Outdated and irrelevant - this is the narrative surrounding Bitcoin's Original proof-of-work (PoW) consensus mechanism in recent months. As an influx of exciting innovations enter the crypto industry, and Ethereum looks to shift away from PoW, the sentiment is shifting against the resource-intensive PoW mechanism.

But we shouldn't be so quick to dismiss Satoshi's original creation - there was good reason that he (or they) decided to go down the PoW path. And when you dive into the depths of the data, the fundamental facts of why Proof of Work is still relevant begin to reveal themselves.

First, let’s go over exactly what a consensus mechanism means in the world of crypto. A consensus mechanism refers to the system used by the participants of a cryptocurrency's network to validate transactions, provide security, and agree on the state of the network. In general, as an incentive for doing this, people receive a reward in the form of newly created crypto.

Bitcoin, created by the infamous Satoshi Nakamoto, was the world's first cryptocurrency. It utilizes a proof-of-work consensus mechanism. It requires specialized computing equipment to connect to the network from all over the world and contribute computational power, a process referred to as mining. Multiple other major cryptocurrencies have adopted this consensus mechanism for their own networks since.

In 2012, an alternative consensus mechanism – Proof of Stake – was first implemented. It requires network participants to own a certain amount of the cryptocurrency and “stake” it for a certain amount of time in order to secure the network. This alternative was suggested due to it being far more energy efficient than PoW and not requiring any bulky computing equipment. 

Both consensus mechanisms have proven to work efficiently on a small scale. But as Bitcoin and Ethereum (the world's second-largest cryptocurrency) both run a proof-of-work system, it is only Proof of Work that has been tested and proven reliable on a large scale.

However, for our purposes, saying PoW will still be needed in the future simply because it has a better track record isn't enough. It would be like people saying cassette tapes will always be needed because they have a better track record than CDs.

There will come a time when PoS and other alternative consensus mechanisms are tested to the same scale as PoW. For example, Ethereum's switch to a PoS based model is just around the corner. If it's successful and shows Proof of Stake can work securely on a large scale, does that mean PoW will become irrelevant?

Well, let’s find out! We can start by going back (briefly) to the original Bitcoin Whitepaper.

It is often stated that Proof of Stake was invented as an alternative to Proof of Work. Although this is more or less true, it implies that Satoshi was unaware of the concept of PoS when creating Bitcoin.

The original Bitcoin whitepaper references eight outside sources, one of which is Wei Dai’s 1998 proposal of “B-money”. Believed to be the first ever proposal of cryptocurrency as we know it, the B-money paper outlines a consensus mechanism where “each server is required to deposit a certain amount of money in a special account to be used as potential fines or rewards for proof of misconduct.” – a mechanism almost identical (although outdated) to those commonly used in today’s proof-of-stake systems.

It wasn’t until Hal Finneys 2004 “Reusable Proofs of Work” proposal that an alternative to Dai’s proof-of-stake mechanism was devised.

So, we can be confident that Satoshi was familiar with both PoW and PoS consensus mechanisms before creating Bitcoin. But why did he choose PoW?

It is impossible to ask the mysterious Satoshi directly, but a popular principle exists that can help us understand his choice. 

Generally referred to as the "fundamental value" principle, it sheds light on the continued importance of Proof of Work moving forward. Let's go over it in more detail.

To mine a Proof of Work cryptocurrency, there is an inherent cost of production. First of all, it requires expensive specialized mining and cooling equipment. Which, beyond their initial cost, also requires constant maintenance and monitoring (paid man-hours) to make sure they are always connected to the network. Secondly, are the electricity costs – running the mining equipment consumes a large amount of electricity.

Due to these factors, the market price of a PoW cryptocurrency will consistently fluctuate around its cost of production. Using Bitcoin as an example, averaged out over its entire life cycle, the cost of production and the market price end up at an almost exact 1:1 ratio.

Image source: https://medium.com/coinmonks/bitcoins-cost-of-production-a-valuation-approach-for-bitcoin-dcd76951040a

Seems logical, but when we try to figure out the exact reason as to why this occurs, we are presented with two potential options:

Option 1 – The market dictates mining (the price of Bitcoin attracts people to build more mining rigs due to the profitability, therefore maintaining the 1:1 ratio).

Option 2 – Mining dictates the market (the mining infrastructure controls the price, and any change in market price outside that is purely speculative).

A mathematical test called the "Granger Causality Wald Test" can be used to work out which option holds true. Thankfully, a research paper by Adam Hayes implemented this test on Bitcoin already, so we don't have to do it ourselves.

What is discovered when applying the Granger test is that "Option 2" – mining dictates the market – is the most credible result. Showing that the fundamental value of Proof of Work-based cryptocurrencies comes directly from the cost of production.

On the other hand, if you apply the Granger test to a Proof of Stake-based cryptocurrency, "Option 1" – the market dictates mining (or staking in this case) – holds true. 

This is due to PoS blockchains not having a fundamental cost of production. They utilize the “cost of the stake” – which is ultimately dictated by the market – to act like the cost of production within their systems.

This isn't an issue when the market is thriving, but how did Proof of Stake chains survive and continue to develop during less prosperous times?

It’s because Proof of Work cryptocurrencies had their back.

So, the Granger test shows us that PoW mining will always give fundamental value to PoW-based cryptocurrencies. But why is this important for PoS based cryptocurrencies and the rest of the crypto space?

The answer to this question is more of an economic concept, so not to be too boring, I'll attempt to explain it using the story of "Bill the Baker and the red seashells."

Bill the Baker lives on a small island in the middle of the Pacific.

One day, Bill comes up with a new invention – a bread-making machine that automatically bakes a loaf of bread whenever someone puts a red seashell into it.

After building his machine, he leaves it unattended and allows the villagers to use it as they wish. At the end of each day, Bill goes and collects all the red seashells.

What Bill may or may not realize is that by creating such a machine, he has guaranteed that one red seashell will always be worth one loaf of bread.

So Bill and the rest of the villagers decide to create a "red seashell ecosystem" and start exchanging red seashells for other goods and services within the village.

Everything is working well for some time, and the red seashell economy is thriving. But one day, suddenly, the red seashell ecosystem collapses. Nobody wants to accept red seashells as payment anymore.

Although it is a shock, the villagers left with a bag full of seashells don't panic. They know they always have the safety net of using Bill's machine to exchange one red seashell for a loaf of bread. And if they wish, they can even hold onto their red seashells and try to build up the economy again in the future.

This is how proof-of-work mining provides a safety net to the crypto ecosystem. Every mining machine needed for PoW acts like one of Bill's bread-making machines. 

So, even when people become unenthused about cryptocurrency and we enter the proverbial "crypto winters," Proof of Work will act as a safety net, preventing the market from a catastrophic collapse.

With so much enthusiasm surrounding the crypto space recently, it is easy to forget the times of non-prosperity. The reliability of Proof of Work and the fundamental value it provided allowed innovation to continue during these less exciting times. As the crypto industry moves towards future innovations, PoW will continue to be relied upon – without it, we lose our safety net.