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Bitcoin’s raison d’être was artificial scarcity, as Juan previously pointed out. But that wasn’t the No. 1 cryptocurrency’s only practical innovation.
Everyone has, at some point, needed to trust that something will happen outside of their control.
Until Bitcoin, there were only two choices available:
1) The two parties could transact in person — fairly effective, but impractical. Or …
2) They could pass through a trusted intermediary — a bank, for instance, or a payment provider (like Visa, Mastercard or Amex). This is more practical but requires an even greater level of trust, by both parties, toward a third party. It required the hope and faith that the third party would never abuse your trust, never suffer security breaches and never fail financially.
But, what if you didn’t trust second or third parties? And what if you wanted more certainty than just the hope that they’d respect their end of the bargain?
Proof-of-Work (PoW) was the answer —
Satoshi Nakamoto, the inventor of Bitcoin.
Proof-of-Work (PoW) was Satoshi Nakamoto’s way of ensuring that the Bitcoin network would work in a way that’s not controlled by any single entity and does not require trust to function. In other words, in a decentralized, trustless manner.
A key issue this also resolved is called “double spending.” Satoshi made sure that users could not spend the same Bitcoin twice. This was done by ensuring the other party would always know that funds have been debited from your account and transferred into their own.
Essentially, it all comes down to the problem of knowing whether the other party is being honest.
How was this achieved? By adding additional blocks of (transaction) data to the blockchain and setting up the system so that most miners (those who move the transactions instead of a trusted third party) will always act in the best interests of the parties because it is in their own best interest, as well.
Incidentally, these best interests also happen to coincide with those of the network; avoiding unnecessary work and cost. This keeps the network moving, as miners are strongly incentivized to remain honest, and not play the system.
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The Bitcoin network relies on solving complex equations, generating solutions that are easy to verify.
The math problems are solved in a computer’s central processing unit, the brains of the system. Then, once the solution is found, it’s broadcast across the network for easy verification by the other participants (nodes).
When the Bitcoin network first got a foothold, more miners became involved. Extra miners meant more competition to solve the mathematical problems.
Satoshi designed the Bitcoin system in such a way that this problem-solving would get more difficult as the number of participants increased. That meant more computer power and runtime — which, in turn, meant more electric energy needed to solve the same mathematical problems.
When people talk of Bitcoin needing the entire energy supply of countries in order to function, you can begin to understand why.
As we learned in physics, energy cannot be created from nothing; it can only be transferred from one form to another.
Without the spent computer energy, there would be nothing at stake. People could game the system. It is a proof that work has been done. And that’s what acts as a barrier to those who may want to harm the network by spamming, canceling and altering previous transactions.
Why go to all this trouble? It’s necessary to achieve consensus, or agreement, among participants on the network.
Somebody must be chosen to add the next block onto the blockchain. They are consensually selected because they are the ones who have solved the mathematical equations that I mentioned earlier. Whoever is chosen receives the reward of newly minted Bitcoins and adds the transaction data to the network.
Is Proof-of-Work problematic? For some, the additional energy spent on ensuring Bitcoin’s move from one place to another is extremely costly, at least environmentally. This energy could have been used elsewhere, they argue — the opportunity cost is high, especially when many have no access to a functional electricity supply.
However, one thing is for sure. The Bitcoin network began running in January 2009 and the security of the network has yet to be compromised.
Proof-of-Work does what it says on the tin can!
In a future issue, we will talk about another emerging solution that certain coins have adopted to solve the need for a trusted intermediary — Proof-of-Stake (PoS).
The big questions: Will Proof-of-Work die a death? Or is it just getting started?
Best,
David Foulk
Les August 24, 2018
Unlike credit cards which have become standard worldwide…..Blockchain is safer with no third party involved. If the speed and the high energy problems can be solved blockchain will eventually become the universal form of currency and trade.
David Foulk reply_all Les August 31, 2018
Awareness breeds familiarity and, with that, confidence will come. Once confidence is acquired, adoption won’t be far away.
Bob Schubring August 25, 2018
The only fiat currency not subject to the double-spend problem, is the Swiss franc, and then only if deposited in a Swiss demand deposit (checking) account. That’s because Swiss law prohibits fractional banking reserves.
