Proof of Work is Here to Stay
The Utility of PoW vs. PoS
I have more than 90% of my portfolio in Bitcoin. In order for me to be confident that my investment is safe, I needed to convince myself that the constituents of bitcoin are sound. I also needed to be sure that the components of bitcoin are integrated with one another in harmony.
The promise and possibility that bitcoin will increase in value (in terms of USD and CAD) is not enough for me to hold an asset. I need to have the assurance that the system as a whole will remain intact long into the future.
Putting aside the blockchain, the code, and the network for a moment; I’d like to focus on what is perhaps the most contentious aspect of bitcoin. Proof of work.
Many have rightfully pointed out that proof of work is energy intensive. In the same breath, many have wrongly pointed out that proof of is wasteful or without utility.
In this letter, I will lay out exactly why proof of work is useful, how this relates to the utility of bitcoin, and why I can be confident that proof of work, and thus bitcoin, will be around for decades to come.
Proof of Work is Useful
There is a narrative that proof of work is wasteful and unproductive.
In the interest of not confusing terms and definitions, I’ll define how proof of work works for the context of this letter.
Proof of work a trial by error competition to find an input that satisfies a known and specified output. The winner of the competition wins a monetary reward.
Following are the core aspects of proof of work that you need to wrap your head around.
Trial by Error
The fact that proof of work is based on trial by error is actually very important to understanding the utility of proof of work. To produce any given block, an answer to a mathematical question must be found; because the answer to the given question can only be found through trial and error…
This evidently means that the entity that guesses more times than any other entity has a higher statistical likelihood of finding the right answer.
The answer could not have been found any other way, thus proving that the provider of the answer has proven that they’ve “done the work”.
The competition is winner-takes-all such that the entity that has provided the answer earns the entire monetary incentive.
What is the Utility in Proof of Work?
The utility lies within point 1 and 3. All entities are using a massive amount of energy to make these guesses. This energy is not free as all energy comes at a cost to harness.
Think of the energy as the input and bitcoin as the output. Through this lens, proof of work can be conceptualized as a system that converts energy into money.
The energy comes from the physical domain of matter, and is translated into the digital or virtual domain of information. Knowing this, we can derive two core utilities of proof of work.
1. Proof of work utilizes stranded energy
The first utility is that some energy used for proof of work mining utilizes energy that would have otherwise not been used. This comes from a brief analysis of the business case for mining.
Businesses naturally want to maximize profit. One of the ways to achieve this is by minimizing costs. Bitcoin miners seek the cheapest electricity, while energy providers attempt to sell their supply of energy for as much money as possible.
Since energy companies necessarily overproduce and over-harness their sources (natural gas, hydroelectric, wind, solar, coal, nuclear), they are left with energy that they cannot sell.
Proof of work is a way to monetize otherwise un-utilized, and un-sold energy.
Since proof of work miners are simply an array of computers, they can be turned on, or off, in accordance with the natural fluctuation in consumer demand for electricity.
In this way, proof of work miners act as a buffer for energy producers. Miners are economically productive for both themselves, and the power companies they are purchasing energy through.
It is a myth that bitcoin puts extra demand on electricity grids. It would simply not be profitable for bitcoin miners to operate if they were to pay consumer prices for electricity. Therefore we see bitcoin miners naturally pursuing the most profitable setup and scenario for their mining operation.
The most profitable scenario to mine bitcoin is the one wherein the miners consume energy for which there isn’t demand. Since there is low, or no demand for the energy, the miners can get a reduced, and more economical rate for the energy they’re using.
In other words, bitcoin creates a win-win situation for both parties.
Bitcoin miners get energy at a cost that makes their operation economical
Energy companies sell energy for more than $0, that they would otherwise part with for $0.
The documentary “This Machine Greens” further details and outlines this utility of proof of work.
Nic Carter has writer extensively on the relationship between bitcoin miners and energy companies.
