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Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments.
While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model.
Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes.
The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services.
With the possibility of reversal, the need for trust spreads.
Merchants must be wary of their customers, hassling them for more information than they would otherwise need.
A certain percentage of fraud is accepted as unavoidable.
These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.
What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.
Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.
The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.
Bitcoin’s most notable feature is its decentralization. It operates securely without the involvement of a central authority. A distributed network of users store and update the digital ledger that records transactions — called the blockchain — on their own computing hardware.
However, this raises an important question: Without a central authority to act as a final arbiter, how does Bitcoin ensure that nobody manipulates the blockchain for their own ends? The answer is proof of work.
Proof of work is a consensus mechanism used to confirm that network participants, called miners, calculate valid alphanumeric codes — called hashes — to verify Bitcoin transactions and add the next block to the blockchain. It does so by having other participants in the network verify that the required amount of computing power was used by the miner that is credited with calculating the valid hash.
We define an electronic coin as a chain of digital signatures. Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner and adding these to the end of the coin. A payee can verify the signatures to verify the chain of ownership.
The problem of course is the payee can’t verify that one of the owners did not double-spend the coin.
A common solution is to introduce a trusted central authority, or mint, that checks every transaction for double spending.
After each transaction, the coin must be returned to the mint to issue a new coin, and only coins issued directly from the mint are trusted not to be double-spent.
The problem with this solution is that the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank.
We need a way for the payee to know that the previous owners did not sign any earlier transactions.
For our purposes, the earliest transaction is the one that counts, so we don’t care about later attempts to double-spend.
The only way to confirm the absence of a transaction is to be aware of all transactions.
In the mint based model, the mint was aware of all transactions and
decided which arrived first.
To accomplish this without a trusted party, transactions must be
publicly announced , and we need a system for participants to agree on a single history of the order in which they were received.
The payee needs proof that at the time of each transaction, the majority of nodes agreed it was the first received.
The solution we propose begins with a timestamp server.
A timestamp server works by taking a hash of a block of items to be timestamped and widely publishing the hash, such as in a newspaper or Usenet post .
The timestamp proves that the data must have existed at the time, obviously, in order to get into the hash.
Each timestamp includes the previous timestamp in its hash, forming a chain, with each additional timestamp reinforcing the ones before it.
To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proofof-work system similar to Adam Back’s Hashcash , rather than newspaper or Usenet posts.
The proof-of-work involves scanning for a value that when hashed, such as with SHA-256, the
hash begins with a number of zero bits. The average work required is exponential in the number
of zero bits required and can be verified by executing a single hash.
For our timestamp network, we implement the proof-of-work by incrementing a nonce in the
block until a value is found that gives the block’s hash the required zero bits. Once the CPU
effort has been expended to make it satisfy the proof-of-work, the block cannot be changed
without redoing the work. As later blocks are chained after it, the work to change the block
would include redoing all the blocks after it.
The proof-of-work also solves the problem of determining representation in majority decision making.
If the majority were based on one-IP-address-one-vote, it could be subverted by anyone able to allocate many IPs.
Proof-of-work is essentially one-CPU-one-vote.
The majority
decision is represented by the longest chain, which has the greatest proof-of-work effort invested in it.
If a majority of CPU power is controlled by honest nodes, the honest chain will grow the fastest and outpace any competing chains.
To modify a past block, an attacker would have to redo the proof-of-work of the block and all blocks after it and then catch up with and surpass the work of the honest nodes.
We will show later that the probability of a slower attacker catching up diminishes exponentially as subsequent blocks are added.
To compensate for increasing hardware speed and varying interest in running nodes over time, the proof-of-work difficulty is determined by a moving average targeting an average number of blocks per hour.
If they’re generated too fast, the difficulty increases.
Proof of work (PoW) describes a system that requires a not-insignificant but feasible amount of effort in order to deter frivolous or malicious uses of computing power, such as sending spam emails or launching denial of service attacks. The concept was subsequently adapted to securing digital money by Hal Finney in 2004 through the idea of “reusable proof of work” using the SHA-256 hashing algorithm.
Following its introduction in 2009, Bitcoin became the first widely adopted application of Finney’s PoW idea (Finney was also the recipient of the first bitcoin transaction). Proof of work forms the basis of many other cryptocurrencies as well, allowing for secure, decentralized consensus.
