What is Proof of Work (PoW)?

Introduction

Proof of Work is much older than its most commonly known use for Bitcoin’s consensus mechanism. It was first developed in 1993 as a way to combat spam emails.
As was described in more detail in a prior article: “What is a Consensus Mechanism?” - these mechanisms are necessary for distributed systems to process valid transactions and filter out malicious ones while maintaining consensus or agreement among all parties involved.

Proof of Work is very similar to other consensus mechanisms - what sets it apart, however, is its first step of selecting someone in charge. Thereby, every network participant (miner) is competing with their computing power to generate a winning “lottery ticket” by solving a cryptographic puzzle. This ticket generation is very energy-intensive as it requires electricity in order to run respective hardware around the clock.

Problems & Flaws

Energy Consumption - Example Bitcoin

Currently, the Bitcoin network is the largest PoW blockchain and it uses approximately 54 TWh (Terawatt Hours) per year - enough to power five million US households or even power the entire country of New Zealand for an entire year.

Albeit this energy consumption being the most commonly referenced problem with PoW, it makes up the underlying security of the network. Any attacker would need to spend the same amount of energy in addition to acquiring 51% of the network’s computing power in order to attack the network in a meaningful way. This makes PoW extremely secure over time, regardless of whether individuals or entire states attack the blockchain.

However, many critics don’t see the PoW system as scalable nor sustainable for processing transactions of billions of people. Some regard this use of energy as wasteful since these computations do not fulfill any other purpose aside from securing the network.

Centralization

Centralization can be viewed from different perspectives. Generally, any form of centralization could be seen as a weak point for distributed systems. The original motivation behind these kinds of systems is to prevent monopolies from potentially manipulating the system to their advantage. Hence, any centralized parts of cryptocurrencies may offer an attacking vector to the system itself. But centralization may come in different forms.

During the first years after Bitcoin’s emergence, the computing power of an everyday laptop was sufficient for producing (mining) Bitcoins. However, the total computing power of the Bitcoin network has grown to such an enormous extent that it has become uneconomical. To combat this, many miners have grouped up and developed special hardware, which is optimized for Bitcoin mining.

In Bitcoin’s case, there is an argument to be made for supply chain centralization for certain mining hardware. There are currently just a handful of hardware producers supplying the mining hardware globally. These “lottery ticket”-producing machines are also called ASICS (Application-Specific Integrated Circuits). This hardware is custom developed for Bitcoin’s “lottery” (technical term: hashing algorithm). However, the hardware cannot be used for any other kind of computation.

Another weak point is the number of large mining pools in Bitcoin. As the computing power of a single laptop wasn’t enough to consistently earn Bitcoin over time, network participants (miners) agreed to pool their computing power together. That way, they are able to receive smaller rewards more frequently to finance their operations instead of producing a block once a year or even every 100 years.

This behavior incentivizes economies of scale as there are fewer entities building large-scale server centers mining Bitcoin while it becomes cheaper running more mining hardware. This is a form of centralization because not everyone is an expert on building data centers to support the network. Hence, Bitcoin mining is arguably centralizing around the five largest mining pools.

One advantage many Bitcoin supporters highlight is the anonymity of the founder Satoshi Nakamoto. Many founders of other cryptocurrencies are not anonymous and could represent a central weak point in terms of trust in the cryptocurrency.

Additionally, some founders have benefited enormously from the increase in value of their self-developed cryptocurrency. Since most known cryptocurrencies are limited in their supply, people with larger amounts, such as founders, can move the price and manipulate the market in their favor at short notice.
Even in Bitcoin’s case, it is assumed that Satoshi Nakamoto produced the majority of all blocks during the first two years and thus owns around one million Bitcoin, none of which have been sent to date. The only exception was his first “test” transaction to a well-known cryptography expert at the time Hal Finney, who died of ALS in 2014.

Some suspect that Satoshi Nakamoto may no longer be alive and that his private keys may have been lost with him.

Conclusion

In summary, decentralized systems centralize along with the weakest link - whether it would be the storage layer, computation layer, or the network layer. Bitcoin’s mining economy seems to centralize around its computation layer - fundamental to its consensus mechanism and network security.

Nonetheless, Bitcoin’s network using PoW today is arguably the most secure, open computer network on earth. But whether building a decentralized PoW blockchain will scale to what many supporters advocate will be seen in the future.

After 12 years of Bitcoin’s existence, we can observe some of the disadvantages and problems, which have led to even more innovative solutions, so-called blockchains of the second and third generation like Ethereum, Cardano, and many others.