Why Proof of Work works: It’s the economics, not just cryptography

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Although it is a combination of cryptography and mathematics, Bitcoin’s solution to the consensus problem is deeply rooted in economic principles.

One of the little-known aspects of Bitcoin is Proof of Work (PoW), where the probability of mining a block depends on the work done by the miner. This creates a distributed trustless consensus and solve the double-spend problem.

In PoW, the probability of mining a block depends on the work done by the miner. Mining activities, however, require sizeable investments these days, as mining equipment moves from GPU to ASIC. This is one of the reasons why alternate proof of work systems have started emerging.

But there is no meaningful alternative to PoW, at least for the foreseeable future. And that’s because the system solves for the problem using economic principles. To quote developer Paul Sztorc, “Proof-of-Work exists because money is being created. It is, then, impossible to ‘create a new form of money’ without invoking Proof-of-Work.”

Writer Sumanth Neppalli also explained how Proof of Work “discourages collusion of actors” because unlike Proof of Stake, where the creator of a new block is chosen in a deterministic way, PoW is “a global decentralized free market that cannot be influenced by any action other than investment into the network.”

“The security isn’t the computing power but is actually the economic investment behind the computing power. As the network gains more value, it incentivizes more people to join the network and further decentralize the network increasing the cost to reverse transactions,” Neppalli wrote in a Medium post. “The distinction from proof of stake solution as has been proposed comes in the requirement to constantly reinvest. A proof of stake system requires a single investment. Once this investment is created, the system is incentivized towards the protection of the earlier investment.”

Neppalli’s Medium post, which analyzes nChain chief scientist Dr. Craig Wright’s paper, “PoW as it relates to the theory of the firm,” can be read here.