This explanation will focus on proof of work as it functions in the bitcoin network. Bitcoin is a digital currency that is underpinned by a kind of distributed ledger known as a “blockchain.” This ledger contains a record of all bitcoin transactions, arranged in sequential “blocks,” so that no user is allowed to spend any of their holdings twice. In order to prevent tampering, the ledger is public, or “distributed”; an altered version would quickly be rejected by other users.
The way that users detect tampering in practice is through hashes, long strings of numbers that serve as proof of work. Put a given set of data through a hash function (bitcoin uses SHA-256), and it will only ever generate one hash. Due to the “avalanche effect,” however, even a tiny change to any portion of the original data will result in a totally unrecognizable hash. Whatever the size of the original data set, the hash generated by a given function will be the same length. The hash is a one-way function: it cannot be used to obtain the original data, only to check that the data that generated the hash matches the original data.
Generating just any hash for a set of bitcoin transactions would be trivial for a modern computer, so in order to turn the process into “work,” the bitcoin network sets a certain level of “difficulty.” This setting is adjusted so that a new block is “mined”—added to the blockchain by generating a valid hash—approximately every 10 minutes. Setting difficulty is accomplished by establishing a “target” for the hash: the lower the target, the smaller the set of valid hashes, and the harder it is to generate one. In practice, this means a hash that starts with a very long string of zeros.
Since a given set of data can only generate one hash, how do miners make sure they generate a hash below the target? They alter the input by adding an integer, called a nonce (“number used once”). Once a valid hash is found, it is broadcast to the network, and the block is added to the blockchain.
Mining is a competitive process, but it is more of a lottery than a race. On , someone will generate acceptable proof of work every ten minutes, baverageut who it will be is anyone’s guess.
Miners pool together to increase their chances of mining blocks, which generates transaction fees and, for a limited time, a reward of newly-created bitcoins.
Proof of work makes it extremely difficult to alter any aspect of the blockchain, since such an alteration would require re-mining all subsequent blocks. It also makes it difficult for a user or pool of users to monopolize the network’s computing power, since the machinery and power required to complete the hash functions are expensive.
The steps to run the network are as follows:
1) New transactions are broadcast to all nodes.
2) Each node collects new transactions into a block.
3) Each node works on finding a difficult proof-of-work for its block.
4) When a node finds a proof-of-work, it broadcasts the block to all nodes.
5) Nodes accept the block only if all transactions in it are valid and not already spent.
6) Nodes express their acceptance of the block by working on creating the next block in the
chain, using the hash of the accepted block as the previous hash.
Nodes always consider the longest chain to be the correct one and will keep working on
extending it. If two nodes broadcast different versions of the next block simultaneously, some
nodes may receive one or the other first. In that case, they work on the first one they received,
but save the other branch in case it becomes longer. The tie will be broken when the next proofof-work is found and one branch becomes longer; the nodes that were working on the other
branch will then switch to the longer one.
New transaction broadcasts do not necessarily need to reach all nodes. As long as they reach
many nodes, they will get into a block before long. Block broadcasts are also tolerant of dropped
messages. If a node does not receive a block, it will request it when it receives the next block and
realizes it missed one.
By convention, the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This adds an incentive for nodes to support the network, and provides a way to initially distribute coins into circulation, since there is no central authority to issue them. The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended. The incentive can also be funded with transaction fees. If the output value of a transaction is less than its input value, the difference is a transaction fee that is added to the incentive value of the block containing the transaction. Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.
The incentive may help encourage nodes to stay honest. If a greedy attacker is able to assemble more CPU power than all the honest nodes, he would have to choose between using it to defraud people by stealing back his payments, or using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth.
Once the latest transaction in a coin is buried under enough blocks, the spent transactions before it can be discarded to save disk space. To facilitate this without breaking the block’s hash, transactions are hashed in a Merkle Tree, with only the root included in the block’s hash. Old blocks can then be compacted by stubbing off branches of the tree. The interior hashes do not need to be store
A block header with no transactions would be about 80 bytes. If we suppose blocks are generated every 10 minutes, 80 bytes * 6 * 24 * 365 = 4.2MB per year. With computer systems typically selling with 2GB of RAM as of 2008, and Moore’s Law predicting current growth of 1.2GB per year, storage should not be a problem even if the block headers must be kept in memory
It is possible to verify payments without running a full network node. A user only needs to keep a copy of the block headers of the longest proof-of-work chain, which he can get by querying network nodes until he’s convinced he has the longest chain, and obtain the Merkle branch linking the transaction to the block it’s timestamped in. He can’t check the transaction for himself, but by linking it to a place in the chain, he can see that a network node has accepted it,
and blocks added after it further confirm the network has accepted it.
