Proof of Work: what underlies cryptocurrencies
Kyiv • UNN
Proof of Work (PoW) is a mechanism that allows decentralized cryptocurrency networks to reach consensus on the validity of transactions without a central authority, requiring miners to solve complex cryptographic problems that validate transaction blocks and provide miners with rewards in their native cryptocurrency.
Cryptocurrencies are known for their lack of a centralized verification authority, but how does a decentralized network manage to come to a consensus? How is data verified and abuses prevented? Elena Sosiedka, co-founder of Ukraine's first fintech ecosystem Concord Fintech Solutions, told UNN about the principles that underlie cryptocurrencies and allow data and transactions to be verified.
"Proof of Work (PoW) is a concept that underpins the operation of many cryptocurrencies, including bitcoin. It is a mechanism that allows a decentralized network to come to a consensus in the absence of a central authority," said Elena Sosiedka.
Key aspects of PoW:
- *Solving Complex Problems*: In a PoW system, participants (miners) solve complex cryptographic problems to create a new block in the blockchain. This process requires significant computational power.
- *Confirmation of transactions*: If the task is successful, the miner can add a block of transactions to the blockchain, which is a kind of confirmation of those transactions.
- *Mining Reward*: For adding a block to the blockchain, a miner receives a reward in the form of cryptocurrency (e.g. bitcoins). This incentivizes participants to engage in the mining process.
- *Protection against double spending*: PoW also helps prevent the problem of double-spending, where the same unit of cryptocurrency can be spent twice.
- *High security*: In theory, modifying a blockchain with PoW requires controlling more than 50% of the computing power of the entire network, making such attacks virtually impossible in large networks such as bitcoin.
This principle is the basis of the most popular cryptocurrency, bitcoin. Besides bitcoin, there are many other cryptocurrencies that use the Proof of Work (PoW) mechanism. Here are some examples:
- *Litecoin (LTC)*: Often referred to as the "silver to bitcoin's digital gold", Litecoin was one of the first cryptocurrencies to follow bitcoin and uses a similar PoW algorithm to bitcoin but with some changes, such as a shorter block generation time.
- *Ethereum (ETH)*: Until recently, Ethereum used PoW, but with the recent Ethereum 2.0 update, it is moving to a Proof of Stake (PoS) mechanism. This change is aimed at improving scalability and reducing power consumption.
- *Bitcoin Cash (BCH)*: This is a bitcoin fork created in 2017 that also uses PoW. BCH was created to increase the block size to handle more transactions.
- *Dogecoin (DOGE)*: Originally created as a "joke" cryptocurrency, Dogecoin also uses PoW, similar to Litecoin.
- *Monero (XMR)*: This is an anonymity-focused cryptocurrency that also uses PoW. Its PoW algorithm is specifically designed to provide a more decentralized mining process.
"These cryptocurrencies use PoW to secure their networks, although each has its own unique features and variations in PoW implementation," the expert added.
The PoW mechanism contributes to a secure and resilient network, but also has its disadvantages such as high energy consumption and slow transaction processing compared to some other mechanisms such as Proof of Stake (PoS).
PoS is based on staking. According to this mechanism, validators must block a certain amount of cryptocurrency in the network in order to be rewarded for their work in the blockchain. And although validators are chosen randomly for their work - those of them who have blocked a greater amount of currency have a better chance of being chosen by the algorithm. PoS does not require a constant technological race, reduces energy consumption and is therefore greener than PoW.
What affects the value of cryptocurrencies
The value of cryptocurrencies, including bitcoin, depends on a variety of factors.As with most assets, prices are determined in part by the balance between supply and demand.
"For example, halving bitcoin, which cuts the reward for mining blocks in half, reduces the supply of new coins, which can affect the price," the expert explained.
In addition, there are a number of other factors that influence the value of cryptocurrencies:
- *Regulation*: News of regulation or bans in various countries may cause significant price fluctuations.
- *Technological changes and updates*: Developments in blockchain technology may affect the perception and functionality of cryptocurrencies.
- *Investor interest*: Increased interest from institutional and retail investors may contribute to price appreciation.
In addition, there are a number of other factors that, as Elena Neighbor points out, will influence the price of cryptocurrencies in 2024. Among them, the most significant are:
- *Federal Reserve monetary policy*: The policies of the U.S. Federal Reserve affect financial markets in general, including the cryptocurrency market. For example, rate decisions can influence investment appetite for risky assets such as cryptocurrencies.
- *Geopolitical environment*: Instability in global politics and economics may contribute to increased interest in cryptocurrencies as alternative assets.
- *Halving bitcoin*: The upcoming bitcoin halving, which will cut the reward for mining by half, could create a supply shortage and thereby increase the bitcoin price. Historically, such events have led to higher prices.
- *Infrastructure development*: Advances and improvements in technology, including the emergence of spot bitcoin ETFs, may increase the flow of institutional investment and, as a result, support cryptocurrency price growth.
- *Financial inflation and macroeconomic indicators*: General economic trends such as inflation can also affect cryptocurrency markets. For example, high inflation may encourage investors to seek "safe-haven assets", which may include bitcoin.
Predictions regarding the future value of bitcoin vary widely and depend on many factors, including economic, technological and regulatory changes. Some analysts and cryptocurrency experts suggest that the bitcoin price could reach significant heights. For example, one prediction claims that bitcoin could reach the $240,000 mark based on factors such as increased demand, upcoming halving and the possible launch of spot bitcoin ETFs.
There are also more conservative estimates. For example, JPMorgan predicts bitcoin will hit the $45,000 mark, down from its current all-time high. Other analysts, such as Fundstrat, predict a significant rise in the bitcoin price, to $180,000, by April 2024, based on a possible increase in daily demand.
"It is also worth considering that the cryptocurrency market is characterized by high volatility and unpredictability, so even if there are certain trends and preconditions, the actual dynamics can differ significantly," - the expert notes.
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