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.
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?
What do you think?