As such, the verification is reliable as long as honest nodes control the network, but is more vulnerable if the network is overpowered by an attacker. While network nodes can verify transactions for themselves, the simplified method can be fooled by an attacker’s fabricated transactions for as long as the attacker can continue to overpower the network. One strategy to protect against this would be to accept alerts from network nodes when they detect an invalid block, prompting the user’s software to download the full block and alerted transactions to confirm the inconsistency. Businesses that receive frequent payments will probably still want to run their own nodes for more independent security and quicker verification.
Although it would be possible to handle coins individually, it would be unwieldy to make a separate transaction for every cent in a transfer. To allow value to be split and combined, transactions contain multiple inputs and outputs. Normally there will be either a single input from a larger previous transaction or multiple inputs combining smaller amounts, and at most two outputs: one for the payment, and one returning the change, if any, back to the sender.
It should be noted that fan-out, where a transaction depends on several transactions, and those transactions depend on many more, is not a problem here. There is never the need to extract a complete standalone copy of a transaction’s history
The traditional banking model achieves a level of privacy by limiting access to information to the parties involved and the trusted third party. The necessity to announce all transactions publicly precludes this method, but privacy can still be maintained by breaking the flow of information in another place: by keeping public keys anonymous. The public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone. This is nsimilar to the level of information released by stock exchanges, where the time and size of individual trades, the “tape”, is made public, but without telling who the parties were.
As an additional firewall, a new key pair should be used for each transaction to keep them from being linked to a common owner. Some linking is still unavoidable with multi-input transactions, which necessarily reveal that their inputs were owned by the same owner. The risk is that if the owner of a key is revealed, linking could reveal other transactions that belonged to the same owner
We consider the scenario of an attacker trying to generate an alternate chain faster than the honest
chain. Even if this is accomplished, it does not throw the system open to arbitrary changes, such
as creating value out of thin air or taking money that never belonged to the attacker. Nodes are
not going to accept an invalid transaction as payment, and honest nodes will never accept a block
containing them. An attacker can only try to change one of his own transactions to take back
money he recently spent.
The race between the honest chain and an attacker chain can be characterized as a Binomial
Random Walk. The success event is the honest chain being extended by one block, increasing its
lead by +1, and the failure event is the attacker’s chain being extended by one block, reducing the
gap by -1.
The probability of an attacker catching up from a given deficit is analogous to a Gambler’s
Ruin problem. Suppose a gambler with unlimited credit starts at a deficit and plays potentially an
infinite number of trials to try to reach breakeven. We can calculate the probability he ever
reaches breakeven, or that an attacker ever catches up with the honest chain, as follows [8]:
p = probability an honest node finds the next block
q = probability the attacker finds the next block
qz = probability the attacker will ever catch up from z blocks behind
Given our assumption that p > q, the probability drops exponentially as the number of blocks the
attacker has to catch up with increases. With the odds against him, if he doesn’t make a lucky
lunge forward early on, his chances become vanishingly small as he falls further behind.
We now consider how long the recipient of a new transaction needs to wait before being
sufficiently certain the sender can’t change the transaction. We assume the sender is an attacker
who wants to make the recipient believe he paid him for a while, then switch it to pay back to
himself after some time has passed. The receiver will be alerted when that happens, but the
sender hopes it will be too late.
The receiver generates a new key pair and gives the public key to the sender shortly before
signing. This prevents the sender from preparing a chain of blocks ahead of time by working on
it continuously until he is lucky enough to get far enough ahead, then executing the transaction at
that moment. Once the transaction is sent, the dishonest sender starts working in secret on a
parallel chain containing an alternate version of his transaction.
The recipient waits until the transaction has been added to a block and z blocks have been
linked after it. He doesn’t know the exact amount of progress the attacker has made, but
assuming the honest blocks took the average expected time per block, the attacker’s potential
progress will be a Poisson distribution with expected value:
To get the probability the attacker could still catch up now, we multiply the Poisson density for
each amount of progress he could have made by the probability he could catch up from that point:
Rearranging to avoid summing the infinite tail of the distribution…
Proof of work requires a computer to randomly engage in hashing functions until it arrives at an output with the correct minimum amount of leading zeroes. For example, the hash for block #660000, mined on Dec. 4, 2020 is 00000000000000000008eddcaf078f12c69a439dde30dbb5aac3d9d94e9c18f6. The block reward for that successful hash was 6.25 BTC.
