Bitcoin’s Proof-of-Work (PoW) mechanism is one of the most misunderstood aspects of the system with a popular misconception that it is a useless waste of energy. This misconception is perverse because the true purpose of Bitcoin is to save energy through efficiency, and it cannot achieve this without using PoW. Bitcoin’s PoW mechanism is ultimately the cost of distributing control of a public information system in a trustworthy manner, and a trustworthy public information system is what enables energy savings through efficiency.
Wikipedia page
Wikipedia page
To distribute control over a public blockchain through competition, Bitcoin’s design incentivizes Full Nodes (FN: digital time stamp servers/transaction processors/miners) to invest capital, time, and energy in order to generate revenue from block rewards (new coins + transaction fees = incentive value). FNs must invest in computing power to perform functions that support the network through transaction processing (essentially functioning as comptrollers) and to scan for a SHA-256 hash that begins with a certain number of zeros known as a nonce. The first node to solve for the nonce receives the block reward and enters the transaction information for that block into Bitcoin’s public blockchain. The system’s requirement to scan for a nonce, functions as a Game Theoretic Proof-of-Work mechanism that creates competition and distributes control in a trustworthy manner. We can trust this Game Theoretic mechanism because the initial investment a person (corporations are considered persons under the law) must make to setup and run a FN is much higher than the revenue it will receive from any one block reward. This means that it will require a significant amount of time for that person to become profitable; making it in that person’s own financial interest to act honestly. If a FN acts dishonestly, their blocks will be orphaned by honest nodes, they will not receive the block reward and the person who financed the dishonest node will not be able to generate enough revenue to cover their initial investment. People will stop using the system altogether if the majority of FNs collude to act dishonestly; this would cause the whole system to fail and no investor would be able to recover their initial investment. The work (capital/time/energy) persons running FN have invested is a Signaling Theory proof to users that those they are serious about competing for the block reward and can be trusted to honestly perform the tasks required to maintain the network. This trust enables a more efficient transaction settlement method that will more than offset the cost of solving for the nonce.
– Bryan Daugherty
Our current digital monetary systems depend on private databases because no one was able to figure out a way to distribute control of a public database before Dr. Wright designed Bitcoin. Transferring information between private databases in a trustworthy manner requires a third-party intermediary to authenticate the transacting parties and validate information being transferred. In an August 2022 Forbes Advisor editorial titled Credit Card Processing Fees (2022 Guide), Kimberlee Leonard and Cassie Bottorff said “the average credit card processing fee ranges between 1.5% and 3.5%.” Bitcoin uses cryptographic hashing and digital signatures to tokenize information on its public blockchain in a nonfungible manner. The system then uses a public/private key pair transaction model to transfer those digital tokens between parties in a peer-to-peer manner. Using this model, Full Node computers can validate transactions of any monetary size for a fraction of one cent (see Bryan Daugherty’s Linked in post, SmartLedger post). The only way to use this efficient transaction model is through hashing on a blockchain, the only way for masses to leverage this blockchain capability is if it is public, and the only way to make a public blockchain trustworthy is by using the PoW mechanism Dr. Wright imbedded in Bitcoin’s incentive model. FNs can validate information using Bitcoin so much more efficiently than intermediaries can on legacy systems that it will more than cover the cost in energy required to solve for the PoW nonce and reduce the net energy required to maintain these types of systems. The genuine Bitcoin is extremely efficient right now, as can be seen in Bryan Daugherty’s post, and it will become more efficient as it scales.
The net energy per transaction saved using Bitcoin will only increase as the system scales up and the new coin portion of the incentive value is halved away. We know Bitcoin can process individual transactions more efficiently than our current systems making it obvious that total energy saved will increase with each transaction processed. But, scaling up will also require FNs to invest more in their transaction processing operations. It is probable that this increased requirement will squeeze some FNs out of business resulting in reduced competition for the block rewards and subsequently reduce the amount of energy required for PoW hashing. Jack Pitts and Joshua Henslee touch on this dynamic about 35:18 minutes into their Dedicating the Next 20 Years to Bitcoin SV conversation. These energy savings in transaction processing alone justify the use of PoW hashing but it is not the only efficiency benefit we will see from the use of the Game Theoretic mechanism in the system.
In the 19 April 1965 issue of the trade journal Electronics, Gordon Moore published a paper entitled Cramming More Components onto Integrated Circuits. He began the paper stating, “With unit cost falling as the number of components per circuit rises, by 1975 economics may dictate squeezing as many as 65,000 components on a single silicon chip.” The proportional cost savings per unit he described is analogous to the marginal cost saving we will see in Bitcoin transactions per unit and, similarly to the way Moore said economics would dictate silicon ship progression, economics will dictate FN hardware progression. The real driver behind this economics driven progression is the same as the driver of every other innovation in human history: energy efficiency. We see how Bitcoin enables us to process transaction more efficiently but the economics-based competition created by the PoW hashing mechanism creates a sort of Red Queen Hypothesis game where FNs will have to innovate for energy efficiencies just to stay in the game. We have already seen Bitcoin drive innovation in the use of current microprocessors (repurposing of GPUs) and development of new types of microprocessors (ASICS chips). In the discussion between Pitts and Henslee mentioned above, they talk through the scenario where the scaling of Bitcoin shifts FNs’ distribution of energy from hashing to transaction processing and say that shift could reveal a misallocation of resources in the development and implementation of computer processors. The paragraph above shows that I agree with this sentiment but; I believe these misallocations are growing pains any new system must go through. The Wikipedia page on Moore’s law says that Moore’s observations and projections of historical trends are based in an empirical relationship linked to gains from experience in production rather than a law of physics. As Bitcoin matures, its economic dynamics will solidify, FN operators will learn from experience, and the competition created by the PoW mechanism will continue to drive innovation in development and implementation of computer processors. These innovations will bring efficiency and energy saving to computers in all industries, not just Bitcoin.
Bitcoin’s PoW mechanism is not a waste of energy, it is the cost of distributing control of a public information system in trustworthy manner that will reduce friction in every digital transaction processed, drive innovation through competition, and ultimately bring significant energy savings.
PoW Gas Station Analogy with Payment Channel Applications:
One transaction that will be significantly different using Bitcoin is the purchase of gasoline. Most gas stations require payment before pumping because it is so easy for criminals to drive off without paying if they are allowed to pump first. The problem with paying first is that we don’t know how much gas we need to fill our tank and therefore do not know how much to pay. The third-party financial institutions that validate transactions in our current system solve this problem by acting as insurers that guarantee payment to the gas station (cost of this function is part of the transaction fees). Bitcoin can solve this problem more efficiently using a payment channel where the gas station would set up an escrow account on Bitcoin and require customers to deposit an amount of Bitcoin greater than it would cost to fill their tank. When the deposit is received the pump will turn on. When the customer shuts the pump off, the amount owed to the gas station can be paid out from the escrow deposit and the remainder can be returned to the customer. Gas stations will not need to trust customers because they can automatically shut the pump off once an amount of gas equal to the amount of Bitcoin in escrow has been pumped. Customers can trust gas stations to give them the proper amount of change because the work put into building the gas station is proof that the owner is trying to run a legitimate business. Word of a gas station acting dishonestly would hinder the business’s ability to generate revenue and make it impossible for the owner to be profitable. This transaction model would eliminate insurance fees and the actual execution would be smoother for customers.