Proof of Work (PoW): The Foundation of Cryptocurrency Security

Proof of Work (PoW) is a foundational mechanism designed to prevent double-spending in digital payment systems. It plays a critical role in securing the networks of Bitcoin and many other cryptocurrencies, ensuring the integrity and reliability of blockchain data. As a consensus mechanism, PoW allows multiple participants to reach an agreement without relying on trust.

Introduced by Satoshi Nakamoto in the 2008 Bitcoin whitepaper, Proof of Work was the pioneering consensus algorithm and remains a key player, alongside Proof of Stake (PoS). The concept of PoW predates Bitcoin, with early implementation seen in Adam Back’s HashCash. This proof-of-work algorithm was used to combat email spam by requiring senders to perform a minimal computational task. While this task imposed negligible costs on legitimate users, it effectively deterred those sending mass emails.

What is Double-Spending?

Double-spending occurs when the same funds are spent more than once. The concept is used primarily in the digital money environment. After all, it would be difficult to spend the same physical money twice.

For example, when paying for a coffee today, you hand over cash to a cashier who is likely to keep it in a cash register. You cannot go to another coffee shop and pay for another coffee with the same notes you gave earlier. However, in systems that use digital cash, there is a possibility that this can be done.

You have no doubt at some point duplicated a computer file using copy-and-paste commands. It is also not difficult to email the same file to several dozen people. Since digital money is nothing more than data, people must be prevented from spending twice, i.e., replicating and consuming the same units in different places. A digital payment system that fails to avoid double-spending will crumble in a short space of time.

Why is the Proof of Work Mechanism Required?

With blockchain technology, cryptocurrency users constantly transmit transactions to the network. However, these transactions are not immediately deemed valid; they are only confirmed and added to the blockchain after validation.

The Bitcoin blockchain, for example, serves as a public transaction database (ledger) accessible to all users. Imagine the following scenario: you and three friends have a ledger to keep track of your Bitcoin transactions. Every time one of you wants to make a transfer of value, you write it down:

Laura pays Bob 5 BTC; Bob pays Carol 2 BTC, etc.

Every time you make a transaction, you refer to the transaction from which the funds originated. So, if Bob were paying Carol with 2 BTC, the entry would look like this:

Bob pays Carol 2 BTC, which came from the previous transaction with Laura.

This method provides a way to track the BTC units. If Bob tries to make another transaction with the identical 2 BTC he just sent to Carol, everyone will know instantly. The group will not allow the transaction to be added to the ledger because those 2 BTC have already been used.

This system works well in a small group where everyone knows each other, and they can agree on who should add transactions to the ledger. However, in a larger group of 10,000 participants, this approach becomes impractical, as no one would want to entrust ledger management to a stranger.

This is where the Proof of Work mechanism comes into play. It ensures that users cannot spend money they are not authorized to spend. By combining game theory and cryptography, a PoW algorithm enables everyone to validate the blockchain according to the system’s rules.

How Does PoW Work?

Now, imagine that our notepad used in the example above is the blockchain. We do not add transactions one by one but group them in the form of blocks. We announce transactions to the network, and then users who create blocks bring in a candidate block. Transactions are only considered valid once the candidate block is transformed into a confirmed block, signifying that it has been added to the blockchain database.

The methodology of validating transactions and adding new blocks is called mining. It is both costly and difficult, but also rewarding. The block reward is made up of both transaction fees from users and new bitcoins created through the protocol.

The Proof of Work mechanism demands a miner, who is a user creating the block, to invest resources such as electricity and computing power to hash the data of their candidate block until they can solve the puzzle.

Hashing the block data means passing it through a hash function to make a block hash. The block hash operates like a «fingerprint»: it is an identity for the input data and is unique to each block.

In other words, an engineer has to verify and collect the pending transactions, sort them into a candidate block, and pass the block data through a hash function to create a valid hash. If they find a valid hash for their candidate block, they transfer it to the network, add the block to the blockchain network, and finally collect the mining rewards.

As soon as a miner transmits their candidate block and its hash to the network, other network participants will do the same hashing process to verify that the output is completely valid.