That block will always contain 745 transactions involving just over 1,666 bitcoins, as well as the header of the previous block. If somebody tried to change a transaction amount by even 0.000001 bitcoin, the resultant hash would be unrecognizable, and the network would reject the fraud attempt.
The primary advantage of proof-of-work is that it provides a solid mechanism for achieving consensus and preventing abuses and misuses. Note that consensus is at the core of blockchain technology and its specific applications to include cryptocurrencies, as well as its benefits such as security, trust and legitimacy, and decentralization.
Note that a blockchain is a decentralized or distributed database that represents a ledger of transactions. A peer-to-peer network of participants maintains the database by achieving consensus or agreeing on things like the order of transactions and account balances.
PoW fundamentally is a system for authenticating transactions without the need for a third party, as well as for preventing individuals or organizations from tampering with the database. The mechanism makes it difficult to alter any aspect of the ledger of transactions, thus ensuring the authenticity and traceability of each transaction.
There are other consensus mechanisms used in blockchain technology. These include proof-of-stake or PoS and proof-of-burn or PoB. However, while PoS is more efficient, it has numerous flaws to include greater susceptibility to attacks and tampering.
A specific advantage of PoW is that it depends on computational capabilities. Although it is theoretically possible for an individual to tamper with the blockchain, doing so would require expending computing capabilities that are impractical and uneconomical to the point that the cost significantly outweighs the gains or benefits.
The biggest disadvantage of proof-of-work centers on the computational capabilities needed to solve mathematical problems in authenticating blockchain transactions. Note that this is also one of the biggest drawbacks of blockchain, a major criticism of cryptocurrencies, and the primary reason that PoW-based blockchains have negative environmental impacts.
Of course, to participate in a blockchain network that utilizes PoW as a consensus mechanism, a party must have a powerful computer equipped with advanced hardware. Scaling the operation means purchasing and setting up more expensive computers.
But the cost does not rest alone in the aforesaid purchases. Powerful computers inherently consume a lot of energy. Furthermore, these machines require effective heat management or cooling system to remain operational and prevent overheating, as well as associated damages to hardware components due to internal heat build-up.
The same energy-intensiveness is also the reason behind the more specific disadvantages of proof-of-work. For example, because of the cost associated with running and maintaining powerful computer systems, PoW-based blockchains have scalability limitations.
In addition, the associated cost also prevents a number of individuals and organizations from participating in a particular blockchain network. Hence, while blockchain technology is based on the concept of decentralization through public participation, cost serves as a key barrier for the greater public to participate, thus creating some semblance of centralization.
The drawbacks of PoW collectively represent a major reason why other blockchain platforms have utilized alternative consensus mechanisms. Take the Cardano blockchain for example. Note that the Ethereum blockchain will be moving from PoW to PoS.
Aside from Bitcoin, pretty much all the cryptocurrencies based on or forked from it also use proof of work. These include:
There are also a wide variety of other cryptocurrencies not based on Bitcoin that currently use proof of work, including:
While proof of work is popular, another consensus mechanism known as proof of stake is also widely used. Instead of verifying the amount of computational work done, proof of stake uses the amount of cryptocurrency block publishers are willing to deposit as insurance against their misbehavior.
“Conceptually this is quite appealing because it short-cuts the step of having to invest in high-performance mining hardware and also the energy related to the use of that hardware,” Knottenbelt says.
However, proponents of proof of work argue that proof of stake and other consensus mechanisms inevitably lend themselves to some form of centralization, precisely the thing proof of work was designed to avoid.
“Proof of stake is fundamentally centralized,” says Jimmy Song, a Bitcoin author, educator, and developer. “There’s no way to tell which to go with in case of a conflict.”
We have proposed a system for electronic transactions without relying on trust. We started with the usual framework of coins made from digital signatures, which provides strong control of ownership, but is incomplete without a way to prevent double-spending. To solve this, we proposed a peer-to-peer network using proof-of-work to record a public history of transactions that quickly becomes computationally impractical for an attacker to change if honest nodes
control a majority of CPU power. The network is robust in its unstructured simplicity. Nodes work all at once with little coordination. They do not need to be identified, since messages are not routed to any particular place and only need to be delivered on a best effort basis. Nodes can leave and rejoin the network at will, accepting the proof-of-work chain as proof of what happened while they were gone. They vote with their CPU power, expressing their acceptance of valid blocks by working on extending them and rejecting invalid blocks by refusing to work on them. Any needed rules and incentives can be enforced with this consensus mechanism.
Souce: bitcoin – businessinsider – investopedia – profolus
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