Proof of Work(PoW) consensus algorithms are at the heart of the most popular cryptocurrencies in the market such as Bitcoin and Ethereum. From the economics perspective, PoW can be seen as one of the fundamental elements that drives the price of cryptoassets. Remember Jamie Dimon’s unfortunate comments claiming that Bitcoin was a fraud because it didn’t have any underlying mechanisms driving the price. Well, PoW can be seen as that underlying mechanism. Plain and simple, it cost money to make a Bitcoin. If you think about Bitcoin as a commodity, PoW can be seen as a metric of the production cost. Some of the classic theory in commodity pricing even states that the price of an asset should trade in relative proximity of its production cost which is an indicator of how relevant PoW can be on the economics of a cryptoassets.

Like any other asset production mechanisms, PoW introduces a series of economic dynamics/rules in the crypto-asset markets. One of the most fascinating, and not-so-well-known, in PoW models is what is known as the Verifier’s Dilemma which has come to play an important role in the economic and security behavior miners in PoW-based networks such as Bitcoin or Ethereum.

The Verifier’s Dilemma

The concept of the Verifier’s Dilemma was first introduced in a paper titled: Demystifying Incentives in the Consensus Computer published by researchers at the University of Singapore. The paper outlines this simple conflict between the economic incentives or miners and the requirements of PoW models that can result in security vulnerabilities in a crypto network.

To understand the Verifier’s Dilemma, let’s take a look at the miners role in a PoW network such as Bitcoin or Ethereum. As new blocks enter a PoW network, miners need to run a computation process to answer PoW puzzles that validate the transactions and maintain the integrity of the network. Miners are rewarded for their work with new crypto-assets. Typically, the first miner who successfully broadcasts a solution to the current PoW puzzle proves that she has spent the necessary computation power to merit appending her new set of transactions to the blockchain, and this step awards the miner a set of newly minted coins. This process works beautifully for simple process but creates certain friction for computational intensive puzzles.

Despite its mathematical sophistication, PoW models fail to account for the rational human factor in the consensus process. PoW protocols dictates that miners should participate in the consensus process free in order to preserve the integrity of the network which, it turns, benefits all participants. However, in non-trivial computational puzzles, miners can spend a lot of resources without receiving any rewards. Consequently, many miners decide are incentivized to deviate from the protocol and reserve their limited computation resources to the next, more appropriate, block. The problem is that, by skipping the verification processes, miners open the door to serious security vulnerabilities in a PoW network.

A classic attach caused by the Verifier’s Dilemma is one in which a bad actor publishes a series of computational intensive transactions into a PoW network in order to exhaust the computational resources of the miners. As rational miners compete to solve the resource-intensive puzzle, the bad actor can gain an advantage to start mining the next blocks in the network. Other side effects of the Verifiers Dilemma include miners accepting invalid transactions without running the proper verification process which compromises the integrity of the network.

The Verifier’s Dilemma is fundamentally a friction between the computational complexity of puzzles in a PoW consensus network, the economic incentives for solving those puzzles and the rational behavior of the miners.

The cryptocurrency industry has produced various solutions to address the Verifier’s Dilemma. Among my favorites, TrueBit provides a gamified approach that shuffles the incentives among the network actors in order to solve a puzzle. Other solutions in the Ethereum network have focused on moving the mining computations off-chain.