How Bitcoin Mining Works

Despite popular belief, mining cryptocurrencies is not an easy job. Using your computer to harvest these coins can be expensive and time-consuming, and only occasionally rewarding. In spite of these misconceptions, mining has an allure to it for many investors who are interested in growing their cryptocurrency portfolios. This could be because some start-ups see its enormous potential; much like the Californian gold rush prospectors did in the 1800s. Plus, if you have the time and resources to spare, why not give it a try?

But before you put any money into cryptocurrency mining, you should read through this guide first to see if it’s for you. We’ll start by focusing on Bitcoin throughout the article, and will be posting more guides in future that touch on the other tokens.

Reasons For Mining Cryptocurrencies

When you mine cryptocurrencies, you are able to grow your portfolio without having to trade your dollars for these virtual coins. With that being said, you don’t actually need to own a mining machine (or group of machines) to acquire crypto coins. Most people exchange their dollars for cryptocurrencies using an exchange platform such as Coinbase or Bitstamp. These companies allow you to trade dollars and even other coins for Bitcoin. You can even earn these online currencies through playing video games online, or creating content on websites that reward its users with crypto. One example a platform that rewards its writers is called Steemit, where posters are given what are called Steem tokens for creating high value content. Steem can then be traded for dollars or Bitcoin later on.

It’s important to note that mining cryptocurrencies does not just benefit the person mining, but rather it fulfills several economic and functional purposes to keep a network alive and liquid. Miners help to release new coins into circulation. In this way, miners are essentially creating supply for the coins out of thin air (or electricity). For example, there are around 17 million Bitcoin in circulation at the time of writing this article. Apart from the genesis block, which was the first Bitcoin block created by its founder, Satoshi Nakamoto, every other coin in the blockchain came to be from the work of miners. Without miners to power the network, Bitcoin would still exist and be usable, yet there would no more coins ever created. It’s interesting to note that Bitcoin has a hard cap on the amount of Bitcoins that can exist, set at 21 million coins.

In addition to keeping cryptocurrencies liquid, miners also play a key role in verifying transactions. This means that when transfer a made from one address to another, a miner is required to authenticate that trade and update the status on the blockchain. This is what makes Bitcoin a decentralized and “trustless” form of currency, as everything is done automatically without a bank or intermediary that sits in between consumers. So, without miners, no trades would be possible.

How Much Can Miners Earn?

Bitcoin is mined in what are called blocks. The reward that miners receive from completing a block depends on its block size, and the miner’s relative contribution. Mining involves solving mathematical equations, with the equations getting harder and more time-consuming to complete as time goes on. As the blocks get bigger and equations increase with difficulty, this has an inverse effect on supply, which helps to preserve the value of Bitcoin by not flooding the market. This mining methodology also helps to control inflation.

To get an idea of what you missed out on in 2009 when Bitcoin mining started, completing just one block would have earned you 50 BTC. In 2012, that figure was halved to 25. In 2016, 12.5 BTC. In the next four years, that reward will be halved again to a mere 6.25 BTC.

There are various websites that update when the next halving of the Bitcoin block will occur, such as the Bitcoin clock. This website gives you the advantage of seeing the block information in real time.

Why is mining so important for the Bitcoin network?

As we have explored above, Bitcoin miners are getting rewarded for their work as both auditors and defacto regulators of the crypto universe. Miners help to verify transactions, which helps to keep its user base transparent and honest. The use of miners was Satoshi Nakamoto’s idea, and was implemented to prevent the problem of double spending.

In this case, double spending occurs when a Bitcoin user tries to use the same money twice. We don’t have the problem of double spending with physical cash or back transfers, as the money is tangible or otherwise regulated by a bank. However, Bitcoin and other virtual tokens are cryptographic in nature, and they do not exist in “reality”, nor are they tied to physical assets such as gold or a national economy. This then presents a risk that a user could make a copy of their tokens and then send the copy to a merchant while retaining their original. This activity is the same as counterfeiting fiat dollars.

An example of how double spending would work with Bitcoin is this: for instance, you have a real $50 bill and a counterfeit note. If you tried to spend both bills at once, an intermediary would then check the validity of the note’s serial numbers and would discover they were the same number. If this were the case, then one of the bills would be fake. This is what a Bitcoin miner does in a nutshell; they check the legitimacy of each transaction to ensure that users cannot send the same coin twice.

Bitcoin Miner Reward

Miners are rewarded in various ways for maintaining the blockchain, with each network having their set levels of remunerations. With Bitcoin, once a miner has authenticated 1 megabyte worth of transactions, they become eligible to win 12.5 BTC. This megabyte limit was set by the founder of Bitcoin, Satoshi Nakamoto, has been a point of contention, as some people believe that the block size should be enlarged to handle more data.