Although it takes many attempts to find a valid hash, someone must confirm that the hash created is correct. You only need to send the same input, via the hash function, and verify if the output is the same.

In Proof of Work, you must send data whose hash meets specific conditions. However, the exact method to achieve this is unknown. The only approach is to pass your data through a hash function and check if the conditions are met. If not, you need to slightly modify your data to produce a different hash. Even changing a single character in the data will result in a completely different output, making it impossible to predict the result.

Consequently, creating a block involves a guessing game. You aggregate information related to all the transactions you wish to add, along with some additional relevant data, and group them. To avoid consistently obtaining the same hash, you need to add as much varying information as possible. This variable data is known as a nonce. The nonce is a number you alter with each attempt to achieve a different hash.

In essence, mining is the process of organizing blockchain data and hashing it with a nonce until you find a valid hash. If you discover a hash that meets the protocol’s conditions, you can broadcast the new block to the network. At this point, other participants in the network can update their blockchains to include the new block.

For the most important cryptocurrencies on the market today, the conditions are challenging to achieve. The higher the hash rate on the network, the more complicated it is to find a valid hash. This process is done to ensure that blocks are not found quickly.

As you might think, trying to guess the massive number of hashes can be a costly task for your computer, wasting computer cycles as well as electricity. However, if a valid hash is found, the miner will be rewarded in the form of cryptocurrencies.

Let’s recap what we know so far:

• Mining is difficult and expensive, but it secures the network.
• Miners who produce a valid block are rewarded with newly issued cryptocurrencies and transaction fees.
• Producing a valid hash takes time, but other users can easily verify its validity by repeating the hashing process.

So far, so good. But what if someone tries to cheat? What prevents them from adding a series of fake transactions to the blockchain and still generating a valid hash?

That’s where public key cryptography comes in. When you complete a transaction, you sign it. Anyone on the network can verify your signature using a public key and check if they match. They will also check if you can spend your funds and if the amount of your inputs is greater than your outputs, i.e. don’t spend more than you have.

Any block that includes an invalid transaction is automatically disallowed by the network. Even cheating is costly, as you can lose your resources without getting any reward.

Therein lies the essence of the Proof of Work mechanism: it makes it expensive to cheat, but profitable to act honestly. Any rational miner wants a return on their investment, so they can be expected to behave in a way that is most likely to produce income.

Proof of Work (PoW) vs. Proof of Stake (PoS)

Apart from PoW, there are many consensus algorithms, but one of the most famous is Proof of Stake (PoS). The concept originated in 2011 and has been implemented in Ethereum and additional protocols.

In Proof of Stake systems, miners are replaced by validators. There is no mining required and no race to guess hashes. Instead, users are chosen on the fly; if chosen, they must propose or forge a block. If the block is valid, they will get a reward made up of transaction fees from the block.

However, not just any user can be chosen; the protocol selects them based on several factors. To be eligible, participants must lock in a stake, which is a predetermined amount of the blockchain’s original currency. The stake operates as a bail bond. Just as defendants pay large sums of money to avoid going to trial, validators lock a stake to discourage cheating. In the case of dishonest behavior, both the stake and a part of it can be taken.

The Proof of Stake mechanism offers some advantages over Proof of Work. The most notable is the lower carbon footprint. As PoS does not require energy-intensive mining farms, the electricity it consumes is only a fraction of that consumed in PoW.

Nevertheless, PoS does not go the same route as PoW. While it could be perceived as a waste of resources, mining is the only consensus algorithm that has been battle-tested for more than a decade. Bitcoin’s PoW mechanism has secured trillions of dollars worth of transactions since its launch. To say with certainty whether PoS can compete with the security of PoW, staking must undergo proper long-term testing.

Conclusion

Proof of Work (PoW) was the pioneering solution to the double-spending problem, demonstrating remarkable reliability and security. Bitcoin’s success illustrates that centralized control is not required to prevent the same funds from being spent multiple times. By leveraging innovative applications of cryptography, hash functions, and game theory, PoW enables decentralized participants to reach consensus on the status of a financial ledger.