If I open a personal checking account in most US banks, the banker is free to borrow my funds and invest them in short-term investments of some sort, for a profit. He may even share some of the profit with me, as interest on my checking account. This introduces Systemic Risk to the US banking system: If I need to buy something with the funds in my checking account, the bank must convert the short-term investments into cash, so that they can pay the check I wrote. If something interrupts the transfer of funds (as the Bear Stearns and Lehman Bros bankruptcies did in 2008), my checks can go unpaid. If enough people’s checks threaten to go unpaid, a run on the banks will develop. That’s what led the Fed to engage in Quantitative Easing, along with a massive purchase of worthless mortgage-backed bonds that nobody else wanted to own.
SEC Commissioner Hester Peirce has echoed a theme that’s been heard from Justice Sandra Day O’Connor and various other members of what’s become The Federalist Society: US States are free to pass their own laws, and run social experiments of various sorts. Failed experiments can be abandoned, and successful ones can be emulated after they’ve proven themselves. Commissioner Peirce seems of the opinion that a healthy market in cryptocurrencies would enable various economic theories to be tested by the backers of cryptocurrencies and the results of those experiments observed. Rather than impose a single monetary policy via the Dollar, we could have competing monetary policies, based on the competing monetary theories of various economists, as each of the alt-coins competes with one another. (In fact, the US Constitution explicitly allows all 50 states to coin their own money, as long as they do it with gold or silver. So a system of Blockchain warehouse receipts redeemable in gold or silver, might be issued by any one of the 50 states. California actually did this back in the 1860s…the Legislature in Sacramento authorized minting of 100-dollar gold bars that had been assayed as gold, because there was a shortage of US currency coming into the state and many prominent taxpayers were in the gold mining business. Of course, a modern blockchain system might allow microgram or picogram quantities of gold to change hands digitally, making it convenient to buy groceries with gold, and not require tweezers and microscopes to carry out the transaction.)
The primary difference between using a commodity (gold, wheat, cotton, coffee) as a medium of trade, and using Proof of Work, is that the commodity has intrinsic value when taken out of trade. Consuming energy to prove that a calculation was performed, is one way of solving the double-spend problem, provided there’s a way to re-use the energy for some useful purpose (e.g. heating houses in winter). If the energy spent, serves no useful purpose at all, the value of Proof of Work is questionable. Commodity ownership is inherently a Proof of Stake. A bushel of wheat, a barrel of diesel fuel, or a gold bar, is an object that someone would use for some purpose, My holding of that commodity and using it in trade, is a cost to me, because people who need to consume the wheat for bread, the diesel oil to dig a basement, or the gold to fill a tooth cavity, are trying to outbid me for it.
If Proof of Work is to have a real future, someone needs to devise a work algorithm that solves a genuinely-useful mathematical problem.
Cryptologists would probably like to have a table of the first ten billion non-Rajaratnam Prime Numbers, so exploring for prime numbers might be a useful form of Proof of Work. Cancer researchers might want an exhaustive map of the human genome, from which to identify the missing nutrients that can reverse cancer growth, if fed to the patient who’s missing them. SETI has organized a volunteer effort, by which people donate their spare compute cycles to comb through random radio noise, hoping to find radio signals emitted by extraterrestrial civilizations.
I don’t think the Proof-of-Work and Proof-of-Stake competition will be settled quickly. There’s room for market competition to develop. And as Juan Villaverde often points out, about 70% of the planet’s population lacks accurate records of land ownership and lacks any access to the banking system. Inviting those people to join the developed world, by providing them with the means to make small financial transactions, will probably do more to eliminate poverty, than will an infinite amount of charitable give-aways.
David Foulk reply_all Bob Schubring August 31, 2018
Excellent food-for-thought.
Much in agreement over the dual-purpose PoW model to ensure that the energy is not wasted.
Users will, ultimately, vote with their mice.
phoenix1969 September 13, 2018
You should look at developments in blockchain, POW is old tech already, DPOS algos like Lisk are proving to be ultra efficient.