Proof-of-work cryptocurrencies are digital assets that use a process known as mining to reward users who keep track of transactions and balances on an underlying blockchain network. Bitcoin, Litecoin and Dogecoin are among the popular proof-of-work cryptocurrencies.
The mining process at the center of proof-of-work systems can be very energy intensive, which has fueled environmental critiques of cryptocurrency. Ethereum, the second-most valuable cryptocurrency, is moving to a more efficient protocol known as proof-of-stake, and many newer crypto projects are also looking beyond mining. (Note: When you see “protocol” in crypto, it really just means the procedures and rules used to run the system.)
Nonetheless, proof-of-work technology remains a crucial concept in the world of cryptocurrency. Bitcoin, still the dominant crypto on the market, continues to use it to create new coins. And crypto mining, by some estimates, is a multibillion-dollar industry.
Proof-of-work and mining
Mining cryptocurrency is an integral part of the proof-of-work system. Successful miners are rewarded with newly created cryptocurrency in exchange for their services, keeping the underlying network up and running.
Cryptocurrency miners collect records of recent transactions and package them into a “block” that can be entered into a cryptographically protected permanent record for the network. But for that block to be accepted by the network, miners must also crack a mathematical puzzle that requires massive computing power to solve.
With highly valued cryptocurrencies such as Bitcoin, mining rewards can be worth tens of thousands of dollars, so competition to solve those complex puzzles is exceptionally stiff. Miners typically use expensive, single-purpose computers. Your laptop doesn’t stand a chance.
Why does Bitcoin need proof of work?
Bitcoin and other cryptocurrency networks are designed to carry out peer-to-peer transactions between people who don’t necessarily know or trust each other. This is easy enough when you have a trusted central authority such as a bank determining who owes who and how much. However, cryptocurrencies are also supposed to be decentralized, with no single entity in control, and operate without the need for trust.
Proof of work is known as a consensus mechanism, designed to enable cryptocurrencies to be both “trustless” and decentralized. Any user can attempt to update the shared ledger of transactions, so cryptocurrencies need systems to prevent fraud or mistakes.
The basic idea is that consensus mechanisms such as proof of work make it more financially rewarding to be honest than to lie. Let’s use Bitcoin as an example.
Say you have 1 Bitcoin. What does that actually mean? It means that users worldwide have copies of the historical record of transactions using Bitcoin, and those records are all in agreement about the balance in your account.
But what if someone wants to submit a fraudulent transaction trying to spend that same Bitcoin again after they had previously paid it to you? This is why miners must check every new transaction, each of which has unique identifying information, against the historical record to ensure it adds up. And they have a strong incentive to do this.
A miner who’s in a position to submit a block will have spent vast sums of money on equipment and electricity in pursuit of the mining rewards. If other users reject a submission, they lose a chance at a significant payday.
Alternatives to proof-of-work
The primary alternative to proof of work is a protocol called proof of stake. Instead of mining, proof-of-stake cryptocurrencies use a consensus mechanism that relies on a process known as staking.
People who own proof-of-stake cryptocurrency can use it to help validate transactions, either by submitting blocks themselves or by delegating the network power of their cryptocurrency to someone who is doing that work. In order to propose a block, you have to put some crypto “at stake.”
Like proof of work, proof-of-stake cryptocurrencies reward users for successfully submitting blocks. And both types of systems can also provide a disincentive for fraud and mistakes: if you submit inaccurate information, you can lose some of the crypto you put at stake.
The bottom line
Proof-of-work is a foundational technology in the world of cryptocurrency. Bitcoin popularized the mining concept, and many of its competitors — often called altcoins — adopted similar systems.
However, proof-of-stake cryptocurrencies have been increasingly popular, and they offer some virtues. Notably, they are more energy efficient because they do not require as much raw computing power. Staking is also technically and financially more accessible than mining, thanks to the cost of securing mining equipment and paying for the electricity to run it.
There are also other consensus mechanisms, such as proof of burn, which requires a user to destroy some amount of cryptocurrency to propose a new block.
That said, proof-of-work cryptocurrencies have a longer track record than their competitors, and significant infrastructure is built around them. When evaluating a cryptocurrency investment, the consensus mechanism is only one thing to consider.
One of the most important questions with any investment is, what gives it value? So if you’re considering buying a digital asset, make sure you ask what it’s designed to do, whether it does that well and whether any competitors might do it better — regardless of their consensus mechanism.
The author owned Bitcoin, Ethereum and Dogecoin at the time of publication. The editor owned Bitcoin and Ethereum.