Just like central banks print money, many cryptocurrencies are gradually released through a process known as mining. Computing power is instrumental in generating new coins — and the levels of processing power required tend to increase in time.
Of course, the biggest blockchain to embrace cryptocurrency mining is Bitcoin... otherwise known as BTC for short. In the very early days, all Bitcoin miners needed to get their hands on new coins was a laptop. But now, increasing hash rates has meant it's a lot harder to achieve profitability unless you have sophisticated mining hardware.
What Is Proof-of-Work (PoW)?
Cryptocurrencies and blockchains depend on an array of consensus mechanisms — the most common of which is proof-of-work.
PoW isn't just crucial for cryptocurrency mining, it's also instrumental in verifying Bitcoin transactions. The proof-of-work algorithm ensures that new blocks containing transactions can be added to the blockchain. Generally speaking, this process happens every 10 minutes — and new Bitcoin is created in the process.
One thing that varies between blockchains that use proof-of-work is the mining reward that's on offer. In the early days, 50 BTC was rewarded to the miner or mining pool that successfully solved a complex PoW puzzle and added a block to the Bitcoin network. But in recent years, these rewards have been halved — first to 25 BTC, then to 12.5 BTC and now to 6.25 BTC.
Halvings take place every 210,000 blocks (about every four years) and make Bitcoin mining harder because there are much fewer coins to find. It's expected that the next halving event will take place in 2024, reducing the amount of Bitcoin in a block reward to just 3.125 BTC.
There are a plethora of PoW coins out there — and major altcoins including Litecoin, Monero, Bitcoin Cash and Bitcoin SV also use this consensus mechanism. Some of these digital currencies are application-specific integrated circuit (ASIC) resistant, meaning they can only be mined using the graphics cards in a GPU.
Unfortunately, there can be a lot of downsides when you mine Bitcoin — many of which concern the environment. The electricity costs associated with mining operations are through the roof, with a recent estimate by TradingPlatforms.com estimating that BTC alone uses $25 million worth of power each and every day. Some countries with cheap sources of electricity, such as Iran, have recently linked expansive mining rigs in the country to devastating power outages.
When Satoshi Nakamoto first laid out his vision for BTC, he imagined a public ledger that would be accessible to all. Unfortunately, the advanced mining software and strategies that are needed to generate new Bitcoin has now led to criticism that only those with mining rigs and CPUs that cost thousands of dollars can participate in the mining process. Although cloud mining is an option — which effectively involves pooling processing power together and splitting the mining reward — there have been concerns that some of these offerings are scams.
One alternative to the algorithms used by Bitcoin is proof-of-stake (or PoS for short.)
What Is Proof-of-Stake (PoS)?
A chain doesn't necessarily have to rely on energy-intensive algorithms to remain secure. Proof-of-stake eliminates the need for miners and expensive CPUs altogether by enlisting validators who have a financial interest in ensuring that the blockchain operates as it should.
But things are going to get a little more interesting in the coming years. One of the world's biggest digital currencies, Ethereum, is gearing up to move away from proof-of-work in the next couple of years — shifting the emphasis to staking tokens in the process.
Whereas PoW decides who will verify a new block of transactions based on which miner completes a complex mathematical puzzle first — almost like the "fastest finger first" round in Who Wants To Be A Millionaire? — the honors on PoS blockchains are based on how much cryptocurrency a validator has staked.
PoW vs PoS
There are pros and cons associated with both of these digital currencies.
Just like it can be expensive to set up a mining rig, getting involved with proof-of-stake cryptocurrencies can have a lot of requirements. Validators on the ETH blockchain are required to stake 32 ETH in order to get involved — and many crypto enthusiasts don't have tens of thousands of dollars lying around to spare. There can also be a risk of financial penalties if a validator falls offline... and in more egregious circumstances, their stake can be slashed too.
There's also another reason why cryptocurrency exchanges are dominated by proof-of-work coins: this consensus mechanism is proven to work. All eyes will be on Ethereum 2.0 to see whether the transition to PoS goes without a hitch. Given how this blockchain is responsible for transferring hundreds of billions of dollars in funds, the slightest of technical hitches could have huge ramifications for a plethora of DeFi protocols.