What is Proof-of-Work & Why Is It Important?
By: Team Luno
Tags: Proof Of Work, Bitcoin, Cryptocurrency, Consensus, Bitcoin Mining

Why is proof-of-work needed?

These aren’t the only consensus mechanisms out there. Some cryptocurrencies use others, such as delegated proof-of-stake, proof-of-authority, and proof-of-weight (we’ll get into some of these a bit later). Each has its own pros and cons, despite having the same purpose: to provide a way to process and verify transactions, while keeping the network secure.

The purpose of proof-of-work is to give miners an incentive to support and secure the Bitcoin network by making it profitable to do so and making it unprofitable to attempt to hack the network.

In the process, proof-of-work helps protect the network from malicious activity, ensuring that miners cannot add fake blocks to the blockchain. If a miner tries to attack the network, they will need to use a lot of expensive resources, but they won’t receive the reward (newly released Bitcoin) that ‘friendly’ miners do. For this reason, it makes more sense to play by the rules.

Alternatives to proof-of-work?

Proof-of-stake is an alternative system, used by a number of altcoins (alternative cryptocurrencies). Now, where proof-of-work is concerned, mining depends on computing resources, whereas with proof-of-stake it depends on how much of a given cryptocurrency a miner owns. So if a miner has 1% of the existing coin, they would be able to mine 1% of the coin released in a new block.

It’s not about how much computing power you have, it’s about how much cryptocurrency you have.

Think about having a stake in a poker game, or in a company — the more ‘stake’ you have, the more power you have to control outcomes. In this case, the outcome is how much cryptocurrency you can mine. Proof-of-stake is believed to reduce the likelihood of attacks on the network because an attacker would need to own a majority of the cryptocurrency, which would be unreasonably expensive. So, it would seem that size doesn’t matter after all…

What is ‘mining difficulty’?

As time passes, computing equipment tends to get cheaper and more powerful. The Bitcoin network launched in 2009 and technology has progressed a lot since then. If you remember buying a computer or phone (read: giant brick-and-battery contraption) back then, or even just a few years ago, it was probably more expensive relative to how much less powerful it was than the one you use today. So, to prevent the cost of mining Bitcoin from dropping too low compared to the price, the ‘mining difficulty’ keeps changing.

Mining difficulty refers to how hard it is to mine new Bitcoin. A new block is released on the blockchain every 10 minutes.

Every 2016 blocks (roughly, two weeks), the difficulty is adjusted to keep the time taken to solve each block consistent. If advances in the computing equipment necessary to run the network reduce the time, the difficulty is increased. If the time taken to solve a block increases for any reason, the difficulty is reduced. The network calculates how much to adjust the difficulty by establishing whether the last 2016 blocks took more or less than two weeks to solve. In the early days, the difficulty was so low that anyone could mine their own Bitcoin on a normal laptop, but that’s no longer feasible.

When the Bitcoin network first launched, miners received 50 Bitcoin per block. This reward halves every 210,000 blocks, which takes around four years.

The total supply is capped at 21 million and no more Bitcoin will be released once it’s all been mined. This will probably happen sometime around the year 2140. It’s not known why Satoshi Nakamoto, the creator or creators of Bitcoin, chose these particular numbers.

The importance of consensus

One of the key drawbacks to the current banking system is the absence of transparency, and we’re not of the belief that how your money is handled or processed should be on a need-to-know basis. In almost every context you can imagine, it’s understandable how and why the notion of consensus makes sense in order for decisions or actions to be made fairly and without malicious or self-serving motives.

In addition to this, proof-of-work is an integral part of Bitcoin. It underpins the value inherent to it.