Stranded energy does not just mean utilizing energy that is already being harnessed but not used. It also means liberating energy from sources that are not economically viable to pursue.
Hydroelectric energy is abundant, but typically located in remote areas. In some cases, the most expensive part of an energy infrastructure project is not the cost of the hydroelectric dam, but the cost of moving that energy to its place of utilization, and thus monetization.
Proof of work miners offer a way to monetize energy as soon as the ability to harness the energy becomes available. By deploying proof of work miners directly on the site of the facility (miners are portable), they can be plugged in to immediately start generating revenue for the project.
This revenue can be used to recoup infrastructure costs, or fund transmission lines to a nearby village, town, or city.
I see this collection of points as objectively useful and productive. Not just to bitcoin miners, but also to energy companies and energy grids owned either by private (companies) or public entities (governments).
The function of the profitability of proof of work necessarily increases demand for cheap sources of electricity. The trend is that greener sources are, and (hopefully) will continue to be the cheapest sources of electricity.
I see these benefits of proof of work as one of the driving factors behind the utilization of proof of work in energy systems now, and well into the future.
As long as two things remain true, the aspects of utility outlined above are maintained.
The reward for mining bitcoin (or any other proof of work asset) is less than what it costs in electricity.
The world demand for energy continually increases.
I believe the stranded energy points are sufficient for proving that proof of work, and thus bitcoin is productive, useful, and here to stay. However, there is a broader conversation to be had around the utility of money, which is the by-product of proof of work mining.
2. Bitcoin is (money) constrained by physical limitations
The usefulness of a tamper-proof money is understated. Let me first state the utility of money so that there is no ambiguity that money is the most useful tool that our society uses. The optimal money is the thing that best satisfies the 6 properties of money.
Money is used in approximately 50% of all transactions globally. (Money generally, not necessarily USD, gold, or BTC). This is because money is a precursor to any productive activity actually taking place.
In order to build an iPhone, workers must be paid, materials must be bought and aggregated, production lines need to be manufactured, electricity is required to be paid for to run the machines, marketers and salespeople must be employed, and the phones themselves need to be delivered to the consumer.
Can you imagine the level of coordination required to assemble an iPhone if we didn’t have money as the common tool that lubricates the exchange of all goods and services?
Money is the vital lubricant of human exchange — Robert Breedlove
Money solves the coincidence of wants problem. More clearly, money is the common item that all economic actors are willing to trade for their offered good or service.
Because money solves this problem, it facilitates productivity itself. This makes money useful, as it is the thing that can be used in 99% of all economic transactions.
Money is used to purchase any good or service. We purchase goods and services that we do not have the skills or materials to produce and do ourselves. We simply do not have enough time or energy individually to manufacture everything we want or need to live our lives, so we use money to obtain those things from others.
Money can therefore be thought of as time, and/or energy.
Money, which is the representation of the work required to generate goods and services, can also be viewed as stored energy — Michael Saylor
Inflation of the monetary supply creates new units of money that represent a claim on the productive resources of a society (either goods or services). If the supply of energy or materials does not increase proportionate to the rise in the money supply, then the creation of new units of money dilutes and reduces the purchasing power of all other units of currency in circulation.
Removing ethics and malicious intent from inflation, we can unbiasedly say that inflation proportionately siphons the purchasing power of all money in existence and allocates it to the newly printed money.
This happens without the consent and oftentimes knowledge of those who hold the units of the currency being inflated.
The phenomenon can rightfully be thought of as a problem, as it incrementally destroys the primary function of money; to provide purchasing power to the user. The solution to a money wherein the supply can be manipulated, is a money wherein the supply cannot be tampered with.
The reason why bitcoin is tamper-proof lays within its use of the proof of work system. In order to tamper with the monetary supply of bitcoin, one would need to satisfy the following requirements
Acquire more physical computational equipment (ASICs) than 50% of the network.
