In the traditional financial system, we rely on companies that provide the services of storing, verifying, and approving our transactions. I already explained the amount of trust that is required to make this work, and how problematic this can be (If you haven’t read this yet, find the article here).
Now, let’s take a look at how this normally works:
A transaction happens;
Someone registers it on the books;
Someone else does the audit work to make sure the recorded transaction is valid.
When we look at the crypto world, it follows a similar process flow. The only difference is that instead of trusting a particular institution to do the work, the crypto space removes the traditional intermediaries, and offers a decentralized mechanism. When a transaction happens, it gets grouped with other transactions and gets registered into a block. Once the block is uploaded and linked to the rest of the chain (hence, the name blockchain), it gets verified and validated in the network.
The people who do this book-keeping work are the famous
“Miners”
. The underlying mechanism that defines the rules by which miners work, is called
“Proof of Work” (PoW)
, and the action of carrying out this process is called
“Mining”
.
Let’s take a closer look at how this works by answering key questions!
Who can become a miner?
Anyone can be a part of the mining network for a particular blockchain. You and I can become a miner if we want to.
The only requirement to do so is that you will need to get the right computer hardware and servers that will enable you to solve the algorithmic puzzles and win the right to mine the block.
What do miners do?
As I briefly explained already, miners are the group of people that will:
create the block, which means registering the transactions and upload them on the chain;
validate the information in the block, primarily ensuring there are no invalid transactions or double spending cases.
Obviously, this is a mutually exclusive role, per block: everytime a block is created, there is someone who will be in charge of step 1, and the rest of the miners will be in charge of running step 2. This is a check and balance system, where the mining community holds each other accountable.
What do the miners get in exchange for doing this work?
The miner who successfully gained the right to register transactions and create the block, is rewarded with native coins of the blockchain they are mining on. Turns out, with every newly mined block, new coins are also created.
In the case of Bitcoin, for example, the miner gets to add a special transaction to his/her block that’s called a “coinbase transaction” that basically specifies the amount of Bitcoin that gets minted and rewarded to the miner for mining the block. That particular amount gets halved every 4 years: it started with 50 BTC when Satoshi Nakamoto mined the first block, and right now it’s currently at 6.25 BTC per block.
If the miner that gets rewarded is the one who does step 1 (generating the block), how do you determine who gets to do that?
Comes in,
Proof of Work (PoW).
Crypto follows the PoW mechanism in which the miners need to solve an underlying algorithmic puzzle that has literally millions of potential answers. Without going too technical, let me just say that this puzzle involves a Hash Function that is basically a special function where you put in any string of letter, numbers or data and you will get a long string of numbers combination.
Now, it’s basically guesswork. Imagine rolling a giant die that produces numbers from 0 to the number of atoms in the universe. In order to win the guess, you have to roll out a number that is below the set target for that particular block.
This is a probability game: the more times you roll the die, the more chances you have to get it right.
The miner who wins this race, wins the right to generate and upload the block. The process of playing this PoW lottery game, is called mining. The rest of the mining community will do the validation work.
How do we ensure nobody wants to cheat?
As I mentioned, a miner needs to race to solve the algorithmic puzzle, and since you already know that it’s a probability game, the more and faster you can generate your guesses, the better.
In order to do so, you need to invest in a good set of hardware that will allow you to do that and power it up with a considerable amount of electricity required to keep “rolling the die” and increase your chances of winning the lottery.
You might win the race or not, but since you are investing a decent amount in equipment and energy, whatever you do, you want to make sure everyone accepts and approves your block, and therefore being able to receive your reward. Therefore, everyone is highly incentivized to ensure the ledger is correct due to economic rewards.
The alternative is to get your block rejected and lose all the investment you put in.
This is how PoW ensure it is real-world costly.
Game theory, simple.
This last point gives you some perspective regarding why there is so much criticism around energy consumption against the crypto industry.
In order to solve this issue, many blockchains are already running on a Proof of Stake mechanism, or with a roadmap to transition into this latter, presenting a solution to network congestion as well as optimizing for energy consumption.
I’ll explain better how Proof of Stake can achieve this in the following article, so stay tuned!
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