Cryptocurrencies are known for their high level of security — and in many cases, that security is made possible by a proof-of-work (PoW) algorithm. The proof-of-work consensus algorithm is currently used by Bitcoin, Ethereum, Dogecoin, Litecoin, and many other cryptos (although the Ethereum network is transitioning to a different algorithm known as proof-of-stake).
Proof of work largely serves to prevent double spending, which is when the same coins are spent more than once. Digital currencies are prone to double spending since they don’t have any material exchange — it can seem easy and tempting to forge transactions that are just numbers on a screen.
Proof of work and the blockchain keep track of every transaction to prevent this from happening. The algorithm is extremely secure and complicated, making it nearly impossible to double-spend Bitcoin and other PoW cryptocurrencies.
The concept of proof of work was originally developed to prevent denial of service attacks (DDoS) and spam emails, but in 2004 Hal Finney adapted it for use in blockchain digital currency networks. Bitcoin was the first cryptocurrency to put the idea to use.
Recommended: What Is Blockchain Technology and How Does it Work?
How Proof of Work (PoW) Works
Proof of work is basically what it sounds like: proof that work has been done. The “work” is the conversion of electrical energy into “weight” on the Bitcoin blockchain through the use of computing power and a complicated mathematical calculation. Overall, this work makes forging transactions on the blockchain prohibitively expensive and difficult.
The mathematical calculation involves a hash function, which in turn generates a long string of unique numbers. This helps validate transactions and create the next block on the blockchain. Each block contains information about a specific Bitcoin transaction. As the transactions are validated and recorded on the chain, this ensures that double spending hasn’t occurred. Once information has been stored on the blockchain, it cannot be changed or deleted. This helps to keep the private keys of Bitcoin owners secure and anonymous.
Miners’ Role in Proof of Work
Bitcoin miners (nodes) run specialized machinery that works to solve the equation as quickly as possible, and they are rewarded with new bitcoins depending on how much computing power, or hash power, they contribute to keeping the network running.
The objective of PoW is to extend the blockchain. The miner that creates the longest chain gets the reward as well as the transaction fees contained in the block. The best way to solve the calculation is through trial and error, so the more computing power a miner can put into doing as many trials as possible as quickly as possible, the more likely they are to win the block reward.
Why Proof of Work is Needed
Proof of work ensures that double spending doesn’t occur in digital asset networks. It provides security and a record of transactions as well as an incentive for miners to keep the network running.
Proof of work is also needed because Bitcoin has no central authority (vs. a bank, for example). A central authority would keep track of transactions as well as issue new bitcoins to the network. Instead of this, the network of miners keeps track of the blockchain.
Proof of work also adds value to Bitcoin because it shows that people are willing to convert energy, a material resource, as well as fiat currency, into the production of the cryptocurrency. This provides more confidence for those who are interested in investing in Bitcoin.
Pros and Cons of Proof of Work
There are several reasons why PoW is used for Bitcoin and other popular cryptocurrencies, but there are arguments against it as well.
Pros of Proof of Work
• PoW helps keep the network secure
• It prevents double spending
• It adds value to the network through the use of energy
• It is an integral part of the decentralized authority system of the network
Cons of Proof of Work
• It requires computational power, which uses a significant amount of electricity
• PoW has low performance capacity for the execution of on-chain transactions
• Getting involved in mining requires a large upfront equipment cost and ongoing maintenance and electricity costs
• There is a risk that miners may group together to attack the network, undermining its decentralized nature
Which Cryptocurrencies Use Proof of Work?
Proof-of-work is the most commonly used algorithm for cryptocurrency networks. However, some cryptocurrencies use other algorithms, such as proof of stake. The following cryptocurrencies use proof of work:
• Ethereum (ETH) (for now until it moves to proof-of-stake)
• Bitcoin SV
Proof of Work vs. Proof of Stake
Since PoW has some downsides, developers have been working on many other types of consensus algorithms for cryptocurrency networks. One of the most anticipated is proof of stake (PoS).
Rather than miners, PoS uses validators who are chosen to create blocks based on how many coins they hold, rather than having to compete to create the blocks. Proof of stake rewards validators that hold the most coins with the ability to mine blocks and validate transactions.
The benefit of PoS is that it uses a lot less electricity. However, PoS rewards nodes for holding tokens, resulting in hoarding rather than use of the crypto. PoS is also vulnerable to 51% attacks, where an individual crypto miner or group of miners gets control of more than 50% of a network’s blockchain.
Proof of work is the original way to secure blockchains and protect cryptocurrency from being double-spent and potentially devalued. Bitcoin uses the PoW consensus algorithm, as do a number of other cryptocurrencies.
If you’re interested in trading cryptocurrencies, SoFi Invest® makes it easy. You can choose from more than 20 different cryptos, including Bitcoin, Solana, Enjin Coin, Cardano, Litecoin, and more.
Photo credit: iStock/MesquitaFMS
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Third-Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.