What it means
In a network with no central authority, the participants need a way to agree on which transactions are valid and in what order. Proof of work solves this by making block creation costly, so that the right to add a block has to be earned with real resources.
Anyone can check the winning answer easily, but finding it takes a great deal of trial and error. Miners gather transactions into a candidate block and repeatedly run it through a mathematical function called a hash function until the result meets a target set by the network.
This is a guessing game, so the chance of winning is proportional to the computing power, or hash rate, that a miner contributes compared with the whole network. The network adjusts the difficulty of the puzzle so that blocks arrive at a steady pace.
For Bitcoin the target is about one block every ten minutes, and if miners add more power the difficulty rises, and if they leave it falls. The system works because rewriting history would require redoing the work of every block since the change, faster than the rest of the network adds new ones.
An attacker would need to control a majority of the network's computing power, which is very expensive. This is why large proof of work networks are considered highly secure, although smaller networks can be vulnerable.
The costs are significant. Miners spend heavily on specialised equipment and electricity, and the energy use of large networks is a frequent subject of criticism.
Mining economics therefore depend on the coin price, the block reward, equipment cost and electricity rates, and they change over time.
In practice
Real-world examples.
Example
A mining company builds a facility with 5,000 machines and buys electricity at a fixed price. Its finance team models profit under different coin prices and finds that it breaks even if the coin trades above a certain level.
Example
A hobbyist joins a mining pool, where thousands of miners combine their power and share rewards in proportion to their contributions. He receives small, steady payments instead of waiting years for a rare solo win.
Example
A fund manager analysing a mining company's shares looks at its cost to mine one coin compared with the coin price. She notes that the margin between the two determines whether the company is profitable or must sell its holdings to stay afloat.
Formula
Calculation
A miner's expected income depends on its share of the network's computing power:
Expected blocks per day = (Your hash rate / Network hash rate) x Blocks per day
Daily profit = (Expected blocks x Reward per block) - Daily costs
Suppose a mining company controls 0.1% of the network's hash rate, and the network produces 144 blocks a day. Assume each block pays a total reward worth $300,000, and the company's electricity and running costs are $30,000 a day.
Expected blocks per day = 0.001 x 144 = 0.144.
Expected revenue = 0.144 x $300,000 = $43,200.
Daily profit = $43,200 - $30,000 = $13,200.
If the coin price fell by 40%, the reward would be worth $180,000 and revenue would drop to 0.144 x $180,000 = $25,920, leaving a loss of $4,080 a day.Case study
Seen in the real world.
Granite Peak Mining is an illustrative, fictional company that built a mining farm when the coin price was high. It borrowed $4,000,000 to buy machines, planning to repay the loan from mining income.
Within a year, the coin price had halved and the network's total computing power had risen, which reduced the company's share of the rewards. Its daily revenue fell from $12,000 to $5,000, while electricity costs remained at $6,000.
The company negotiated cheaper power with its supplier and sold part of its fleet to repay debt. The illustrative lesson is that proof of work mining is a business with high fixed costs, which means that borrowed money, a volatile coin price and rising competition can combine to create serious difficulty.
Watch out
Common mistakes.
- Assuming the puzzles are meaningful calculations, when they are deliberately arbitrary and their value lies in the cost of the work.
- Estimating mining profit from today's coin price and difficulty, when both can change quickly and make the forecast wrong.
- Believing that the number of machines alone decides income, when electricity price, machine efficiency and network share matter as much.
Questions
People also ask.
Why does proof of work use so much energy?
The security of the network comes from the cost of the computing, so a high energy bill is part of what makes the record difficult to attack.
What is a mining pool?
It is a group of miners who combine their computing power and share rewards in proportion to their contribution, which gives steadier income than mining alone.
Is proof of work the same as proof of stake?
No, proof of work depends on computing effort while proof of stake depends on coins locked up as collateral, and they have different costs and risks.
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