Harness more energy than 50% of the network.
No one lays out the difficulty and results of achieving these requirements better than Andreas Antonopoulos.
As Andreas rightfully points out, if an actor was to somehow accumulate the equipment and energy to overthrow the network, they could instead just mine bitcoin and make a lot of money.
Proof of Work vs. Proof of Stake
Herein lays the crux of (one piece of) the debate between Proof of Work and Proof of Stake. Underpinning the security, governance, and thus the “tamper-proof-ness” of bitcoin and its supply is tangible, physical, and energetic limitations. In the case of proof of stake, the core asset of the network (ETH, ADA, SOL) has a value as well as voting power.
Because there is not an explicit requirement to spend energy to contribute to governance, Proof of Stake systems lack what I perceive to be an essential tie with our physical reality.
To be clear, I think it is essential for the creation of money (digital or physical) to be bound to physical reality through energy and procurement of materials so as to minimize the opportunity to centralize the governance of the system as a whole.
It is for this reason that I don’t believe proof of stake systems “solve” the security problem and provide anything close to the same level of assurance that is given with bitcoin.
Although it may seem like I’m cherry picking events on other networks, the points I raise illustrate my argument that other blockchains are subject to higher degrees of centralized activity.
Ethereum EIP1559 changes the monetary policy of ethereum. If the policy can be changed once, it is not unreasonable to suggest that it can be changed again.
Solana was offline for 18 hours in September after the developers of the code contacted the validator network and instituted a network-wide shutdown. If the network can be shutoff by developers, it can be shut off by malicious actors.
To be completely fair to proof of stake, I don’t think there has been a large scale deployment, and testing of a proof of stake blockchain. The closest examples we can point to is Cardano, Polkadot, Cosmos, and Solana.
Perhaps the real test will be when ETH2.0 finally completes its migration to PoS. I’ve heard/read arguments that PoS is inherently centralizing, as rewards are paid out proportionately to stakers.
Because of this, large bag holders and stakers receive a larger absolute cut of the reward pool, increasing their overall stake and thus governance in the system.
Again, I will wait with baited breath to see whether or not proof of stake works in practice. Regardless of if it works or not, I don’t see how proof of stake systems can escape the critique of being a purely digital or virtual implementation of money.
I believe that Cardano (and maybe Cosmos) is the best example of a decentralized, proof of stake blockchain that we have today. Because I believe this, I hold 2% of my portfolio in ADA and 0% in ETH, ATOM, SOL, and DOT which reflects my opinions and investment thesis.
Concluding Thoughts
I will leave you with some points that summarize my argument.
Money in general is necessarily the most useful tool we use, as it is a precursor and enabler of all productivity.
Bitcoin is the optimal money as it best satisfies the 6 properties of money.
Proof of work provides long term incentives to expand the harnessing and providing of energetic resources. Proof of stake does not have these physical and energetic incentive structures, and thus I don’t believe it has the same long-term viability.
Proof of work is tied to physical reality through its direct use of energy and its conversion into money. This provides physical and energetic constraints on whether or not the money supply can be tampered with.
Proof of stake systems have yet to be tested at scale and on a long enough time scale to determine its resiliency towards resisting theorized centralization.
I have arrived at these understandings about bitcoin and proof of work systems through the help of Robert Breedlove, Michael Saylor, and Nic Carter. I recommend checking out these individuals and putting in the effort to understand the arguments made by them. The arguments they and others make are sound, and backed up historically, and empirically.
As always, I welcome open discussion, thoughts, opinions, and constructive criticism on anything I write. With 90% of my money in bitcoin, it is important for me to know where there are holes in my rationale.
I would gladly change my investment strategy should I be faced with a compelling set of arguments that invalidate my current body of research. This was the case when I sold my bitcoin for baskets of altcoins in 2017, and it would be the case if I discovered reasons to believe bitcoin to be without utility or value now and in the future.
Regards,
Keegan