Proof of work
Most cryptocurrencies today employ proof-of-work mechanisms; that evolved from Bitcoin’s original mechanism, solving complex hashing problems and consuming a lot of energy. The current Bitcoin implementation uses SHA-256 . This approach to confirming transactions, after validation (on the nodes) is extremely wasteful for many reasons. Crypto-currency designers and blockchain designers such as Dash have created incentive mechanisms, wherein “node” maintainers who validate transactions also get rewarded, in addition to the miners. Some economists and a few bitcoin champions have argued that this conversion of energy to “bits and bytes” through hashing is what provides the fungible value to Bitcoin as an asset.
The Bitcoin core-dev team led by luke-jr (one of the highest contributors) to the Bitcoin core code, have proposed algorithms to update the current Proof of work system. This system hasn’t as yet gained approval of the core – team, miners, etc. however, at some time in the critical future, this might take shape.
Issues with Hashing
a) Firstly, solving the hashing problem consumes significant energy, and this consumption increases as the difficulty of the solution increase at regular intervals. By some estimates, the largest miners combinedly surpass power consumption in some of the world’s nation states.
b) Despite spending the energy there is a possibility that all transactions included in the newly mined block can be abandoned for many reasons, one of which includes the race to include only the longest block with the most number of transactions for reward. In Bitcoin this leads to orphaned blocks. In Ethereum, this leads to blocks called uncle-blocks that are not entirely abandoned but are connected with the main blockchain.
c) Thirdly, the rewards for mining reduces over a period of time, and halves every few months. The next day for halving rewards for the bitcoin blockchain. The assumption of most miners is that this reduction in rewards will be offset by the positive growth in USD valuation of the cryptocurrency.
d) Lastly, as the difficulty levels increase, and the rewards from mining reduce, equipment used for mining would become obsolete. This creates a marketplace for mining wherein a few specialists with the ability to keep up with the technology changes needed to mine would dominate.
e) To top it all, there are incentive alignment challenges in these markets, wherein the few miners who dominate the mining market would wield enough controlling power (as in network hash rate) to block any new development initiatives by the core development team. These handfuls of miners can pretty much block or allow any change to the protocol layer.
Lastly, this process of earning disproportionate rewards has led to significant investment in the ASIC technology, and the over-demand for GPUs that are used for mining. Almost the entire of GPU inventory sometimes get bought out by miners, leaving very few of them for the gamers.
To solve this problem of extreme wastefulness, and making crypto-currencies more efficient, there is this massive initiative of the ethereum network towards proof of stake. More on this approach later.