It’s important to note that 1 MB of data makes a single miner eligible to earn some Bitcoins and not everyone who verifies the transaction. Although Bitcoin and other cryptocurrencies are commonly mined in ‘pools’ of distributed computers working together, each miner (and computer) is rewarded on an individual basis, relative to how much they contribute to the mining process.

This 1MB transaction size is possible to earn though a single transaction, but this is uncommon. Otherwise, that 1MB could be split over thousands of trades. It really depends on how much data each transaction uses.

So, even if you put the effort into verifying a countless number of transactions, you may not get a single Bitcoin from verifying the data. This is due to two factors: effort, and luck, otherwise known as proof of work.

The proof of work algorithm rewards the first miner to solve the numeric problem, and is what allows blocks to be mined on the blockchain and transactions to be processed.

What is proof of work?

There is some good news and bad news when it comes to the proof of work system that Bitcoin uses to reward its miners. The good news is that there is no advanced math required. A misconception about the blockchain is that it involves solving large amounts of math problems. This description is used as it’s easy to explain to a common person how it works, but there is arguably a better answer. What miners are really trying to do is to be the first to discover a “hash”, or 64-bit hexadecimal number. Although there is math involved with this process, it is essentially just high-level guess work.

And the bad news? As the process is guess work, you do need a lot of computing power to be the first one to claim the hash. For mining to be profitable, you need a high hash rate. This can be measured in several ways, such as through mega hashes, gig hashes, and even tera hashes per second.

In general, the more established a coin becomes, the higher the requisite hash rate is for miners to actually make money. While on the other hand, newer, more experimental cryptocurrencies can even be mined with your home PC. It all comes down to how much effort you are willing to put in, and how much you’re willing to commit to a particular venture.

What equipment do I need to mine?

Mining can be accomplished through the use of either a CPU or GPU that can be found on a computer. But for the most serious of mining ventures, application-specific integrated circuit (ASIC) miners are used for their enormous hashing potential. ASIC miners can cost from between $500 to tens of thousands of dollars. Due to how prohibitively expensive mining can be, some currencies such as Ethereum support GPU mining, as this can be a cheaper and more efficient use of energy. These graphics cards also allow miners to use their home computers if they’d like to contribute to the Ethereum network. Due to their low costs, even people with a limited budget can start mining cryptocurrencies using a home-made machine.

A Simple analogy to explain cryptocurrency mining

You tell your 3 friends Tom Dick and Harry that you are thinking of a number between 1 and 200, you then write that number down on a bit of paper and hide it in an envelope. Your friends do not need to guess the right number; their role is to be the first to guess a number that is either less or equal to the number you are thinking of. There is no limit to the number of guesses your friends can get, and there is no time limit either.

Let’s say that your number is 19. If Tom guesses 21, Tom loses because 21>19. Yet if Dick picks 16 and Harry chooses 12, then they have both made theoretically viable guesses, as 16<19 and 12<19. It should be noted that Dick does not get extra credit for his answer of 16, even if his guess was closer to your number of 19.

However, if Tom, Dick, and Harry all guess 19 at once, this simple analogy becomes no longer useful.

In the real world, miners who get the first prize happens often, but there can be only one payable answer. When more than one miner guesses correctly, the Bitcoin network will decide by a majority for who gets paid. Usually, it is the miner who has done the most amount of work in terms of verification's that gets the reward.

To expand the analogy of the guessing game between your friends Tom, Dick, and Harry, let’s increase that friendship group to millions of people. Also, instead of a number between 1 to 100, let’s say it is a 64 digit hexadecimal number. With these insanely complex variables, it then becomes obvious that guessing the right number will involve a lot of time, competition, and computational power to earn some Bitcoins.

What exactly is a hexadecimal number?

You might be wondering what exactly a hexadecimal number is, so here’s an example provided for you below:

0000000000000000057fcc708cf0130d91e21c5819203e9f967ac56e4df598ee

The above number is exactly 64 digits long. Easy enough so far. You might notice that string contains numbers, as well as letters.  So, why are letters used?

In order to understand why letters are used in hexadecimal strings, and their uses in mining, let’s explore the definition of the word “hexadecimal”. The decimal system is something that you are already familiar with. Decimals use a base of 10. This means that every digit can only have 10 possibilities: (1,2,3,4,5,6,7,8,9,0).

The hexadecimal system has a base of 16, meaning that each digit has 16 possible values. This is interesting because, our numeric system only contains 10 possible numbers (0 to 9), hence the requirement of letters. Hexadecimal numbers use the letters a through f. The result of a hexadecimal string can be seen in our first example, which means there are far more possible values to be “guessed” by the miners as they need to calculate to a base of 16 using both random numbers and letters.

