complete in a single second. Bitcoin, backed by the largest networks of cryptocurrency miners, boasts a hash rate of more than 200 exahashes per second (EH/s).

Halving and Block Rewards

Most Proof-of-Work cryptocurrencies undergo a programmed event–usually referred to as halving–after a certain number of blocks have been added to the blockchain. Halvings decrease the amount of block rewards over time to regulate the number of new coins that enter circulation via cryptocurrency mining.

In the case of Bitcoin, block rewards are reduced by 50%, or halved, every 210,000 blocks. In practice, this takes place every four years. It is worth noting that the reduction of block rewards doesn't need to be slashed precisely in half and is thus dependent on each currency’s monetary policy. 

Bitcoin block rewards chart from LocalBitcoins.com

Visual representation of Bitcoin mining rewards halving cycle. Image source: LocalBitcoins.com

Moreover, some Proof-of-Work cryptocurrencies don’t slash their block rewards at all. For example, Ethereum doesn’t regulate its supply with scheduled mining rewards reductions but rather with real-time burning of Ether transaction fees.

Examples of a Proof-of-Work blockchain

The most prominent example of a Proof-of-Work cryptocurrency is Bitcoin, the world’s oldest and largest decentralized blockchain network. Bitcoin uses the SHA-256 cryptographic algorithm, which means that the computational output the Bitcoin network produces is always 256-bits in length and cannot be decrypted. 

Bitcoin is far from the only blockchain network using the Proof-of-Work consensus mechanism. Ethereum, Litecoin, Monero, and Dogecoin are some examples of popular cryptocurrencies that use Proof-of-Work to achieve a consensus among their network participants. 

It is worth noting that the share of Proof-of-Work cryptocurrencies is steadily decreasing as an ever bigger number of blockchain systems operate using the more energy-efficient Proof-of-Stake algorithm. 

How much energy do Proof-of-Work networks consume?

One of the most significant drawbacks of the Proof-of-Work mechanism is its high energy consumption. Running state-of-the-art computer hardware around the clock requires a huge amount of electricity. Bitcoin, being the largest PoW network, consumes 113.8 TWh/yr (terawatt-hours per year), roughly 40% of what the banking and gold industries consume on a yearly basis. 

Ethereum, the second largest Proof-of-Work cryptocurrency, consumes considerably less electricity, with its yearly energy footprint being 44.5 TWh/yr. Here’s a table to help you contextualize the power consumption of popular PoW networks: 

  Energy footprint As % of global elec. supply
Global elec. generation 26,730 TWh/yr 100%
Banking sector 263.7 TWh/yr 0.98%
Bitcoin network 113.8 TWh/yr 0.42%
Finland 86.1 TWh/yr 0.32%
Ethereum network 44.5 TWh/yr 0.16%
Dogecoin 6.36 TWh/yr 0.02%

Source: Galaxy Digital, IEA, Ethereum.org, Digiconomist

What is the difference between Proof-of-Work and Proof-of-Stake?

Whereas in Proof-of-Work, miners compete for the privilege of adding new blocks to the blockchain and winning a block reward, in Proof-of-Stake, participants don’t use their hardware to verify transactions but instead, they stake their coins (hence the name).

Staking refers to a process in which cryptocurrency owners put their digital assets as collateral to verify transactions and add new blocks to the blockchain. Some people who stake their coins are typically randomly selected to become validators, who are tasked with securing the networks and processing transactions. The more coins a user stakes, the better the chance of being selected as the validator. 

Graphic comparison between Proof-of-Work and Proof-of-Stake consensus algorithms

Visual comparison of Proof-of-Work and Proof-of-Stake consensus algorithms.

Instead of being compensated with mining rewards for their effort (as is the case with Proof-of-Work), Proof-of-Stake networks reward stakers with a part of transaction fees that are generated by users that use the network.

Since Proof-of-Stake requires no special hardware for the verification process to take place, Proof-of-Stake networks are far more energy efficient than their Proof-of-Work counterparts. For a better idea of just how big the discrepancy can be, let’s take Ethereum as an example.

The popular smart contract platform is slated to transition from Proof-of-Work to Proof-of-Stake in the near future. According to the Ethereum Foundation, the network’s energy usage could decrease by as much as 99.95% once the transition is complete.

Another benefit of Proof-of-Stake cryptocurrencies is that they are generally more efficient than Proof-of-Work networks, meaning they are capable of processing transactions at a faster pace and at lower costs.

Final thoughts

Proof-of-Work is an essential component of blockchain technology, powering most transactions that take place in the cryptocurrency sector. While Proof-of-Stake is generally more efficient and can handle transactions faster, it can be argued that the costs associated with cryptocurrency mining give Proof-of-Work cryptocurrencies inherent value

Peter is a seasoned article writer at CoinCodex with over a decade of experience in the dynamic realm of blockchain and cryptocurrency. His insightful analyses and articulate reporting offer readers nuanced perspectives on the ever-changing crypto landscape. Peter also explores the captivating world of blockchain gaming and online crypto casinos, infusing his coverage with enthusiasm that adds a refreshing dimension to his work.

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