Fortunately, you do not need to guess the whole 64 digit hash, which would take an inordinate amount of time. Going back to your friends again and the guess my number game, that number you sealed away in the envelope is what would be called the target hash using Bitcoin mining lingo.

As we described earlier, what Bitcoin miners are doing with their farms of computers is guessing that number printed inside your envelope. Miners make money by guessing as many times as possible. This system to guess the right target hash is called a nonce, which a fast way of saying: number only used once. This methodology is key for discovering the 64 bit hexadecimal number. A single nonce is only 32 bits in size, which is far smaller than the hash, which is 256 bits. And the first miner to get the hash is rewarded in Bitcoin.

Methods for guessing the target hash

So now that we have described how miners work, and what their actual purpose is in the blockchain for making money, how would you go about guessing the right hash?

Let’s begin this process by looking at a typical Bitcoin hash. Each begins with the digit 0, and has between 8 and a maximum of 63 0’s per hash.

See below:

00000000abcd0000000000000000000000000000000000000000000000000000

So, with this description in mind, how do you ensure you are the first person to guess the correct hash?

In order for mining to be profitable, it’s required that you use a fast mining computer (such as an ASIC miner). Otherwise, you can join what is called a mining pool. Mining pools consist of groups of miners who share their mining power and split the proceeds of the reward. A real-life analogy of a mining pool is a lottery syndicate that you see at workplaces and social clubs. In these groups, people team up to purchase a large amount of lottery tickets with the agreement to split the earnings if someone gets lucky.

It’s important to note that far more Bitcoin is mined through the concerted efforts of Bitcoin mining pools than through individual miners.

Another way of describing how you can make money with Bitcoin is that it is a simple numbers game. There is no way you can guess, or make a prediction of one hash based on a previously solved one. And keep in mind that as time goes on the blocks become progressively harder to mine, which then has the effect of diminishing returns for both mining pools and individuals. At present, the likelihood of guessing a correct hash with the current block size is less than 1 in 1 trillion.

How can I know if Bitcoin mining will be profitable for me?

Feel free to take this next piece of advice with a grain of salt: for most people, they should avoid the temptation to start mining Bitcoin. Why? Well, unless you have access to a large number of computers, or another way to guess an inordinate number of hashes on the Bitcoin network, then your power consumption alone would cost more than the Bitcoins you’d earn.

Today, most of the Bitcoin mining is conducted in China, where computers and electricity are cheap. Although the Chinese market is changing, with speculation that its government could look to close down these Bitcoin mining farms due to the amount of electricity they consume. It is estimated that the total amount of power Bitcoin uses to mine blocks exceeds that of the entire country of Ireland.

There are also concerns about the effect of Bitcoin mining on the environment. Most mining farms are powered through fossil fuels: usually in the form of coal power that damages the environment. While others have criticized the mining process as not contributing any value to society or the economy whatsoever. Besides mining coins, these farms are literally a waste of energy. Statistically, more than one trillion guesses is needed for a miner to provide any utility to the network or to produce value to the miner. The other trillion-odd guesses only consume power and pollute the environment even more.

So, if Bitcoin mining is out of the question for most people, what are your options then? The easiest way to get a hand in the crypto game is to buy it through the secondary market, or through an exchange such as Coinbase.com. Otherwise, you could take advantage of what is called a pickaxe strategy. In a craze like the 1848 gold rush, or the crypto boom that we see today, sometimes the best thing you can do is to make the tools needed for mining. You can do this through investing in companies that design mining software, create your own blog or website about cryptocurrencies, or speculate on companies that produces ASIC devices. Either way, this means you can benefit from the direction that the market is heading or the billions of dollars it’s taking with it. All without being affected by the notorious peaks and valleys that comes with cryptocurrencies.

Will Bitcoin Mining In China Be Shut Down?

Despite the potential for regulatory backlash, China remains as one of the most popular hotbeds for mining activity. 70% of the world’s hashing power comes from these Chinese mining pools, with the company Bitmain dominating the market.

Although there are fears about what the government is going to do about the Bitcoin mining industry, this threat is unlikely.  This rumor surfaced from a flyer that was distributed by a power station in Sichuan, China. The flyer stated that Bitcoin was “illegal” and thus the business would no longer supply electricity to Bitcoin mining farms.

In short, the flyer was nothing more than a notice put up by a single power company in a China, and erroneously used the word “illegal”. This flyer has been mistaken as an official ban on Bitcoin mining.

With this hysteria in mind, it’s therefore important to restate that China has never claimed that Bitcoin is illegal. In fact, Bitcoin in China is regarded as a type of good. For this reason, the government would have no reason to close down the Bitcoin mining farms producing value for its economy. However, it is true that certain farms are facing pressure of a possible suspension of its services, but this is due to the excessive and sometimes illegal use of electricity, and not for mining cryptocurrencies.

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